The letter-grade ratings–which range from ‘AAA’ for financially stable companies to ‘D’ for a company in default, for example–are used by investors as a measure of a company’s financial health and by banks to determine the amount of interest a company pays on its debt.
But a recent survey by the Association of Financial Professionals (AFP) shows that nearly one-third (29 percent) of financial executives who work for companies with rated debt believe their companies’ ratings are inaccurate. Thirty-eight percent believe that changes in their company’s ratings have not been timely–and the same percentage of financial practitioners who use ratings for investment decisions agree. One problem, say critics, is a lack of competition. Three major agencies control the market now: Moody’s Investors Service, Standard & Poor’s and Fitch Ratings. Ninety percent of the 715 surveyed (which included both corporate financial executives at companies with rated debt as well as financial practitioners who use ratings for investment decisions) believe that the Securities and Exchange Commission should take additional action to improve its oversight of the agencies and allow for more competition. In hearings this month, the SEC began considering such changes. NEWSWEEK’s Jennifer Barrett spoke with AFP president and CEO Jim Kaitz, who testified before the SEC last week, on improving the process for rating Corporate America’s credit-worthiness.
NEWSWEEK: What’s wrong with the credit ratings industry now?
Jim Kaitz: In our survey, what really comes through are the issues of accuracy and timeliness in ratings. A number of respondents–both from companies that have had an upgrade and from companies that have been downgraded–said that the ratings are not timely.
How would you fix that?
There should be some sort of periodic SEC review of these agencies. And removing the barriers to entry for other ratings agencies is also a critical issue. Only three agencies have been designated as Nationally Recognized Statistical Rating Organizations. There needs to be a clarification of the designation process at the SEC so that other agencies better understand what the process entails.
Do you think the SEC is likely to adopt these changes?
I think the SEC absolutely takes this issue seriously. They have to issue a report to Congress in January. I think the ball is in their court right now.
At least two small agencies have complained that they filed applications years ago, but have yet to receive “nationally recognized” status. If competition is so important, why hasn’t the SEC already made it easier for other entrants to gain the same status as the major agencies?
Enron was the trigger in terms of getting Congressional interest in this. It’s a confluence of the economy, of some companies obviously having some major problems. We are in a position now where everyone is looking to increase investor confidence in our financial markets. I don’t think it is so much that the smaller players have been squeezed out. But the SEC does need to remove some of the barriers to the process.
What would that entail?
In order to be nationally recognized you have to get a letter from the SEC. It is a very unclear and convoluted methodology now to be recognized as an NRSRO. I think the SEC would acknowledge that. Under the new Congressional mandate, they will be addressing the issue of clarifying the process for entry for other credit ratings agencies.
How much of a difference would it make if smaller ratings agencies could achieve nationally recognized status?
There is nothing more important than the agencies’ reputations and the integrity of their ratings. The issue here is not necessarily getting smaller agencies, but you want to remove the barriers because competition is good. Competition should help to make the process more efficient and more accurate. You can’t make a blanket statement that just because there will be more competitors in the market that all these issues will go away. But our system of capitalism works on the concept that competition will enhance performance. If you know there is a potential threat from a competitor you will do a better job for the customer.
How could this affect the average investor?
The economy has slowed. President Bush and Congress are talking about economic stimulus. It is critically important that we boost investor confidence in the financial markets now. And the credit rating agencies play a major role both for those companies that issue debt and also–and maybe more importantly–for investors. They need to know that the credit [bonds] they buy is worth what the agencies say it is.
There has been a lot more focus on Wall Street analysts than on credit-rating agencies over the past year. Should investors have been paying more attention to credit ratings?
I think you have to focus on both. Maybe there is not as much consciousness about credit ratings agencies because people are focusing so much on those Wall Street analysts now, but for investors, these agencies play a major and important role too.
title: “Bad Credit” ShowToc: true date: “2022-12-25” author: “Larry Torres”
With consumer debt at nearly $2 trillion, debt management remains one of the nation’s fastest-growing–though still largely unregulated–industries. In the past half dozen years, hundreds of nonprofit groups and for-profit companies offering credit counseling, debt consolidation and low-interest loans have sprung up throughout the United States and Canada. But as the number of new agencies has increased so have the problems. “Our concerns have really grown,” says Ron Berry, senior vice president for the Council of Better Business Bureaus. “It used to be that there were a relatively small number of these services and they were all nonprofit and didn’t charge a fee … But since a few years ago, there are more entrants that are looking like for-profits but calling themselves nonprofit.”
In 2002, the number of complaints lodged with the Better Business Bureau against credit-counseling and debt-management services jumped 78 percent. And one quarter of the complaints received–ranging from allegations of hidden fees to contractual issues and late or missing payments to creditors–were not resolved.
Many credit-counseling services do benefit consumers burdened by debt by offering personal-finance counseling and debt-management services for little if any money. But recent high-profile lawsuits have accused some of the nation’s largest nonprofit agencies of charging excessively high fees for their services or of pressuring clients to apply for loans or use other services offered by related for-profit businesses. “There is a nuance to the term ’nonprofit’ that implies that the entity is about something other than profits, that it’s mission-driven. It is problematic when an organization operates on a nonprofit basis only superficially, while it really operates as a funding mechanism to a company that is for profit,” says Mark Pacella, president of the National Association of State Charity Officials. “They put consumers at a disadvantage and consumers can actually find themselves in a worse situation afterward. That is the crux of this issue.”
