[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]
REFORMING CREDIT RATING AGENCIES:
THE SEC'S NEED FOR STATUTORY
AUTHORITY
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
CAPITAL MARKETS, INSURANCE AND
GOVERNMENT SPONSORED ENTEREPRISES
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED NINTH CONGRESS
FIRST SESSION
__________
APRIL 12, 2005
__________
Printed for the use of the Committee on Financial Services
Serial No. 109-14
U.S. GOVERNMENT PRINTING OFFICE
23-047 WASHINGTON : 2005
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HOUSE COMMITTEE ON FINANCIAL SERVICES
MICHAEL G. OXLEY, Ohio, Chairman
JAMES A. LEACH, Iowa BARNEY FRANK, Massachusetts
RICHARD H. BAKER, Louisiana PAUL E. KANJORSKI, Pennsylvania
DEBORAH PRYCE, Ohio MAXINE WATERS, California
SPENCER BACHUS, Alabama CAROLYN B. MALONEY, New York
MICHAEL N. CASTLE, Delaware LUIS V. GUTIERREZ, Illinois
PETER T. KING, New York NYDIA M. VELAZQUEZ, New York
EDWARD R. ROYCE, California MELVIN L. WATT, North Carolina
FRANK D. LUCAS, Oklahoma GARY L. ACKERMAN, New York
ROBERT W. NEY, Ohio DARLENE HOOLEY, Oregon
SUE W. KELLY, New York, Vice Chair JULIA CARSON, Indiana
RON PAUL, Texas BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio GREGORY W. MEEKS, New York
JIM RYUN, Kansas BARBARA LEE, California
STEVEN C. LaTOURETTE, Ohio DENNIS MOORE, Kansas
DONALD A. MANZULLO, Illinois MICHAEL E. CAPUANO, Massachusetts
WALTER B. JONES, Jr., North HAROLD E. FORD, Jr., Tennessee
Carolina RUBEN HINOJOSA, Texas
JUDY BIGGERT, Illinois JOSEPH CROWLEY, New York
CHRISTOPHER SHAYS, Connecticut WM. LACY CLAY, Missouri
VITO FOSSELLA, New York STEVE ISRAEL, New York
GARY G. MILLER, California CAROLYN McCARTHY, New York
PATRICK J. TIBERI, Ohio JOE BACA, California
MARK R. KENNEDY, Minnesota JIM MATHESON, Utah
TOM FEENEY, Florida STEPHEN F. LYNCH, Massachusetts
JEB HENSARLING, Texas BRAD MILLER, North Carolina
SCOTT GARRETT, New Jersey DAVID SCOTT, Georgia
GINNY BROWN-WAITE, Florida ARTUR DAVIS, Alabama
J. GRESHAM BARRETT, South Carolina AL GREEN, Texas
KATHERINE HARRIS, Florida EMANUEL CLEAVER, Missouri
RICK RENZI, Arizona MELISSA L. BEAN, Illinois
JIM GERLACH, Pennsylvania DEBBIE WASSERMAN SCHULTZ, Florida
STEVAN PEARCE, New Mexico GWEN MOORE, Wisconsin,
RANDY NEUGEBAUER, Texas
TOM PRICE, Georgia BERNARD SANDERS, Vermont
MICHAEL G. FITZPATRICK,
Pennsylvania
GEOFF DAVIS, Kentucky
PATRICK T. McHENRY, North Carolina
Robert U. Foster, III, Staff Director
Subcommittee on Capital Markets, Insurance and Government Sponsored
Enterprises
RICHARD H. BAKER, Louisiana, Chairman
JIM RYUN, Kansas, Vice Chair PAUL E. KANJORSKI, Pennsylvania
CHRISTOPHER SHAYS, Connecticut GARY L. ACKERMAN, New York
PAUL E. GILLMOR, Ohio DARLENE HOOLEY, Oregon
SPENCER BACHUS, Alabama BRAD SHERMAN, California
MICHAEL N. CASTLE, Delaware GREGORY W. MEEKS, New York
PETER T. KING, New York DENNIS MOORE, Kansas
FRANK D. LUCAS, Oklahoma MICHAEL E. CAPUANO, Massachusetts
DONALD A. MANZULLO, Illinois HAROLD E. FORD, Jr., Tennessee
EDWARD R. ROYCE, California RUBEN HINOJOSA, Texas
SUE W. KELLY, New York JOSEPH CROWLEY, New York
ROBERT W. NEY, Ohio STEVE ISRAEL, New York
VITO FOSSELLA, New York, WM. LACY CLAY, Missouri
JUDY BIGGERT, Illinois CAROLYN McCARTHY, New York
GARY G. MILLER, California JOE BACA, California
MARK R. KENNEDY, Minnesota JIM MATHESON, Utah
PATRICK J. TIBERI, Ohio STEPHEN F. LYNCH, Massachusetts
J. GRESHAM BARRETT, South Carolina BRAD MILLER, North Carolina
GINNY BROWN-WAITE, Florida DAVID SCOTT, Georgia
TOM FEENEY, Florida NYDIA M. VELAZQUEZ, New York
JIM GERLACH, Pennsylvania MELVIN L. WATT, North Carolina
KATHERINE HARRIS, Florida ARTUR DAVIS, Alabama
JEB HENSARLING, Texas MELISSA L. BEAN, Illinois
RICK RENZI, Arizona DEBBIE WASSERMAN SCHULTZ, Florida
GEOFF DAVIS, Kentucky BARNEY FRANK, Massachusetts
MICHAEL G. FITZPATRICK,
Pennsylvania
MICHAEL G. OXLEY, Ohio
C O N T E N T S
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Page
Hearing held on:
April 12, 2005............................................... 1
Appendix:
April 12, 2005............................................... 23
WITNESS
Tuesday, April 12, 2005
Nazareth, Annette, Director of Market Regulation, United States
Securities and Exchange Commission............................. 4
APPENDIX
Prepared statements:
Oxley, Hon. Michael G........................................ 24
Fitzpatrick, Hon. Michael G.................................. 26
Gillmor, Hon. Paul E......................................... 27
Kanjorski, Hon. Paul E....................................... 28
Nazareth, Annette............................................ 30
Additional Material Submitted for the Record
Kanjorski, Hon. Paul E.:
Written letter to Hon. William H. Donaldson, Chairman, U.S.
