September 11, 2002
Mr. Jonathan G. Katz
Re: File No. S7-22-02, Release Nos. 33-8106, 34-46084 (June 17, 2002); Proposed Rule; Additional Form 8-K Disclosure Requirements and Acceleration of Filing Date
Dear Mr. Katz:
We strongly favor transparency, as it will benefit the capital markets. However the reforms suggested by Moody's in their August 26th letter fall far short of what is needed. Moody's recommends limiting disclosure requirements to actions taken by it and Standard and Poor's, a fairly obvious attempt by Moody's to perpetuate the current partner monopoly situation that exists in the rating of corporate debt. Moody's and S&P rate approximately 90% of the US corporate debt, and since two ratings are normally needed, there is almost no competition.
Like most monopolies, the result is poor service and high prices. Regarding service, Moody's and S&P provided little warning for a number of the major corporate failures during the past 18 months. In Enron's case, both Moody's and S&P rated the Company investment grade four days before it filed for bankruptcy. In the case of the California utilities they were rated investment grade 12 days before defaulting. For WorldCom, the largest bankruptcy in US history, Moody's chairman, Clifford Alexander, sat on MCI's board since 1988 and WorldCom's board from Sept. 1998 until June 2001, and was a member of the powerful nominating committee. Nonetheless, Moody's still had trouble warning investors of problems; it maintained an investment grade rating until May 2002 (WorldCom filed for bankruptcy in June 2002). These failures occurred even though Moody's and S&P have been granted the privilege of insider information via an exclusion from Regulation FD. Unlike accounting firms, ratings firms cannot be held liable for faulty ratings because they are deemed investment opinions.
Moody's bills itself as being an investor-driven organization although (i) it receives 85% of its revenues from issuing firms and (ii) it states in its August 28th letter on page 5 that an issuer "dissatisfied with the rating outcome ... may elect to go to the public or private market without our rating." If Moody's is serving investors' interests as it professes, it should be providing warnings to investors regardless of whether the issuer is satisfied with the rating.
Regarding Moody's monopolistic prices, with operating income margins (Sales-COGS-SG&A) of 50% Moody's has some of the highest margins in financial services field; in comparison, Goldman Sachs Group's operating margin was only 23%.
Warren Buffett described his investment in Moody's as a "no brainer" because of the lack of competition. This has to end. The SEC promised to evaluate rating firms after the California utility fiasco and now is required to review the industry as part of the Sarbanes-Oxley Act.
We recommend the following in connection with the issuance of 8K's:
Although these changes are unlikely to make a significant difference in the structure of the industry and the inability of current NRSRO firms to warn investors of problems, it will provide investors with additional information to facilitate their investment decisions.
Sean J. Egan