The U.S. Securities and Exchange Commission published a review of credit ratings agencies' business conduct that noted findings such as the failure to follow policies, keep records, and disclose conflicts of interest. While the regulator did not say who failed at what, financial filings show that the people who run The McGraw-Hill Companies (MHP), of which Standard & Poor's Corp. is a part, continue to lack the checks and balances that would help to prevent corporate governance problems.
S&P and Moody's Corp. accounted for around 83% of all credit ratings, the SEC said this month in its second annual examination of nine firms in the industry. (This article is the first of a two-part series that will discuss Moody's next.) Each of the larger agencies did not appear to follow their methodologies and certain policies in determining certain credit ratings, the SEC found. On a brighter note, the regulator also said that with one exception, all nine agencies appropriately addressed its recommendations in 2011.
But the SEC also found various problems, ranging from inconsistent disclosure about methodology to directors not actively exercising their required oversight duties. Each of the agencies could strengthen its internal supervisory controls, the SEC said. For some, the regulator recommended changes in areas such as staff resources and oversight in the determination of ratings.
In the case of McGraw-Hill, oversight problems exist even in the senior ranks. For example, there are potential conflict of interest problems for several directors on the board. Seven of McGraw-Hill's directors have served more than a decade, including Robert P. McGraw, Pedro Aspe, Winfried Franz Wilhelm Bischoff, and Sidney Taurel, according to the company's most recent proxy filing. The long-tenured directors make up the majority, or chair, four of the five standing board committees at McGraw-Hill. While we recognize the benefits of experience, we feel directors should have relationships that are distant enough for objectivity, as we noted in July.
In part due to such issues, McGraw-Hill is rated "D" on its environmental, social and governance (ESG) risk overall. Its financial statements reflect an AGR ® score of 24, indicating higher accounting and governance risk than 76% of comparable companies.
Some fallout from the risk is readily manifest. For example, the company's board -- which includes the abovementioned family member Robert McGraw -- awarded chairman and CEO Harold W. McGraw III $8.74 million in fiscal 2011, well over three times the median pay for the company's other named executive officers. His compensation includes costs associated with his use of sleeping quarters in the McGraw-Hill building and his travel in company cars and aircraft - even to board meetings for ConocoPhillips and United Technologies Corporation. While some of these expenses may be more work-related than others, they are not directly tied to company performance, making it harder to explain their value for investors. The close ties between the board and Mr. McGraw do not suggest the proper arms-length negotiations appropriate in such relationships, resulting in overly-generous perks and compensation.
Mr. McGraw and the board make decisions that impact every person at McGraw-Hill. Their behavior sets the standard for the rest of the organization. Thus it is doubly important that such decisions foster a culture that would prevent rather than sanction the kinds of mistakes the SEC described in its recent report.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by a financial reporter at GMI. The reporter has no business relationship with any company whose stock is mentioned in this article. Nobody paid GMI to write this article on his or her behalf.