March 30, 2009

Clinging to the “Bottom Rung”

A few weeks back, Moody’s Investor Service published its list called the “Bottom Rung,” which represents the roughly 20% of the companies that it tracks that are in most danger of defaulting on their debt. As noted in this Wall Street Journal article, Moody’s is estimating that approximately 45% of the Bottom Rung companies will default in the next year, and the number of companies falling into this category is rapidly increasing. Moody’s has been separately calling out these bottom tier credits for the last several months, and plans to update the Bottom Rung list on a monthly basis.

What are issuers doing that find themselves on the Bottom Rung list? Based on the WSJ article, Eastman Kodak came out swinging, noting in an e-mail statement that “Any speculation, however informed, suggesting that Kodak is less than financially sound, is irresponsible.” Similarly, Univision issued a statement stating that it “has more than ample liquidity to operate the business in the current environment.” But other companies contacted declined to comment, or didn’t respond, which after all is probably for the best.

I don’t think that a Bottom Rung designation necessarily changes anything that these companies are or should be disclosing in their SEC filings. Item 10(c) of Regulation S-K does not mandate disclosure of security ratings, but rather calls for additional disclosure concerning ratings and changes in ratings when a company voluntarily elects to include any security rating disclosure. (See our summary of the topic in the “Credit Ratings” Practice Area.) Many companies these days will include in their MD&A the actual ratings from the big rating agencies, along with disclosure of the rating agencies’ views that are expressed in addition to the ratings themselves. I would say that this practice is not ubiquitous, however, in that some companies may still resist including the rating information with a view that it is otherwise available to investors and can be difficult going forward to keep up to date.

In the SEC’s credit rating proposals from last summer, which sought to eliminate credit rating references from the SEC’s rules, the Commission proposed to keep this voluntary disclosure scheme, but solicited comment on whether that approach should be reconsidered in favor of specified mandatory disclosure. The SEC has not moved forward on those proposals, and it is unclear whether they will be revisited.

What’s Left to Do on Credit Ratings?

Credit ratings still remain at the forefront of the SEC’s agenda, as Chairman Schapiro noted in her testimony last week before the Senate Committee on Banking, Housing and Urban Affairs. Proposals are currently outstanding (in addition to the proposals referenced above) to require NRSROs (and possibly subscriber-based ratings services) to disclose ratings actions histories for all credit ratings issued on or after June 26, 2007 at the request of the obligor being rated or the issuer, underwriter or sponsor of the security being rated, no later than 12 months after ratings action is taken, and in an XBRL format.

The SEC also re-proposed rule changes that would make it a prohibited conflict of interest for an NRSRO to rate a structured finance product whose rating is being paid for by the product’s issuer, sponsor or underwriter, unless information about the product provided to the NRSRO to determine and monitor the rating is made available to the NRSROs not retained to issue a credit rating. In addition, the re-proposed rule changes would amend Regulation FD to permit disclosure of material non-public information to NRSROs, whether or not the NRSROs make their ratings publicly available.

Further, a roundtable is schedule for April 15 to examine the SEC’s oversight of credit rating agencies. As Chairman Schapiro mentioned in her testimony, further reforms may be considered based on what is discussed at the roundtable.

SEC IG Focuses on Senior Executive Officer Bonuses

Last Friday, the Office of Inspector General released a report on its 2008 Audit of Sensitive Payments. “Sensitive payments” are described as things such as “executive compensation, travel, official entertainment funds, unvouchered expenditures, consulting services, speaking honoraria and gifts, an executive perquisites.” On the executive compensation front, the SEC’s Inspector General did not find any fraud or payments that went over the established limits or budgeted amounts, but did question the lack of justification for seemingly large merit pay increases and bonuses for some SEC executives who worked directly for the Chairman.

As noted on page 10 of the report, the seven SEC senior officers studied who worked directly for former Chairman Cox received merit pay increases ranging from $24,657 to $65,082 for the performance year ending September 30, 2007 and bonuses of $20,000 each. The SEC’s Executive Director noted in his response to the report that these merit increases were unique and unlikely to recur, arising essentially as “catch-up” payments when then-Chairman Cox lifted a cap on the salaries of his direct reports, which had kept them all in line with his own salary of $152,000.

Suffice it to say that as a non-executive SEC Staffer, you are unlikely to see those sorts of increases or bonuses over the course of your career, much less in one year. It is perhaps most notable that the IG had the same question that many Corp Fin Staffers have when reviewing CD&As: “Where’s the analysis?”

– Dave