Risk & Compliance

Connecticut Goes after Ratings Agencies

The state's Attorney General has launched an antitrust investigation of S&P, Moody's, and Fitch.
Alan RappeportOctober 26, 2007

The Attorney General of the State of Connecticut , Richard Blumenthal, has issued subpoenas to credit-rating agencies Standard & Poor’s, Moody’s, and Fitch as part of an antitrust investigation into the industry, he confirmed Friday in a statement.

“The debt rating industry is a highly concentrated market controlled by a handful of companies,” said Blumenthal.

The legal move became public knowledge in a filing by the McGraw-Hill Cos., owner of S&P, which noted that it was responding to a subpoena alleging that the agency violated the Connecticut Antitrust Act.

The subpoenas come as rating agencies have faced intense scrutiny for their role in the recent subprime-mortgage crisis; for having a monopoly in the market for ratings; and for issuing ratings that could potentially benefit their businesses, under the protection of free speech. As fallout from defaulting subprime mortgages has spread, some have accused the rating agencies of inflating the grades they apply to debt. The Securities and Exchange Commission is investigating whether ratings firms face pressure from Wall Street to give mortgage bonds high ratings.

“Without a good credit rating, many loans cannot be made,” said Blumenthal. “My investigation seeks to determine whether credit-rating agencies may be exploiting their dominant positions to unfairly raise prices or exclude competitors.”

According to the release, the Connecticut Attorney General will investigate “unsolicited” ratings — when an agency rates an issuer’s debt against its wishes and then demands a payment. He will also look into “notching,” when agencies allegedly threaten to downgrade an issuer unless they receive a contract to rate the issuer’s entire debt pool. Finally, he will probe exclusive contracts that offer issuers discounts, thus hindering competition.

Lack of competition has been a key criticism of rating agencies: Standard & Poor’s, Moody’s, and Fitch represent about 80 percent of the market. Last May the SEC voted to adopt rules to implement the Credit Rating Agency Reform Act of 2006, giving it greater oversight of the agencies and welcoming fresh competitors into the market.

A spokesman for McGraw-Hill did not return calls for comment on Friday. Anthony Mirenda of Moody’s would not discuss any specific inquiries, but said the agency is “assisting” with several government requests. Fitch spokesman James Jockle told CFO.com: “We have been contacted by the state Attorney General as well as other regulatory authorities and we are cooperating with all of the investigations.” Chris Hoffman, a policy and communications adviser in the Connecticut Attorney General’s office, would not release a copy of the subpoena, which was filed on October 10.

Meanwhile, some call the investigation unfair. “I think it’s a witch hunt,” says Ed Atorina, an analyst at Benchmark Co. “They can’t blame anybody, so they are blaming the rating agencies.” Atorina said he expects other states might follow with their own investigations.

The ratings agencies have fielded criticism not just from investors, but from academia and a variety of regulators. In a 2006 paper, James Partnoy, a law professor at the University of San Diego, wrote: “Credit ratings continue to present an unusual paradox: Rating changes are important, yet they possess little informational value.” But the agencies present themselves purely as information providers and have become hugely profitable by doing so.

In its October “Financial Stability Report,” the Bank of England noted that rating agencies can be useful, but they have room to improve. It suggested that the agencies clarify the definitions of their ratings and become more transparent with their methodologies. Further, a single measurement system used by all of the agencies would avoid the confusion and misinterpretation responsible for recent turmoil in the financial markets. Finally, the FSR suggested that rating agencies broaden their analysis from just credit risk and give better estimates of the probability for defaults.

“Without this evolution, there might be a case for public-sector intervention to specify higher common standards for assessment and disclosure,” the FSR said.

With the action by Connecticut’s Attorney General, such intervention is picking up pace in the United States. Already under so much pressure, rating agencies may soon be due for an upgrade of their own.

4 Powerful Communication Strategies for Your Next Board Meeting