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Comment on SEC Proposed Rules for NationallyRecognized Statistical Rating Organizations
File Number S7-18-118/8/2011
William J. Harrington
 
 
Page 0
 
Table of Contents
A.
 
Introduction to the Members of the Security and Exchange Commission ..................................................... 3
 
1.
 
Would Moody’s Have Formed Durable Opinions Had the Proposed Rules Been Implemented in 2002?
4
 
2.
 
Old Habits Die Hard: Moody’s Public Rationale Belied by its Private Opinions and Actions
.................. 5
 
3.
 
Financial Institutions Mismanaged Risk All By Themselves, Can’t Pin That on NRSROs
...................... 6
 
4.
 
Canvass Analysts Regarding Best Practices for the “Credit Rating Process”, i.e. Opinion Formation
..... 6
 
B.
 
Summary of the Comment and its Rationale .................................................................................................. 7
 
5.
 
The Proposed Rules Will Be Downright Dangerous If Applied to Moody’s
............................................. 7
 
6.
 
If There Be Only One Additional Rule, Let It Be This .............................................................................. 7
 
7.
 
Does the Commission Really Want to Abet Moody’s
 
Management in Debasing Moody’s Opinions?
..... 8
 
8.
 
Moody’s Management Debases Moody’s Opinions Pretty Well on Its Own
............................................. 8
 
C.
 
Moody’s Enshrines Management Conflict of Interest in Opinion Formation
.............................................. 10
 
9.
 
Opinion Factory Gets By Without Quality Control Function ................................................................... 10
 
10.
 
CDO Plant Pumped-Out Public Opinions, Dumped Private Ones on the Factory Floor ..................... 11
 
11.
 
As Before, Analyst Self-Respect Only Mitigation for Conflict of Interest .......................................... 11
 
12.
 
Moody’s Stock Options Exacerbate Conflict of Interest, Particularly for Senior Management
.......... 12
 
D.
 
The “Credit Rating Process,” Committees and the Distinction Between a Private and a Public Opinion
... 13
 
13.
 
Published Methodologies Do Not Ordain a Moody’s Opinion
............................................................ 13
 
14.
 
Moody’s Committees Differs Markedly in Purpose from Corporate Meetings Elsewhere
.................. 14
 
15.
 
Management Routinely Co-opts Committees to Form Desired Public Opinion .................................. 14
 
16.
 
Athilon CDPC Closing Committee
 – 
Management Extracts Opinion Demanded by Issuer ................ 15
 
E.
 
Additional Rules: Hold Analysts’ Feet to the Fire in Each Committee. Burn Away Management Residue
15
 
17.
 
Bears Repeating
 – 
If There Be Only One Additional Rule, Let it Be This .......................................... 15
 
18.
 
Annual Interview of Each Employee Who Has Been Disciplined by Compliance Department .......... 16
 
19.
 
Managers Should Not Vote in Forming a Moody’s Opinion
............................................................... 16
 
20.
 
Train Management in Committee Comportment .................................................................................. 17
 
21.
 
Cite Total Number of Voting Members in Opinion Press Release ....................................................... 18
 
22.
 
Committee Assessment Function --
Analysts Police All Aspects of the “Credit Rating Process”
....... 18
 
23.
 
Acid Test: Durable Opinions Had Committee Assessment Function Been Implemented in 2002? .... 20
 
F.
 
Analysts Keep Correlated Collateral Out of Merrill Lynch CDO Hall of Mirrors (PARCS/PYXIS) .......... 21
 
24.
 
CDOs Had Advanced $8 BN to Merrill Lynch Under Credit Default Swaps with PARCS/PYXIS.... 21
 
25.
 
Analysts Form PARCS/PYXIS Opinions Using Common Sense, Not Published Methodology ......... 22
 
26.
 
Non-Toxic PARCS/PYXIS? Mooted Impact Had Committee Assessment Function Been in Place ... 23
 
G.
 
This Proposed Rule is a Keeper! Moo
dy’s to Maintain Public Comment Site for Each Methodology
....... 24
 
27.
 
Rating-Triggered Market Losses Incurred by a Bank Counterparty to a Securitization Transaction .. 24
 
Contractual Provisions Relating to “Replacement” Rent a Hole in the Fabric of the Universe
................... 25
 
Not Much Incentive to Patch Things Up ...................................................................................................... 26
 
Still, Moody’s Management Tries to Do the Right Thing
- Only Kidding! ................................................. 26
 
Replacement Provisions Mean Market Losses of 0.40% of Un-Netted Swap Notional? ............................. 27
 
In Detail
 – 
the Hedge Framework ................................................................................................................. 28
 
The Way of All Framework Swaps -
“Springing Liabilities” Give Way to “Receding Mark 
-to-
Markets”
. 29
 
Don’t’ Even Mention Moody’s “Hedge Counterparty Rating”
.................................................................... 29
 
Moody’s Press Release On “Flip Clauses” and the “Hedge Framework” with Contributor Notations
....... 30
 
H.
 
