Kroll Laces up

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New York – Jules Kroll, founder and former chairman of global risk consulting company Kroll Inc., has recently completed the purchase of LACE Financial, a small credit-ratings firm based in Maryland.

Kroll, now 69 years old, started the Kroll Bond Rating Agency last year in an effort to provide a “credible alternative” to the top 3 ratings agencies (S&P, Moody’s and Fitch) after the AAA ratings they gave to the top tranche of U.S. subprime-mortgage bonds before the market collapse in 2007.  Jerome Fons, the executive vice president for strategy at Kroll has stated that initially the company will focus on residential mortgage-backed securities.

LACE Financial’s main attraction to Kroll was likely the fact that it has Nationally Recognized Statistical Rating Organization status, which it was granted by the SEC in 2008.  Even with the merging of Kroll Bond Rating Agency and LACE (LACE will maintain its name as a unit of Kroll) the firms can not yet compete on a pure manpower or market share standpoint.  Kroll will likely have about 24 employees compared to 1,300 and 1,200 at S&P and Moody’s rating divisions respectively.  The top three ratings agencies also still issue approximately 97% of all outstanding ratings despite the passage of a law in 2006 designed to increase competition.

Entering the ratings business is a new direction for Jules Kroll who made a name for himself through his investigative work for the financial sector in the 1980’s by profiling investors, suitors, and takeover targets for corporations.  After selling Kroll Inc. in 2004, Kroll remained Chairman until 2008 when he left to pursue other business ventures.

The Kroll Bond Rating Agency is not the only one to have made a move like this in the recent past.    Morningstar recently paid $52 million for Realpoint LLC, a company which was licensed to allow it to rate structured-finance transactions.

Whether or not new competitors can break into the oligopoly at the top remains to be seen, however they do have a couple of points working in their favor.  Trust in the old guard of ratings agencies is currently low, with a portion of the blame for the subprime mortgage crises being placed on their shoulders.  Congress also passed the Credit Rating Agency Reform Act of 2006 with the supposed goal of increasing competition in the credit ratings market.   Legal troubles may also come into play for the well established ratings agencies.  One example of such troubles being S&P’s recent appearance in a court in Frankfurt over its ratings of Lehman before the bank’s 2008 collapse.

Even with these advantages however, new competitors struggling to break into the credit ratings business still face steep challenges as this note from Richard Blumenthal in 2009 highlights.  Ratings agencies in general have also been more proactive in keeping an eye on their ratings, a trend which was shown in the recent downgrade of The Irish Republic’s credit rating by S&P.

Competition is generally a good thing, and certain similarities can be drawn between the 2006 Credit Rating Agency reform act and the 2003 GRAS settlement.  Both have come about after companies providing information to the Street have been shown to be lacking in some regard and both have tried in some fashion to break up the oligopoly at the top.

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