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Conflicts of Interest in the Financial Industry

There is a debate on conflicts of interest that exist between certain bond ratings agencies, such as Moody’s and Standard & Poor’s, and the corporation’s bonds that they rate. There is also a debate on conflicts of interest that exist between financial firms, such as Goldman Sachs and J.P. Morgan, and the corporation’s equity that rate. Discuss strategies that would reduce these conflicts of interest.

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Read “Related to bond rating conflicts of interest” and “Related to equity rating conflicts of interest” on the Module 4: Lecture Materials & Resources page.

Submission Instructions:

  • Your initial post should be at least 200 words, formatted and cited in current APA style with support from at least 2 academic sources. Your initial post is worth 8 points.

Post by classmate 1

The conflict of interest come from the rating agencies that are compensated by the corporations whose bonds they rate. This conflict of interest is compounded when the rating agencies also provides consultancy services to corporate for designing the terms and conditions of the bonds. The same is the case with financial firms like Goldman Sachs and J.P. Morgan who are associated with equity issues of companies.

To reduce these conflicts of interest, transparency and higher level of competition should be encouraged. Transparency will focus on disclosure of ratings. It will also include disclosures with regards to revenues generated from non-rating services that the rating agencies receive from specific issuers which will make them search for more accurate and efficient ways of predicting bond performances. (Lardner, 2010). The concept of ‘indicative ratings’ can also be introduced and this will be very helpful to restrict the issue of ratings shopping. (Home Area, N/D). The same applies to financial firms like Goldman Sachs and J.P. Morgan who are associated with equity issues of companies.

Conflict of interest can be reduced and eventually eliminated by requiring and mandating more detailed disclosures from credit rating agencies and from financial firms like Goldman Sachs and J.P. Morgan. Barriers to entry should also be reduced for the rating business and the business of financial firms like Goldman Sachs. This will increase the level of competition for them and this will help in addressing the issue of conflict.

Post by classmate 2

Rating agencies like Moody’s and Standard & Poor are suffering from a conflict of interest due to the fact that they are being compensated by banks and companies they are task with rating objectively. Strategies that can reduce the conflicts of interest that exist between certain bond ratings agencies is to revise old policies and to implement new policies. The tactics that are currently used by these agencies involve “rewarding lenient voting” and actively harasses analysts. In the article, it mentioned that Moody’s have a culture of “intimidation and harassment” to convince analysts to make sure that ratings match or meet the desired standard of the company’s clients. Members felt free to discuss the negative aspects of the CDO but also felt pressure by management to overlook these aspects when voting (Neate, 2011). According to the article, US financial regulator the securities and exchange commission (SEC), is considering new rules to reform the agencies (Neate, 2011). However, Harrington is convinced that SEC’s recommended changes to regulate these agencies will not significantly help the situation and may provide an easier way for agencies to apply pressure on their employees.

Financial firms like Goldman and J.P. Morgan face conflict of interest with the corporation’s equity that they rate. They are many strategies that can reduce conflicts of interest that exist between financial firms. For the Centre for Economic Policy Research (CEPR), there are nine recommendations to resolve the conflicts of interest in the financial services industry. First, Increase disclosure for investment analysts, credit rating analysts and auditors to reveal any interests they have in the firms they analyze. Second, Improve corporate governance to control conflicts of interest, ensuring that auditors are responsible to shareholders not managers. Third, Increase supervisory oversight over conflicts of interest. The fourth recommendation is to Provide adequate resources to supervisors to monitor conflicts of interest. The fifth recommendation is to Establish best practice codes of conduct to control conflicts of interest, devised by industry and supervisors in cooperation. The sixth recommendation is to Enhance competitiveness in the rating agency industry. The seventh recommendation is to Prevent co-option of private information producing agents by regulators and supervisors. The eighth recommendation is to Avoid the forced separation of financial service activities except in unusual circumstances. The ninth recommendation is to Avoid the socialization of information in the financial service industry in most circumstances. (Crockett, Harris, Mishkin, and White, n.d.).