When commenters look back at the financial crisis, many blame the ratings agencies, at least in part – and in particular, the dominance of a small number of firms (Moody's, S&P, and – distantly – Fitch).  This is why, for example, the SEC has been criticized for erecting barriers that prevent other agencies from earning the coveted NRSRO label. 

Which is why I found this story regarding an apparent effort by Moody's to eliminate a competitor so fascinating.  According to the WSJ:

Moody’s Corp. doesn’t often give away its thoughts free of charge.

But the ratings firm made an exception recently, issuing an unsolicited credit rating to National Penn Bancshares Inc., a small community bank it had never assessed before.

Moody’s grade was lower than one issued just weeks earlier by Kroll Bond Rating Agency Inc., which the bank had hired to rate a new bond.

Kroll contends Moody’s deliberately lowballed its rating—a move that could have ripple effects through the market for National Penn’s bonds—to scare other small banks into hiring it for future deals.

“It seems this was nothing less than intimidation,” said Kroll President Jim Nadler. “Investors and issuers are worried that Moody’s, if it’s not paid their ransom, will continue doing this until they bully their way into the market.”

A Moody’s spokesman said the firm’s unsolicited rating for National Penn was due to the relatively large size of the debt deal for a regional bank. “We thought our opinion would be helpful to market participants,” he said….

Moody’s never met with National Penn senior management. Instead, Moody’s analysts sifted through public disclosures, listened to earnings calls and read news articles, Mr. Tischler said. These types of situations, with no participation from the rated issuer, are “definitely the minority,” he added.

Moody’s hadn’t rated a U.S. bank with assets under $10 billion all year. In its eight-paragraph rating rationale from Oct. 31, Moody’s said National Penn’s “acquisition appetite” for troubled banks “poses risks for creditors,” calling into question the management’s strategy. Few detailed financials were mentioned in the initial Moody’s rating.

Now, this is not the first time Moody's has been accused of this kind of behavior.  In Jefferson County School District No. R-1 v. Moody’s Investor’s Services, Inc., 175 F.3d 848 (10th Cir. 1999), for example, the plaintiff alleged that Moody's publicized an unsolicited low-ball rating as punishment to an issuer for failing to hire Moody's to rate the deal.  In that case, the Tenth Circuit held that ratings are opinions subject to First Amendment protection, and dismissed state law tort claims as well as federal antitrust claims.

It raises really interesting questions, because on the one hand, many observers believe that "ratings shopping" – the practice of one issuer going to different agencies until it receives the rating it wants – corrupts ratings and contributed to the financial crisis.  So we want to encourage agencies to rate securities even when an issuer has chosen a different agency – which necessarily means protecting them from lawsuits by disgruntled issuers.  On the other hand, the last thing we want is for agencies to use ratings as a means to exclude competitors from the market. 

The reality is, the best system would be one in which the issuer itself did not get to choose the agency (or, more creatively, perhaps one in which the rater itself was forced to invest in the securities it rates) – but despite proposals, we haven't been able to adopt a workable system to make that happen (as demonstrated by the fact that investors will sue the agencies for issuing unreliable ratings even as they continue to rely on them as a cornerstone of their investment policy).