Securities and Exchange Commission, April 12, 2005......... 39
REFORMING CREDIT RATING AGENCIES:
THE SEC'S NEED FOR STATUTORY
AUTHORITY
----------
Tuesday, April 12, 2005
U.S. House of Representatives,
Subcommittee on Capital Markets, Insurance,
and Government Sponsored Enterprises,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to call, at 2:05 p.m., in
Room 2128, Rayburn House Office Building, Hon. Richard Baker
[chairman of the subcommittee] presiding.
Present: Representatives Baker, Ryun, Kelly, Brown-Waite,
Hensarling, Kanjorski, and Wasserman Schultz.
Chairman Baker. [Presiding.] I would like to call this
meeting of the Capital Markets Subcommittee to order.
Today, the committee meets for the purpose of receipt of
testimony from Annette Nazareth, who is the director of the
Divsion of Market Regulation of the U.S. Securities and
Exchange Commission.
The committee has had for some number of years interest in
and perhaps concern for the manner by which rating agencies are
regulated and overseen in their function, consistent with the
requirements of the Investment Company Act, which when a public
operating company chooses to issue debt and enter the public
markets, must receive at least two ratings from independent
rating agencies for that debt to be properly issued. That, of
course, sets in motion a number of concerns as to the
independence and insightfulness of the agencies which are
charged with the responsibility to conduct these ratings.
A brief summary of our history and how we arrive at our
hearing today, it was in 1994 that the SEC first established
the nationally recognized credit rating agency definition and
left unclear exactly what it was required of an entity to
become an NRSRO. Subsequent to the 1994 establishment of that
principle, in 1997 the agency issued a subsequent release which
was not adopted because of opinions issued in writing by the
Department of Justice indicating that the standards attempting
to be established would prohibit, in all likelihood, entry into
the market or make it substantially difficult so that there
would not be an ability of competitors to enter into the rating
agency business.
In 2003, the SEC issued another release posing 54 questions
for public comment. A number of issues were raised as a result
of those responses and yet no action of a substantive form was
taken at that time. A rule is now pending issued by the SEC
which is making the attempt, as I view it, to redefine what
constructs the elements of an NRSRO. There are three specific
items listed, but unfortunately I have come to the conclusion
that those elements are not sufficiently different or unique
from the understandings originally posed by the term ``NRSRO.''
Subsequently to the 2003 questions issued to stakeholders
and the number of issues raised in that release and public
comment period, I consider the current rule to be inadequate in
scope and in content. In order to make the point of our
concerns, there is publicly disclosed information by one rating
agency on its financials and in the year 2004 enjoyed an
unbelievable 690 percent return on equity. I know of no other
public operating company that is even close. While more
remarkably, the other principal agency engaged in the market
does not even disclose its financials at all.
Further, there has been neither establishment of nor
disclosure of the methodologies by which a rating agency enters
into a corporation and comes to its ratings determinations.
That remains unclear. The ability to rate a public operating
company without being requested by that company, and of course
subsequently sending the company an invoice, presents some
clear ethical question, at least in my mind, that needs to be
addressed.
In summary, I feel that the rating agencies are somewhat of
mystical anointed monopoly, not unlike our good friends Fannie
and Freddie, but with even less accountability. I hope today in
the course of our questions and answers with Ms. Nazareth to be
able to come to a better understanding of what action, if any,
the Congress should take in assisting the SEC to come to final
resolution on all these matters of public importance.
Mr. Kanjorski?
Mr. Kanjorski. Thank you, Mr. Chairman.
We meet for the third time in the last 2 years to explore
the issue of regulating credit rating agencies. As I have
regularly noted during the past examinations, entities like
Moody's, Standard and Poor's, and Fitch have long published
their views on the credit worthiness of issuers of debt
securities. The significance of these opinions has also greatly
expanded in recent years as a result of increases in the number
of issues and issuers, the globalization of our financial
markets, and the introduction of complex financial products.
Although rating agencies received some scrutiny after the
recent surge of corporate scandals, we have not yet mandated
any substantive changes in their practices. One witness at one
of our past hearings nevertheless noted that the agencies
``played a significant role'' in Enron's failure. A Senate
investigative report also determined that the monitoring and
review of Enron's finances ``fell far below the careful efforts
one would have expected from organizations whose ratings hold
so much importance.''
Outside Enron's auditors, the rating agencies probably had
the greatest access to non-public information about the firm's
complicated financial arrangements. Even with this data, the
agencies exhibited a disappointing reliability in the accuracy
of their coverage. In fact, the three existing nationally
recognized statistical rating organizations at the time of
Enron's failure, rated the company at investment-grade until 4
days before its bankruptcy filing.
The failure of the nationally recognized agencies to lower
their credit ratings in a timely manner in this case and other
instances such as the WorldCom bankruptcy, New York City's debt
crisis, Washington Public Power Supply System's default, and
Orange County's collapse has resulted in great financial losses
for many Americans who little understood the true credit risks
of their investments.
This issue is therefore one on which we should focus our
attention in the 109th Congress. During our past hearings, it
has also become increasingly clear to me that while our capital
markets and the rating industry have evolved considerably in
recent years, the Commission's rules in this area have changed
little, even though it has studied these issues for more than a
decade. Additionally, The Washington Post late last year in a
series of investigative reports on credit ratings concluded
that although the agencies with national recognition are the
gatekeepers of capitalism, they have no commensurate oversight
or accountability.
The regulation of rating agencies, I believe, is ripe for
examination and action. I know that the Securities and Exchange
Commission agrees. Today's witness, Annette Nazareth, the
Commission's Director of Market Regulation, has previously
observed that while rating agencies have generally performed
their work well for nearly a century, they have also missed
some colossal failures in recent years. She has further
described our debt markets as the dark corner of the securities
industry. The time has come to shine some light into this dimly
lit field.
