Speaking at the Council of Institutional Investors Autumn conference in Los Angeles last week, Jules Kroll, chairman and co-founder of K2 Global Partners, told attendees that investors could improve the integrity of ratings by taking ownership of the process.
Investors should not rely solely on regulators to reform rating agencies, three of which generate 95 percent of all credit ratings issued, Kroll said. He also said conflicts of interest inherent in the business model of the leading agencies allow companies to shop the raters for the most advantageous credit ratings. To dramatically improve the integrity of the current system, Kroll said “the people with the greatest interest should form a consortium and establish investor-owned enterprises.” He said these new entities, which would be recognized by the SEC, would be created by investors for investors and would base their employees’ compensation on the quality of the ratings issued in the previous five years. Kroll also urged investors to scrutinize and challenge current ratings. “You need to become part of the process,” he advised. Kroll added that credit rating agencies may be forced to reform thanks to a recent New York court ruling that will allow investors to challenge the First Amendment protections that have shielded credit raters from being sued for receiving big payouts for grossly inaccurate ratings.