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SFC rap on the knuckles for Moody’s – but rating firm’s ‘Red Flag’ credit report was an excellent idea

Closely watched case could well redefine the limits on what can be written in research reports on public companies, potentially curtailing the activities of research firms, and seriously eroding freedom of speech

PUBLISHED : Monday, 12 June, 2017, 3:48pm
UPDATED : Monday, 12 June, 2017, 11:03pm

The Court of Appeal yesterday rejected the appeal by Moody’s Investors Service against the Securities and Futures Commission’s decision to publicly reprimand the agency ... for breaching the code of conduct by issuing a “red flag” report on mainland companies in July 2011.

SCMP, June 9

You cannot really blame the Court of Appeal for upholding this seriously flawed judgement against Moody’s, well, not really.

I mean, it is not the court’s fault the Legislative Council was deceived some years back into allowing the Securities and Futures Commission (SFC), headed by chairman Carlson Tong Ka-shing, to write its own establishing law and make up its own rules in defiance of any reasonable notion of civil liberties.

If our appeal justices then take refuge in the letter of the law as refined by modern equivalents of monkish reasoning on how many angels can stand on the point of a needle, well, it’s a way out of their dilemma and they can furthermore argue they are required to do it this way.

So it is not really their fault that our fundamental civil liberty of freedom of speech has been seriously eroded by this ruling, not really.

But, meanwhile, freedom of speech has indeed been seriously eroded.

What happened here is that back in 2011, Moody’s came out with the brilliant idea of publishing a report rating the creditworthiness of a number of listed mainland companies, by sticking red flags next to their names.

The idea was there are certain definite accounting markers of whether the creditworthiness of any company is questionable or has deteriorated.

Cross one of these markers and a red flag goes up. Count the number of red flags on any company and you have a pretty good benchmark of credit quality.

Moody’s then put out a report on this red flags arrangement and the immediate result was the share prices of more than half of the red flagged companies tumbled on the Hong Kong market the next day.

You nasty miscreant, Moody’s, said the SFC in response.

You have made some big mistakes in these ratings and you have thus broken our code of conduct on dealing honestly, fairly and in the best interests of clients and the market.

Now, let’s have it straight first of all that the code of conduct is not law. It is only the SFC’s own woolly drafting of a statement on how people in the investment business should behave.

Bear in mind here that the SFC is a law to itself. It has its own protected revenue and budget, independent of the Financial Secretary, and, except in outright criminal cases, is its own investigating authority, prosecutor, judge and jury all rolled into one, with only a tame appeals tribunal to exercise any supervision over its findings.

Red flags was an excellent idea, a real service of which investors have now been deprived, and it falls under the heading of freedom of speech, not regulation by an over-empowered semi-police agency. The companies involved had recourse to the law on defamation. The SFC had no business there.

As much to the point, the findings in this case that Moody’s made serious errors, they are purely a value judgement of the SFC’s own manufacture.

I thought they were at most trifling errors. But then anyone can call them serious. You can, too. Just say the word “serious”. You see?

More than this, however, if these red-flagged companies believed they were libelled they had several other routes open to them.

They could immediately have rebutted the accusations in filings with the stock exchange (in fact, they are now required by law to do so) and have brought libel proceedings against Moody’s.

They have not done so.

Even better, they could have bought in bucket loads of their stock on the market when their share prices tanked, in full confidence that prices would soon bounce back. That would have been my way. File your denial and then fill your boots. Thank you, Moody’s, for getting it wrong.

I am not saying the Moody’s report contained no errors. I am sure that in some areas it did. I have never seen an investment report that later proved incontrovertibly right on every point.

But red flags was an excellent idea, a real service of which investors have now been deprived, and it falls under the heading of freedom of speech, not regulation by an over-empowered semi-police agency. The companies involved had recourse to the law on defamation. The SFC had no business there.

It is too bad that our appeal judges would only look at it with a microscope but you can’t blame them, not really.

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