Accordingly, I was pleased that the Commission recently and
finally put forward for public comment a proposed rule to
define what constitutes a nationally recognized statistical
rating organization and the process for making such a
designation. While this proposal is a good step, more still
needs to be done in the area of rating agency oversight. The
agencies, as I am aware, are also working with the Commission
to establish a voluntary framework to improve transparency.
While some hope that this agreement will be effective, many
have lingering doubts. After all, Chairman Donaldson has
already indicated that he does not have the confidence that
these discussions will result in substantive reforms because
the existing agencies with national recognition have taken the
position that they will not allow the Commission to conduct
inspections or take enforcement actions.
As you know, Mr. Chairman, top officials at the Commission
have also regularly suggested that additional legislative
authority may be needed in the area of rating agencies.
Consequently, I have come to conclude that it is time for us to
ask the Commission what specific authorities it believes it
needs to effectively oversee rating agencies. I will therefore
be sending a letter to the Commission after today's hearing to
request this technical assistance. The Congress will ultimately
decide whether to consider a bill related to these issues, but
obtaining the insights of the experts at the Commission will
help us in crafting an appropriately balanced piece of
legislation that addresses First Amendment concerns.
Learning of the Commission's views now on the needed
statutory authority will also help us to expedite future action
if the voluntary framework negotiations break down or result in
a flawed product.
In closing, Mr. Chairman, we must act to ensure the
continued integrity of the rating agencies and the credit
rating process. I also look forward to hearing from our witness
today and to moving forward prudently and promptly on these
important matters.
[The prepared statement of Hon. Paul E. Kanjorski can be
found on page 28 in the appendix.]
Chairman Baker. I thank the gentleman.
I am advised that no other member desires to make an
opening statement at this time, but all members' statements, if
submitted, will be made part of the official record.
At this time, I would like to recognize Ms. Annette
Nazareth, Director, Division of Market Regulation.
Your official statement will be made part of the record.
Please proceed at your leisure, and welcome.
STATEMENT OF ANNETTE NAZARETH, DIRECTOR, DIVISION OF MARKET
REGULATION, UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Ms. Nazareth. Thank you, Chairman Baker, Ranking Member
Kanjorski and members of the subcommittee. Thank you for the
opportunity to testify before you today on behalf of the
Securities and Exchange Commission.
Today, I plan to provide you with an overview of the SEC's
recent work concerning credit rating agencies. I will begin
with a brief history of the SEC's involvement in this area and
then I will discuss recent SEC initiatives regarding credit
rating agencies.
Since 1975, the SEC has relied on credit ratings by market-
recognized rating agencies for distinguishing among grades of
credit worthiness in various rules under the federal securities
laws. These nationally recognized statistical rating
organizations, or NRSROs, have received no-action letters from
the SEC staff. To date, nine firms have received such no-action
letters. However, during the 1990s, several NRSROs consolidated
so that there are currently five such NRSROs: A.M. Best
Company, Dominion Bond Rating Service, Limited, Fitch, Inc.,
Moody's Investor Service, Inc., and Standard and Poor's
Division of McGraw Hill Companies, Inc.
The term ``NRSRO'' was originally adopted by the Commission
solely for determining capital charges on different grades of
debt securities under the Commission's net capital rule for
broker-dealers. Over time, however, the NRSRO concept has been
incorporated into a number of additional SEC rules and
regulations, including rules issued under the Securities Act of
1933, the Securities Exchange Act of 1934, and the Investment
Company Act of 1940.
Congress also has used the NRSRO concept in legislation, as
have other regulatory bodies including banking regulators both
at home and abroad. During the past few years, the Commission
has pursued several approaches on its own and at the direction
of Congress to conduct a thorough and meaningful study of
credit rating agencies and the use of credit ratings under the
federal securities laws. For example, approximately 2 years
ago, the SEC responded to a congressional directive under the
Sarbanes-Oxley Act of 2002 by issuing a report on the role of
credit rating agencies in the securities markets.
To assist in preparing the report, the SEC held 2 full days
of public hearings. Hearing participants included
representatives from credit rating agencies, broker-dealers,
buy-side firms, issuers and the academic community. The
Sarbanes-Oxley report identified a number of substantive issues
that the Commission planned to explore in more depth, including
improved information flow in the credit rating process,
potential conflicts of interest, alleged anti-competitive or
unfair practices, potential regulatory barriers to entry in the
credit rating business, and ongoing regulatory oversight of
credit rating agencies.
On June 4, 2003, the SEC issued a concept release seeking
public comment on the issues raised in the Sarbanes-Oxley
report. Generally, the SEC sought comment on whether credit
ratings should continue to be used for regulatory purposes
under the federal securities laws and if so, the process of
determining whose credit ratings should be used. The Commission
also sought comment on the appropriate level of oversight that
should be applied to credit rating agencies.
Forty-six commenters responded to the concept release. Most
of the 46 commenters supported retention of the NRSRO concept.
Many represented that eliminating the concept would be
disruptive to the capital markets and would be costly and
complicated to replace. Only four commenters supported
elimination of the concept and there was very little discussion
of regulatory alternatives.
Generally, commenters supported improving the clarity of
the process for identifying NRSROs to the extent credit ratings
continued to be relied upon by the Commission in its rules and
regulations. Specifically, commenters generally supported the
Commission's suggestions to specify in more detail what credit
rating agencies need to provide to obtain an NRSRO no-action
letter. With respect to ongoing oversight, a number of
commenters recommended that the Commission enhance the staff's
ability to verify whether an NRSRO continues to meet the
minimum standards that led to its designation.
However, a number of commenters, including each of the
current NRSROs, also raised concerns about the extent of the
Commission's authority to impose requirements on NRSROs. These
commenters argued that the SEC does not have explicit
regulatory authority over NRSROs and that NRSRO rating
activities are journalistic and are afforded a high level of
protection under the First Amendment.
