Regulation Fair Disclosure (Regulation FD), implemented in 2000, prohibits U.S. public companies from disclosing non-public information selectively. Section 100(b)(2)(iii) of the regulation, however, allowed issuers to disclose non-public information to credit rating agencies (CRAs) for the purpose of determining or monitoring credit ratings, as long as the ratings were publicly disclosed. Section 939B of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act or the Act) removed this exemption from Regulation FD, as part of a major regulatory reform of the credit rating industry, following the financial crisis of 2008. This revision to Regulation FD seems to suggest that issuers can no longer make selective, non-public disclosures to CRAs. However, CRAs argue that this regulatory change is unlikely to have a significant impact on the industry’s long-held practice of accessing issuer firms’ material non-public information as part of the ratings process.
CRAs note that they are not on the list of persons specified under Rule 100(b)(1) of Regulation FD to whom selective disclosures may not be made. CRAs further note that Rule 100(b)(2)(ii) of Regulation FD allows U.S. public companies to make selective disclosures to any person who expressly agrees to keep the information confidential. CRAs claim that they already have such confidentiality provisions in place as part of their engagement letters with issuers and therefore should have access to issuer firms’ material non-public information. Some legal commentators support CRAs’ arguments (e.g., Carbone 2010; Ohlson et al. 2010),[2,3] while others note that “it is uncertain whether Congress will be satisfied by the mere repeal of Rule 100(b)(2)(iii) and the continuation of business as usual” (McMahan and Schell 2010; Khvatskaya et al. 2011).[4,5] We contribute to this debate by empirically examining the effect of this regulatory change on CRAs’ access to issuer firms’ non-public information. Specifically, we investigate whether CRAs increase their reliance on public disclosure by examining whether there is a change in the timing of credit rating issuances relative to public disclosure events such as earnings announcements.
We argue that the regulatory change brought about by the Act increases the ambiguity about whether the issuer firms are allowed to share non-public information with CRAs. As a result, issuer firms are likely to become more strategic about disclosing non-public information to CRAs. In particular, issuer firms are more likely to reduce selective disclosure to CRAs of non-public negative information than of non-public positive information. Self-interest, such as career concerns, can motivate managers to withhold from CRAs non-public negative information, up to a certain threshold, with the hope that future firm performance will help bury the bad news. The Dodd-Frank Act also increased legal liability on CRAs for inaccurate ratings, suggesting that CRAs’ incentive to acquire non-public information, especially negative information, from issuer firms would increase. However, since CRAs are paid by issuer firms for providing ratings, they are likely to cater to issuer firms’ interests. Consequently, CRAs’ reliance on firms’ public disclosure to obtain information, especially bad news, is likely to increase. Accordingly, we predict that the likelihood of CRAs issuing rating downgrades following earnings announcements is greater after than before the revision to Regulation FD.
For the sample period 2006 to 2014, we find that the likelihood of the issuance of rating downgrades by CRAs following earnings announcements increases after the revision of Regulation FD. A credit rating is classified as being issued following an earnings announcement if it is issued during [0, +5] calendar days, where day 0 is the earnings announcement date. These results suggest that, following the regulatory change, CRAs increase their reliance on public information for rating downgrades, presumably due to a decrease in their access to issuer firms’ non-public negative information. The above results are robust to using alternative time windows, [0, +10] and [0, +30], to measure the period following earnings announcement. If CRAs wait for earnings announcement to verify the negative information they already have, five days are sufficient to produce a rating. However, if they initiate a rating revision as a result of obtaining significant new information from earnings announcement, they may need a little longer to arrive at a rating. In addition, we consider management earnings forecasts that are not bundled with earnings announcement as another source of material public information and obtain consistent results.
Our evidence suggests that the assertions made by CRAs and some legal experts that the revision to Regulation FD is unlikely to affect CRAs’ access to issuer firms’ non-public information is not valid. We show that there is a change in the timing of the issuance of ratings downgrades. Specifically, there is a shift in the issuance of ratings downgrades from before to after issuer firms’ public disclosures, suggesting a decrease in CRAs’ access to issuer firms’ non-public negative information. Furthermore, the decrease in selective disclosure by issuer firms of non-public negative information to CRAs makes rating downgrades less timely, an outcome that is contrary to the Act’s goal of improving the quality of credit ratings. Finally, our findings indirectly suggest that the exemption for CRAs, when Regulation FD was initially implemented, was a useful provision, because it contributed positively to the timeliness of rating downgrades.
 Rule 100(b)(1) list includes broker-dealers, investment advisors, investment companies and other persons who may reasonably be expected to trade on the information.
 Carbone, D., 2010. The impact of the Dodd-Frank Act’s credit rating agency reform of public companies. The Corporate & Securities Law Advisor.
 Ohlson, J.F., Lane, B.J., Mueller, R.O., Goodman, A.L., and Fabens, A., 2010. Repeal of credit ratings agency exemption from regulation FD. Gibson Dunn.
 McMahan, J.A. and Schell, K.A., 2010. Much ado about nothing? Kirkland and Ellis.
 Khvatskaya, O., Dorsey, D.A., Failla, S.S., Barclay, A.W., Hopwood, J., Mills, S.K., and Stephan, P.B., 2011. Regulation FD: Recent Developments. Hunton & Williams.
This post comes to us from Ashiq Ali and Ningzhong Li, professors at the University of Texas at Dallas’ Naveen Jindal School of Management, and Hoyoun Kyung, a PhD candidate at the school. The post is based on their recent paper, “Revision of Regulation Fair Disclosure under the Dodd-Frank Act and the Timing of Credit Rating Issuances,” available here.