To be classified as a tax-exempt nonprofit organization, a credit-counseling agency must show that it engages primarily in activities that accomplish charitable purposes, like education and budget counseling. The agency is also supposed to operate in a “charitable manner,” meaning for the benefit of the public rather than for that of its officers or of associated for-profit companies. But some of the country’s biggest and best-known nonprofit credit-counseling services have been accused of failing to meet that criteria.
Consumer advocates trace the problem to the passage of the Credit Repair Organizations Act in 1996, which imposes strict regulations and disclosure requirements on credit-counseling agencies but explicitly exempts nonprofit tax-exempt debt-counseling agencies. “The people that this law was directed at went ahead and organized as nonprofits,” says David Vendler, an attorney with the firm Morris Polich & Purdy, who is leading a class-action fraud lawsuit against Debticated Consumer Counseling.
Debticated is one of the most heavily advertised debt-counseling agencies on the Internet, bringing in annual revenues of up to $10 million over the past few years, according to tax records. It was also the target of a lawsuit filed by Ohio’s attorney general in September 2002 alleging that the company failed to provide the services as contracted. Debticated settled the suit this July, agreeing not to charge a fee for providing debt-management and counseling services; it was also ordered to pay a $10,000 fine and to refund fees collected from some consumers.
But Vendler alleges that while Debticated claims to be a nonprofit service providing debt counseling to consumers, it really serves as a business conduit for Infinity Resources Group Inc., a for-profit company owned by Andris Pukke, the brother of Debticated’s president, Eriks Pukke. Infinity provides debt-consolidation loans. It is not the first time that Andris Pukke has allegedly been on the wrong end of the law in this area. In September 1996, he pleaded guilty to a federal charge of trying to defraud consumers by falsely promising debt-consolidation loans then not providing them. The same year, Pukke cofounded AmeriDebt Inc.–one of the largest debt-counseling agencies in the nation, with more than $31.5 million in revenues for the 2001 fiscal year, and the target of two state lawsuits filed this year by the attorneys general of Illinois and Missouri who accuse AmeriDebt of charging excessive fees to clients and of steering money to affiliated for-profit enterprises.
These claims come three years after AmeriDebt reached a settlement with the District of Columbia’s Office of Corporation Counsel (which functions like a state’s attorney general’s office) on similar charges, in which AmeriDebt agreed to stop referring clients to Infinity Resources Group, and Infinity agreed to refund some consumers who had signed up for AmeriDebt’s payment plan to qualify for a debt-consolidation loan through Infinity. Missouri Attorney General Jay Nixon says AmeriDebt still deceives consumers through excessive, hidden fees and by transferring consumers’ accounts and money to its affiliated for-profit companies. “AmeriDebt is not upfront about the way their business operates,” Nixon tells NEWSWEEK. “They market like the Red Cross but their business practices are like Dracula. The not-for-profit is just a shell for a complicated financial network that drains money into for-profit entities.”
In a statement, AmeriDebt counsel Rob Herrell says the organization was both “surprised and disappointed” to learn of the Missouri and Illinois lawsuits claiming that AmeriDebt “has an exemplary record of helping needy debtors negotiate lower interest rates and payments.” He adds that the organization does not impose fees but only asks for monthly contributions to offset the costs of handling client accounts.
Another nonprofit organization that has drawn attention for its ties to for-profit companies is Cambridge Credit Counseling in Agawam, Mass., whose founders also started at least four other businesses that offer related services, one of them a nonprofit in New York and the rest for-profit corporations. Cambridge Counseling president John Puccio is also listed as president of Brighton Credit Management Corporation, Cambridge Brighton Budget Planning, Brighton Credit Corp. and Debt Relief Clearinghouse. All of them are for-profit corporations, except for Cambridge Brighton Budget Planning, which is licensed as a nonprofit in New York and in the process of applying for federal nonprofit status, according to Cambridge spokesman Montieth Illingworth. He said that there is “nothing untoward or illegal” about the relationship between the various businesses and says, “We fully support this initiative by the IRS to examine and clarify which providers in this industry are working in the consumers’ interest–and we are one of those.”
The IRS says it is now looking more closely at both the credit-counseling agencies that are applying for nonprofit tax-exempt status and at those who have already achieved such status but have received complaints about their qualifications. “We decided we needed to give our staff training to delve in deeper and to make sure the organizations are acting in the manner they ought to be acting in–obviously, you can get status and then change the plan, so we also want to look into organizations to make sure they are following the rules,” says Lois G. Lerner, IRS director of exempt organizations, rulings and agreements, the department responsible for assessing applications for nonprofit organizations.
Lerner would not disclose the names or number of agencies that the IRS is including in its investigation, but says a “significant number” of organizations’ names have been referred to the department for inquiry. While some may have crossed the line between nonprofit and for-profit inadvertently and will receive guidance and, perhaps, a slight reprimand, the more egregious offenders could lose their exempt status and be forced to pay up for the period in which the IRS determines they did not meet the criteria to earn tax-exempt status in the first place, she says. In the meantime, she says, consumers should do their own homework before they hand over any money to a credit-counseling organization–whether it’s nonprofit or not.
Consumer advocates recommend checking with the Better Business Bureau and steering clear of nonprofit organizations that require upfront fees for their services (as opposed to voluntary donations). “Do what you would do if you were buying a television or a car,” says Mark Cooper, Director of Research at Consumer Federation of America. “Shop around before you put money down.”