More recently, the Commission on March 3, 2005 voted to
issue a rule proposal that would define the term ``NRSRO'' for
purposes of commission rules. The proposal builds on earlier
commission work relating to the credit rating agencies. The
goal of the proposal is to provide greater clarity and
transparency to the process of determining whether a credit
rating agency's ratings should be relied on as NRSRO ratings
for purposes of commission rules.
The proposed definition and the interpretations thereof are
intended to provide credit rating agencies with a better
understanding of whether they qualify as an NRSRO. The proposed
definition of the term ``NRSRO'' is composed of three
components which the Commission believes to be the most
important criteria in determining whether an entity's ratings
should be relied upon for purpose of commission rules and
regulations.
Specifically, the Commission is proposing to define the
term as an entity that issues publicly available credit ratings
that are current assessments of the credit worthiness of
obligors with respect to specific securities or money market
instruments; that is generally accepted in the financial
markets as an issuer of credible and reliable ratings,
including ratings for a particular industry or geographic
segment by the predominant users of securities ratings; and
finally, uses systematic procedures designed to ensure credible
and reliable ratings, manage potential conflicts of interest,
and prevent the misuse of non-public information and has
sufficient financial resources to ensure compliance with these
procedures. These three components are described in more detail
in my written testimony.
The rule proposal also states the belief that while
adopting a definition of NRSRO would help address commenter
concerns regarding transparency, credit rating agencies might
desire to continue to seek no-action letters in order to
clarify the ability of third parties to rely on their ratings
for regulatory purposes. As such and in light of the
longstanding reliance by broker-dealers, issuers, investors and
others on the existing staff no-action process, the Commission
states in the proposal that if it were to adopt a definition of
NRSRO, it plans to continue to make commission staff available
to provide no-action letters as appropriate to those entities
that choose to seek it. No-action letters would be granted for
a specific period of time, after which the relief would need to
be reconsidered.
As I mentioned previously, a number of commenters to the
2003 concept release recommended that the Commission enhance
the staff's ability to verify whether an NRSRO continues to
meet the minimum standards that led to its designation. Due to
apparent limits on the Commission's authority in this area, the
Commission staff has worked with the current NRSROs during the
past 6 months to craft a framework for voluntary oversight by
the Commission. At this time, our dialogue with the industry
has not resulted in an agreed upon voluntary oversight
framework.
Nonetheless, I believe a strong and effective industry-led
regime could prove to be a constructive and reasonable approach
to address a number of concerns involving the credit rating
industry that have been raised in recent years by Congress, the
Commission and others such as the International Organization of
Securities Commissions.
That said, the Commission believes that to conduct a
rigorous program of NRSRO oversight, more explicit regulatory
authority from Congress is necessary. The Commission has not
taken a formal position on whether additional legislation
should be forthcoming, but it does believe that congressional
hearings on this issue are useful to ensure that this important
question is properly vetted. A well thought-out regulatory
regime could provide significant benefits in such cases as
recordkeeping and addressing conflicts of interest in the
industry.
As Chairman Donaldson said last month before the Senate
Committee on Banking, Housing and Urban Affairs, the Commission
welcomes congressional attention and of course would stand
ready to work with Congress on crafting appropriate legislation
if Congress determines such legislation is necessary.
Thank you for inviting me to testify. I welcome any
questions.
[The prepared statement of Annette Nazareth can be found on
page 30 in the appendix.]
Chairman Baker. Thank you very much, Ms. Nazareth.
I really want to start with your conclusions reached. In
Sarbanes-Oxley, there were a specific litany of, I will list
them as concerns or subjects to explore, which you made
reference to in your remarks. It would seem that the current
definition discussion by the SEC relative to what constitutes
an NRSRO really focuses on one of those points raised in the
Sarbanes-Oxley recitation, which is the potential regulatory
barrier to entry into the market.
However, the other four principal points, conflicts of
interest, anticompetitive or unfair practices, regulatory
oversight, would seem to fall in the area that you made
reference to in your concluding remarks that may be outside the
scope of current authority of the agency requiring going
forward some legislative action. Is that a fair conclusion to
reach from your comments?
Ms. Nazareth. Yes. Basically, we have the authority to use
the term in our rules and to define what the term meant. But as
you pointed out in your statement, this is a very important
area and one where people have become very reliant on this
term. As a result, we believe that it is important to not only
determine that a credit rating agency has met the terms of the
definition at the outset when the no-action letter is issued,
but also that it continue on an ongoing basis to meet that
definition.
In order to do that effectively, one would at the very
minimum need a voluntary framework to be able to oversee the
process and to ensure that those conditions continue to be met
or have a more rigorous oversight program through legislative
authority which would give us the ability to require
recordkeeping and examinations and other things that are more
akin to what a full regulatory program would entail.
Chairman Baker. Assume for the moment that we enter into a
voluntary agreement. I have some familiarity with voluntary
agreements with other enterprises. If they then choose not to
comply, the penalties are some adverse market reaction or
litigation over the terms of the contract, which would seem to
me to put the regulator in a very deficient posture.
What I am proposing is that if we can identify the areas
beyond the definition of NRSRO, that currently are not within
your enforcement authority, I would be very interested in a
statutory framework enabling the regulator to take on at least
as a minimum scope those five points identified in Sarbanes-
Oxley because that did pass the scrutiny of the committee,
voted on by the Congress. There should not be debate that those
five points are good public policy to implement. You would not,
I take it, see that as an inappropriate thing for the committee
to pursue.
Ms. Nazareth. No, not at all.
Chairman Baker. As to the proposed definition that is now
pending, it basically requires that the entity making
application for admission issue publicly available ratings, is
generally accepted in the market as an issuer of reliable
ratings, and uses systematic procedures. I am not sure I
understand how those three elements constitute something
different from what has been historic practice.
Even though we talk about ``nationally recognized'' as
being the art term, when the Commission reviews applicants'
requests for approval, it is that you have to be in the
business of credit ratings. You have to be viewed as a credible
person or entity giving good information out. Obviously, you
have to have some process to arrive at a rating.