I
n Short: Remaining Proposed Rules Will Be Downright Dangerous if Applied to Moody’s
..................... 35
 
Hmmmmnnn
 – 
Ever Wonder What, Exactly,
 Becomes
an Analyst Most? .................................................. 35
 
Proposed Rules + Moody’s Practices = Flay the Analysts, Press Them Into Indentured Servitude
............ 35
 
A Pox on All at The House of Moody’s? Only the Flayed Analysts? Management to be Inoculated?
....... 36
 
I.
 
In Detail: Comment on Those Proposed Rules That are Downright Dangerous .......................................... 36
 
 
Comment on SEC Proposed Rules for Nationally Recognized Statistical RatingOrganizations
File Number S7-18-11William J. Harrington128.
 
Section II. A. Internal Control Structure 1. Self-Executing Requirement ............................................ 36
 
Section 15E(c)(3)(A) of the Exchange Act
 – 
General Observation ............................................................. 36
 
Section II.A.1. Request for Comment ....................................................................................................... 37
 
Moody’s Compl
iance Department Swings Both Ways for DPCs ................................................................ 40
 
29.
 
Section II. A. Internal Control Structure 2.
Proposed Amendment to Rule 17g-2
................................ 41
 
Section II.A.2. Request for Comment. Intentionally blank. ..................................................................... 41
 
30.
 
Section II. A. Internal Control Structure 3.
Proposed Amendments to Rule 17g-3(B)
......................... 41
 
Let’s Think About This – 
Are We
 Interested 
in Moody’
s Self-Assessment? .............................................. 41
 
Section II.A.3. Request for Comment ....................................................................................................... 41
 
Section II. C. “Look 
-
Back Review” 1.
Proposed Paragraph (c) of New Rule 17g-8
...................................... 43
 
“Look 
-
Back” and “Review” Those Happy, Un
-
Conflicted Days at Moody’s Investors Services
............... 43
 
General Observation of Proposed Paragraph (c)(2) of New Rule 17g-8 ...................................................... 43
 
Sections 11.C.1 and 11.C.2. Requests for Comment .................................................................................... 44
 
31.
 
Section II. F. Credit Rating Methodologies 1.
Proposed Paragraph (a) of New Rule 17g-8
............... 46
 
Section II.F.1. Request for Comment ....................................................................................................... 47
 
Acid Test: Impact of Proposed Paragraph (a) of New Rule 17g-8 if Implemented in 2002 ........................ 48
 
32.
 
Section II. G. Form and Certification to Accompany Credit ratings ................................................ 49
 
33.
 
Section II. I. Standards of Training, Experience, and Competence 1. Proposed New Rule 17g-9 ....... 49
 
Analyst Competency Demonstrated in Committees, Not in Compliance Testing Labs ............................... 49
 
Section II.I.1.a. Request for Comment ......................................................................................................... 50
 
Moody’s Trainin
g Rejuvenates! ................................................................................................................... 50
 
Section II.I.1.b. Request for Comment ..................................................................................................... 51
 
Section II.I.1.c. Request for Comment ..................................................................................................... 51
 
CDO Wizard Confers Magical Powers Upon All in the Derivatives Group ................................................ 52
 
Ungrateful Mini-Merlin Wants a Different Kind of Powers. Hold the Mini-Muffins! ................................ 52
 
34.
 
Section VI. Consideration of Impact on the Economy ......................................................................... 53
 
J.
 
Moody’s Policies
- Insinuate Itself into Good Graces of External Taskmasters, Clamp Down on Analysts53
 
35.
 
Pre-2008: External Paymeisters Come First, Last and Always. Analysts to be Seen, Not Heard ........ 53
 
DPC Was “Black Hole” in the P&L of Managing Director 
......................................................................... 55
 
Court the Bankers. Embrace the Bankers. Love the Bankers. Never, Ever,
 Harm
a Banker ....................... 55
 
Making It All Up: Moody’s Methodology for 
 
Structured Investment Vehicles (“SIVs”)
........................... 56
 
Management Launches Personal Attacks on Mark Zandi ............................................................................ 56
 
Two Paymeisters Balk at Application of CLO Methodology to Fortress Credit Investments. That’s OK!
. 57
 
Would That a Moody’s Methodology Had Remained Safely Opaque
......................................................... 58
 
“Staying Involved” with Credit Derivative Product Companies (“CDPCs”)
............................................... 59
 
Isn’t She Lovely? – 
Getting to Know Ms. Pamela Stumpp .......................................................................... 59
 
36.
 
Post-2008: Cozy Up to Regulators. Clear the Way for AIG. Blame, Blame, Blame the Analysts. ..... 61
 
Moody’s In The Community – 
RMBS Managers Learn About Compliance and Get Paid for It, Too! ...... 61
 
RMBS/Compliance Out-Does Regulators by Building Potemkin Village ................................................... 61
 
Derivatives Analysts Whisked Away to Potemkin Holding Pen .................................................................. 62
 
Don’t Ask, Don’t Tell: Derivatives Analysts Pulled
Up Short for Inquiring Into Ratings Debacle ............ 64
 
Management and RMBS/Compliance Open Express Lane Expressly for AIG ........................................... 65
 
If You Say So
 – 
 
Senior Moody’s Manager Says Buddies Are
Not 
“Corrupt or Venal”
.............................. 67
 
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