Over the past twelve years, the markets within the United States have been plagued with research analysts, auditors and now credit rating agencies who were influenced to communicate information that was less than truthful.
Regulatory changes were implemented due to each of these situations, and while they addressed some of the more pernicious practices, they have not fundamentally changed the misalignments that still persist between investors, corporations, and stakeholders.
- 1. The research analysts were financially aligned with the company they were researching rather than with the stakeholders who were relying on the research reports.
- 2. The auditors were financially aligned with the company they were auditing rather than with the stakeholders who rely on the validity of the financial statements.
- 3. The credit rating agencies were financially aligned with the investment bank underwriting the securities rather than with the stakeholders who rely on the validity of the ratings.
At the core of the problem is a lack of fiduciary responsibility; those who manufacture, analyze or rate corporate information do so for the client and not the stakeholder relying on the information. It seems that in order to reestablish trust in the marketplace and to once again reinforce the free-market system, the government must address this real concern.
First, any financial misalignments between those relying on and those creating or supplying financial or corporate information must be eliminated, requiring the mandated divestiture of investment banks’ research departments.
Secondly, it must be ensured that auditors and credit rating agencies are not paid by corporations or investment banks.
Lastly, we must re-establish competition in the market. Today, there are only four major auditing firms, ten credit rating agencies (with the largest three servicing the majority of the marketplace) and only a handful of reputable firms creating independent research. Consideration must be paid to the idea of breaking up the four major auditing practices into a dozen or so companies that will foster competition. Transparent SEC guidelines that enable competent analysts can gain Nationally Recognized Statistical Rating Organization status will also increase competition. By creating more competition in the marketplace, these service providers will continue to seek out new and innovative processes to help create better quality audits, research, and ratings.
Below are some recent articles that may be of interest. We will continue to follow the changes in the market for credit ratings, audits and research. Next week I will be posting a larger analysis of the misalignments between these actors.
http://online.wsj.com/article/NA_WSJ_PUB:SB10001424052748704268004575417811362825370.htm
http://www.nytimes.com/2010/06/01/business/01sorkin.html
http://technorati.com/business/article/credit-ratings-hit-euro-and-greek/
http://www.dailyfinance.com/story/credit/credit-ratings-have-outlived-their-usefulness/19510068/
http://reason.com/blog/2010/08/11/credit-rating-agencies-cant-li
http://www.project-syndicate.org/commentary/bebchuk12/English