So I am having a little trouble understanding how this
three-pronged approach is significantly structurally different
from the current NRSRO requirement. Can you enlighten me on
what you think is the distinction?
Ms. Nazareth. It is not dramatically different. You are
correct. I think after all of this analysis and the hearings
and the comments that we analyzed, it was clear that while
there are some concerns about competitive impact, the strong
majority of opinion was that this is a process that the
marketplace has come to rely upon and that there would be great
market disruption to abandon this process entirely.
That having been said, I think that we were looking to
improve the current situation. So what we did was, this is the
first time we have actually defined the term, which adds
greater transparency, makes it easier for new entrants to
understand what they will have to evidence in order to obtain a
no-action letter. We also did try to be somewhat broader in the
scope of the entities that we would recognize under the
definition.
So for example, for the first time we made it very clear
that you could be nationally recognized even if your expertise
was in a limited sector, either geographically or by topic,
that you did not have to be nationally recognized as in
everybody was using you for all purposes. So we have tried to
find other ways to address some of the competitive concerns. So
in that respect, it is a little bit different, but again we
were hoping that the transparency of the definition would also
make it somewhat easier to apply and might encourage others to
apply.
Chairman Baker. My time is out, but I am going to ask one
more, and given the fact that we have other members, try to
keep it within reasonable time constraints. The definition says
that the entity making application must have a systemic process
by which its ratings are achieved.
Ms. Nazareth. Yes.
Chairman Baker. Does Standard and Poor's have some systemic
process they publicly disclose as to how they go about their
rating process?
Ms. Nazareth. I believe that each of the NRSROs does have
internal processes that they follow in order to issue credit
ratings.
Chairman Baker. But they are not necessarily the same? They
are not necessarily disclosed to the person who is being
reviewed? In other words, if I am the business guy and I want a
rating, I would like to know what is it you are going to need
to know so I can prepare when you knock on the door. What is
worse is when you show up unannounced and do it to me anyway,
but that is another point.
Ms. Nazareth. Yes, which is another problem. I do think
that they do endeavor to apply consistent policies and
procedures across whatever sectors they are covering. I believe
that they make it clear to the entities that they are rating
what it is that the entities will need to evidence to them. A
number of their procedures, including their conflicts
procedures and the like, actually they do publish and are on
their Web sites. We think it is very important that there not
only be rigorous procedures, but that they be uniformly
followed. Obviously, it would be problematic if they had
certain high standards for rating some entities and then did
not apply those standards to others. It is a critical issue.
Chairman Baker. Just a quick follow-on, then. If I were to
request of you help secure for the committee S&P, Moody's,
Fitch, the other two entities, their systematic review of just
financial service entities. Let's just make it just banks. That
we should expect each of those systematic reviews to be
somewhat comparable and similar?
Ms. Nazareth. That is their role, that they should be
comparable.
Chairman Baker. Do you have knowledge that they are? Or
that is what you believe as to their professional
responsibility?
Ms. Nazareth. I believe that they have procedures that
establish that they should uniformly apply with respect to
their reviews. Whether or not they actually do that is another
question. I would hope that they do that, but given that we do
not have examination authority or the ability to audit that, I
cannot represent that that is what is happens.
Chairman Baker. I appreciate that problem. Thank you very
much.
Mr. Kanjorski?
Mr. Kanjorski. Ms. Nazareth, we talked about the
discussions that are ongoing. I suspect that is between the SEC
and the rating agencies?
Ms. Nazareth. Yes.
Mr. Kanjorski. How long have they been ongoing?
Ms. Nazareth. Well, it has been off and on. There were
holidays in between and other events, but I think we started
talking around November.
Mr. Kanjorski. Could you give us just your initial reaction
of how successful those discussions have been to date? I notice
the one suggestion that they are not able to be regulated
because of the protection of the First Amendment. Are the major
five rating agencies asserting that on a regular basis,
seemingly without fear?
Ms. Nazareth. It is a complicated process. I have to say
that in the past when we have negotiated voluntary initiatives
with entities, they tended to be entities that we had regulated
for other purposes and therefore were used to SEC oversight.
The question was whether or not in a new area of their business
they would agree to some sort of voluntary regime.
This is a little more difficult. I believe that the rating
agencies are dealing with us in good faith, but it is more
difficult given that they are not really as used to SEC
oversight. There are some legitimate questions on First
Amendment issues and concerns about regulators imposing
themselves into the editorial process that they are very
sensitive to. So I think it has made the discussions somewhat
more complicated, to say the least.
Mr. Kanjorski. Are you more optimistic than Chairman
Donaldson seemed to be in his testimony before the Senate?
Ms. Nazareth. I don't know if I would say more optimistic.
I certainly agree with the tenor of his testimony. I am
certainly willing to continue our discussions, but I think
Congress should continue its review at the same time and we
will see where we come out.
Mr. Kanjorski. You heard in my opening statement the fact
that I am addressing a letter today to the Commission to give
us an outline of the additional authorities you think you may
need in order to carry on an officially sanctioned involuntary
regulation of these entities. From what I gather from the
chairman's comments, he tends to agree that we now need that.
Can that be forthcoming in a reasonably short period of time?
Ms. Nazareth. Yes, we could definitely do that.
Mr. Kanjorski. I have a feeling that we have had some
consideration of this issue for a number of years now. Can you
give me a qualitative evaluation of success in that ongoing
process? Or is this just dragging along at the slowest rate to
accomplish no regulatory authority?
Ms. Nazareth. I think certainly we have had some progress
in the sense that the Commission now has proposed a rule that
is intended to add greater transparency to the process of
granting no-action relief regarding NRSROs. That is progress. I
think it is progress that Congress is partnering with us to
look at this issue and to determine whether now is the time to
have additional authority or whether to rely on private sectors
means. But I do think that this is the next opportunity to make
some progress in this area.
