Morningstar Potentially Fined for Lack of Internal Control

Life as the fourth-largest Rating Agency has not gone as planned for Morningstar. Last year the firm acquired DBRS – as we discussed here – and were hoping to improve investors’ trust in the rating industry by bringing a new and honest approach to the field. However, as Cezary Podkul of the Wall Street Journal has recently reported, it appears that they are about to be fined for falling foul of one of the oldest conflicts of interests that plagues the rating industry.

The article introduces the news that Morningstar will, in coming days, be fined ‘several million dollars’ for ‘violating riles in its bond-rating business that prohibit analysts who hand out credit ratings from being involved in sales and marketing for their companies’. There are a number of regulations that came in after the Financial Crisis – and, in truth, agencies pledged on a self-regulatory basis to prevent the same thing from happening even before the Crisis – to prevent this behaviour. The calls to erect so-called ‘Chinese Walls’ between analysts and sale-side activities were loud and clear after the crisis, but clearly that particular conflict of interest remains. The SEC and Morningstar have not commented yet, but the WSJ article suggests it will not be long until this settlement will be made public. This comes on the back of more damaging news for Morningstar. Podkul again broke the news that the firm was struggling to integrate the two sets of rating methodologies since the merger and that ‘investors received an almighty surprise towards the end of last year when Morningstar announced that “25% of the bonds that it had rated were likely to be downgraded”. It turned out that, after a deluge of calls from investors, the firm had actually made an error and that it was actually likely to upgrade 25% of the bonds it had rated, with only 3% being downgraded. The article reports that investors have stated that ‘it certainly isn’t confidence inspiring’, and that it probably a polite version.

Life as the fourth-largest agency has certainly not gone to plan for Morningstar since it acquired DBRS. Whilst it is not being suggested that the firm would not be suffering for these aspects if it has not acquired DBRS, it is suggested that the level of scrutiny has been raised on account of its new position in the marketplace. Yes it may not be anywhere near challenging the Big Three, but it is closer. With that comes scrutiny, and Morningstar would do well to avoid proclamations that it will be doing business differently than other agencies, because in all truth it cannot – some of the conflicts of interests within the credit rating arena are inherent. The adoption of the issuer-pays model precipitates the potential for conflicts such as this particular violation to occur, and they cannot be stopped, unless the remuneration model itself is dropped, which will not happen. It is not anticipated that the fine will be substantial – anything in double figures would be surprising – but the agency is now beginning to feel what life is like towards the upper echelons of the credit rating field.


Keywords – credit rating agencies, Morningstar, conflicts of interest, @finregmatters

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