Mr. Kanjorski. My druthers would be that we do not have to
regulate, as I am sure Mr. Donaldson and you would join us in
that. But do you think that they doubt that we have the
backbone here in the Congress to take such action?
Ms. Nazareth. Who would doubt the backbone?
Mr. Kanjorski. These rating agencies.
Ms. Nazareth. I do not think anyone doubts your intentions.
Mr. Kanjorski. Is there any stronger message that we can
send to them? Would it be introduction of authorizing
legislation to give regulatory authority to the Commission?
Would that help in the discussions?
Ms. Nazareth. I think they are well aware of Congress's
efforts. I think to be frank, I think there is a bit of a
dilemma that they have as well, because if they start investing
the time in a voluntary initiative and congressional authority
is forthcoming, it may be that they have to switch gears and do
things somewhat differently. So they have a little bit of a
dilemma themselves in terms of whether they should at this
point invest the resources in that effort, or should they wait
for Congress to give us authority and then just wait for a
rulemaking.
Mr. Kanjorski. Does that underlie the observation on your
part that they perhaps are not doing their best in investing
time and effort in these ongoing discussions?
Ms. Nazareth. I think it is a factor. I would not say they
are not doing their best. They are five very different
organizations with different structures that also have to try
to come to some common conclusion on what to do. But I
certainly think the combination of Congress's review of this
issue as well as a number of initiatives in Europe has made it
difficult for them to assess what exactly is going to be the
landscape in which they are operating, and should they take the
lead or should they wait to see what happens.
Mr. Kanjorski. Well, if I can again urge you to get that
outline of the authorities necessary to pursue this as fast as
possible to see whether or not they can invest some of their
time in responding to the actual legislation.
Thank you.
Chairman Baker. I thank the gentleman.
Mr. Hensarling?
Mr. Hensarling. Thank you, Mr. Chairman.
Ms. Nazareth, I think you indicated in your testimony we
have five recognized NRSROs. I am curious, does the SEC have
information on just how many market participants there are out
there, how many credit rating agencies there are who have not
achieved the NRSRO status?
Ms. Nazareth. The information that we have is that there
are probably at this point over 100 credit rating agencies. The
number of participants has actually expanded quite a bit. I
think the FSA recently discussed the number of participants and
it was quite interesting to us. A great number of them have not
expressed any interest in applying for this. In other words,
their business models do not dictate that they have to be in
this NRSRO business in order to be successful.
Mr. Hensarling. Would you say that the number has been
increasing in recent years?
Ms. Nazareth. I believe it has been increasing, yes.
Mr. Hensarling. Can you discuss aspects of market evolution
or technology that might account for this fact, I guess really
over the last couple of decades, since the SEC first designated
the NRSRO regulation, back in 1975? Can you talk about trends
that might have led to the fact that there are indeed more
rating agencies now and what has led to that?
Ms. Nazareth. I gather that there is obviously a tremendous
appetite for investment in debt securities and the number of
products and the complexity of debt products have really been
explosive in the last several decades. There is an appetite and
a market for good in-depth analysis in order to understand
these products. So a number of market participants are willing
to pay for these analyses to help them better understand their
particular issues.
Mr. Hensarling. It sounds like there has been an increase
perhaps in the number of these rating agencies who are dealing
in niche markets. I believe on page six of your testimony you
talk about that even though a credit rating agency might only
rank debts, say, in a limited sector of the market or in a
geographic area, they might be able to achieve the NRSRO
status. But it does not sound like in reality or in
practicality that is actually happening, since we still have
only five. Is this correct?
Ms. Nazareth. This is the first time we have articulated
this goal of recognizing entities that are in these limited
sectors, although we have historically done so. Again, I think
it depends on whether these market participants choose to
apply. We have had several instances in the past where we would
have been more than happy to entertain the requests, but there
was no interest on the part of those credit rating agencies to
apply.
Mr. Hensarling. Last year before this subcommittee, there
was a gentleman from the American Enterprise Institute, Alex
Pollock, who called the current NRSRO designation a catch-22
because, and I am sure you have heard the argument, if you are
a non-NRSRO you have to become widely accepted to become an
NRSRO. But if you are not an NRSRO, say that three times
quickly, you cannot become widely accepted. So how do you
address his argument that we will continue to have a catch-22
under these new guidelines? If so, how will we ever go beyond
our five recognized agencies?
Ms. Nazareth. Again, I think there are, as we have said
earlier, there are over 100 of these entities, many of which
are very highly regarded in their niche markets. Should they
choose to apply, we would be very pleased to consider their
applications. We have in the past recognized NRSROs within 5
years of their beginning to rate debt securities.
So it is something that we are very obviously concerned
about and interested in. We believe that it is important for
purposes of SEC regulations that the term apply to firms that
really are providing a rating that is based on a process with
high integrity and that is widely recognized in the
marketplace.
That having been said, we do not want this regulation in
any way to impede competition or the ability for new entrants
to enter. So hopefully this new definition with its emphasis on
the niche players as well will assist in that area.
Mr. Hensarling. I see I am out of time.
Thank you.
Chairman Baker. Ms. Wasserman Schultz?
Ms. Wasserman Schultz. Mr. Chairman, I do not have any
questions. Thank you.
Chairman Baker. I thank the gentlelady.
Ms. Kelly?
Mrs. Kelly. Thank you, Mr. Chairman, for holding this
hearing.
Quite frankly, I appreciate your appearing here, Ms.
Nazareth. You state in your testimony that Congress has given
no authority to the SEC to regulate nationally recognized
credit rating agencies.
In my estimation, the ability of the SEC to identify and
define the NRSROs contains the ability to define NRSROs to
exclude from the definition any institution that fails to meet
the standards the SEC expects. Do you agree with that? Could
you please explain it?
Ms. Nazareth. Yes, we certainly have the ability to define
the term and to interpret which entities meet that definition.
What we do not have express authority to do is to have an
ongoing oversight regime to ensure that those who meet the
definition continue to do so and that some of the really
fundamental principles on which we determine to grant the no-
action letter continue to exist.
Mrs. Kelly. Which means that you are seeking authority from
Congress to rate the raters. Is that correct?
Ms. Nazareth. No. We are not seeking authority. We have no
official position on seeking authority. What is being discussed
is granting the Commission authority to have an oversight
regime for those entities who fit the definition and who have
applied for recognition.
Mrs. Kelly. The courts ruled that speech about credit
worthiness is protected by the First Amendment. Wouldn't the
explicit regulation of the NRSROs violate their First Amendment
right to speak freely on the financial markets?
Ms. Nazareth. There are issues on journalistic privilege
and First Amendment issues that do factor into this analysis,
which is why we feel that it is very important for Congress to
be involved in this determination. If Congress determines that
more regulatory oversight is necessary in this area, for
Congress to expressly grant that authority because we feel that
to take an aggressive position in this area, particularly where
there are First Amendment issues involved, would not be
appropriate.
Mrs. Kelly. I am not quite sure how the SEC authority, how
broad that is. Is it limited to how the publicly traded
companies use the information that they get, whether it is paid
or unsolicited from credit agencies? Can you define just a
little bit more about how broad that is?
Ms. Nazareth. Yes, the term was originally used for a very
limited purpose, which was to describe those entities who rated
debt securities, whose investment-grade ratings could be relied
upon by broker-dealers for purposes of some capital benefits
under the net capital rule. So it basically said if a broker-
dealer had in its portfolio bonds that were rated investment
grade, those bonds would have a lower haircut or a lower
capital charge to the firm's capital than would bonds that did
not have such a rating.
So it was really a way for the Commission to determine that
to give this regulatory or capital relief, but doing so in a
way that it felt was responsible in that the ratings that were
being relied upon were generally accepted as reliable and
credible ratings. It was used for that purpose.
What happened was the term over time became a useful proxy
for creditworthy ratings, and was used in other SEC regulations
and then was used in a number of regulations, both by the
states and abroad. We feel that given the reliance that is put
on this definition that it would be certainly more appropriate
to have some sort of ongoing review of whether the entities
that enjoy this designation continue to meet up to the terms of
the definition.
Mrs. Kelly. Credit rating agencies have been accused of
maintaining high ratings on some issuers and arbitrarily
lowering others. I am amazed at some of the stories that I have
read where schools have been bent over backwards by some of
these agencies, municipalities, businesses. I think the public
really does not know that schools, municipalities and
businesses have to pay the credit rating agencies in order to
get those credit ratings.
It seems to me that instead of trying to regulate the
NRSROs, the market might be best served to encourage as many
people to go into the credit reporting field as possible in
order to provide a lot of viewpoints, and then let market
forces make whatever corrections they are going to make in that
field. I would be interested in what your response is to that.
Ms. Nazareth. I think, as I said before, there are a number
of people in this field. There are over 100 credit rating
agencies. Again, this term was used by the Commission for much
more narrow purposes and has taken on a life of its own. There
is nothing in the use of the term or there is nothing that
would in any way require investors to rely solely on the
ratings of these raters. There are a number of other services
that they could use.
Mrs. Kelly. I am sorry. I really did not understand that.
You said there are a lot of people in the field, but there are
only five NRSROs.
Ms. Nazareth. Right.
Mrs. Kelly. There are hurdles, if I understand the
Chairman's and Mr. Kanjorski's and Mr. Hensarling's comments,
hurdles that these other agencies really have to jump, and
there have been precious few. It seems to me congressional
pressure has pushed the SEC to at least admit two more agencies
because there were originally only three.
I do not see how these others in the field are going to get
into the business if we have high hurdles and more regulation.
I am out of time. Thank you, Mr. Chairman.
Chairman Baker. I thank the gentlelady.
Ms. Brown-Waite?
Ms. Brown-Waite. Thank you very much, Mr. Chairman.
I came in probably towards the end of your testimony, but
the basic question that I have is that in your new proposal,
you are apparently limiting it solely to implementation of a
definition and you do not plan to take any other action with
regard to NRSROs without specific statutory authority.
Have you asked for that statutory authority? You may have
covered this in your testimony.
Ms. Nazareth. The Commission has not yet taken a position
on whether it is requesting statutory authority. What the
Commission has done is make clear that it believes that to do
more would require statutory authority.
Ms. Brown-Waite. I think you are repeating what I said. Are
you requesting statutory authority?
Ms. Nazareth. No, we are not at this time officially
requesting statutory authority.
Ms. Brown-Waite. So if I understand you correctly, then you
are just going to do the same old-same old and not expand the
number of them?
Ms. Nazareth. That has nothing to do with the statutory
authority question. That goes to the definitional question. We
would be able to, I believe, designate or recognize additional
credit rating agencies as NRSROs under this definitional
rulemaking that we have done. Whether or not we have the
authority to do more ongoing oversight of those entities once
they receive the no-action letter, that goes to the issue of
authority, ongoing oversight, examinations, recordkeeping
requirements, potential registration requirements.
But the Commission does have the authority to define the
term ``NRSRO'' and that is what the proposed rulemaking seeks
to do. It also seeks to expand potentially the universe of
firms who would be able to satisfy that definition by making it
clear that one could be ``nationally recognized'' even though
that firm is really more recognized for a limited sector of the
market or a limited geographical area. So there is a
recognition that while we feel we need to have high standards
in the definition, we also do not want the definition to
preclude additional parties from being able to apply and to
obtain the NRSRO no-action letter.
Ms. Brown-Waite. After Enron and WorldCom, I think the
question needs to be asked: Who really has oversight over these
NRSROs? Do the firms require continuous education? Our whole
economy was thrown on its heels partially as a result of the
Enron and WorldCom scandals. So what kind of self-governing,
maybe is my question, do they engage in?
Ms. Nazareth. Well, all the credit rating agencies have
policies and procedures in place that include standards on the
educational backgrounds of the people they hire and on how
frequently they review the firms that they rate and the like.
Those procedures are supposed to obviously be rigorously
internally enforced.
Frankly, one of the issues that we will have whether or not
the Commission gets authority here is that there are some
things that it will be difficult for regulation to address.
Regulation is not going to make anybody faster or smarter, but
we can require that people have rigorous procedures that they
follow and hopefully that in and of itself will improve the
process. Certainly having procedures on conflicts of interest
and disclosure of nonpublic information and the like is
important to have in any industry. But it certainly will not be
a guarantee against mistakes in the future in any area.
Ms. Brown-Waite. I do not think you answered my question,
and maybe you are not the right person to answer this, but who
really governs the NRSROs?
Ms. Nazareth. They are not regulated.
Ms. Brown-Waite. They are not regulated at all? Totally not
regulated?
Ms. Nazareth. As part of the no-action process, they were
registered as investment advisers, but really their advisory
work is minimal at best. So for these purposes, their credit
rating processes are not regulated.
Ms. Brown-Waite. Thank you.
Chairman Baker. I am going to start a second round. Since
we have a limited number of members, it will not take long.
Just to follow on to Ms. Brown-Waite's observations, there
is no process clinically established in law or in regulation on
how you become one of these things. Up to the contemplated rule
now pending, you had to be nationally recognized. If you were
not national, you could not be considered.
Now we have a three-part test which is sort of nationally
recognized. You do not have to be national in organizational
scope, with offices from California to New York, but you have
to be recognized nationally for your work in the field of oil
futures. You have to have the financial stability to be able to
operate on a national basis and have a proven record of
credible, reliable, analytical work.
Strangely enough, that standard does not now apply to those
who are NRSROs. We do not know, for example, that all five have
the similar procedure for gauging the financial credit
worthiness of all those in the oilfield sector. One could be
using one methodology; one could be using another. But the
investment company world requires that that oilfield company
which is going to issue public debt have at least two ratings
from two independent entities.
When you look at the way the structure of the current
process works, the profit margins are excessively egregious,
and that is only because we have the voluntary disclosure by
some of their rates of return. Some do not even disclose their
financials period. They are the only entities that have an
exception from Reg FD. They can get access to material fact
that no other person can get and make disclosure of subsequent
to some civil or criminal action, and they can make selective
disclosure of information pursuant to executive interview.
Then they say if we are going to have the SEC either by
rule or by statute come in and perform an audit of the books to
find out if somebody has cooked their books or if somebody is
running off to Tahiti with shareholder funds, they say wait a
minute, you are going to abridge our First Amendment rights.
Huh? If you want to find out as to the analysts who are
performing the work have been previously accused of fraudulent
activities in the world of accounting, they hold up the First
Amendment shield.
Now, the First Amendment shield only goes to the
preparation and release of a statement publicly made. By
removing their designation as an NRSRO, they can still make all
the statements they want, they just cannot charge very much for
them. Therein is the problem. We have a monopoly governmentally
granted without a clear standard of conduct to maintain
professional accreditation. By the way, there has never been
any entity designated an NRSRO that has ever been
decommissioned, and I would like in a minute to ask what is the
process to decommission someone if you find out that they have
engaged in blatant fraudulent conduct.
These enterprises are not outside the law. There is no law.
This is the Wild West, and if you ride through their ranch and
you do not pay their fee, you get shot. You are required under
the Investment Company Act to ride across their ranch. If you
do not pay their freight, you are in real trouble. Plus, they
will show up on your ranch unannounced, perform an audit, and
then give you a B rating when you ought to be an A rating. What
is your recourse?
They have the public operating companies of this country by
the throat. This has got to be at least subject to disclosure
and awareness by the public as to what is going on here because
4 days before Enron, the three NRSROs that were designated at
that time in our country's history all of them listed Enron as
investment-grade investments.
Now, you remember what this committee did to the analysts
and the investment bankers for missing it by a year? What are
we going to do to these guys for missing it by 4 days? And yet
we still have a commission that has been reviewing this matter
for over a decade. This committee has been looking at it for
almost that long.
I do not make this to be interpreted as any kind of threat
at all. I am saying this out of frustration. We need to help
you. We need to give you the authority to act. We need to make
sure that these people are responding to the market need in
professional criteria. And we will have legislation.
Now, I cannot speak to the content of that bill. I do not
know your ability, given the lack of commission direction at
this point to be able to comment, and I do not want to get you
in that adverse position. But should you and those of your
office choose to work with us in the formulation of a bill that
is responsive, I have no confidence in a voluntary agreement. I
have had bad experiences with those.
So I think going forward, we are just going to have to give
the agency the ability to regulate and subsequently to that or
concurrent with that, figure out a way to get past this NRSRO
designation business and let people who want to rate, rate. We
do not do that in the securities and the equities world. We
have all sorts of analysts giving all kinds of ratings all day
long. If you want a rating, I am sure you can find the one you
want because they are all over the map. The point is the market
works without having a governmental designation of who should
become a rating agency.
Back to my question, since I rambled on for my entire time,
has there ever been an NRSRO once designated ever
decommissioned? And is there a process for doing so?
Ms. Nazareth. There has not been one that has been
decommissioned. Again, I am not sure what I would conclude from
that because certainly one of the issues is the ability to do a
rigorous ongoing oversight, which more authority would give us.
Since there has not been as rigorous ongoing review----
Chairman Baker. Let me help you. What you are saying is the
regulator does not have the tools to know whether they are
doing a good job or a bad job. Therefore, how could you
decommission them without the facts?
Ms. Nazareth. But we certainly do have the authority to
remove the no-action letter. As with any market participant, we
have enforcement authority to go after any sort of illegal act
under the securities laws.
Chairman Baker. So you would tell me that over the course
of the 1980s and the 1990s, when investment bankers, analysts,
securities markets, mutual funds, everybody you can name in the
financial services sector got it wrong and there were people
held criminally accountable in most cases, that the monopoly of
the credit rating agencies was above the fray and did
everything right.
Ms. Nazareth. It was not subject to the same regulatory
oversight as those entities.
Chairman Baker. Thank you very much.
Mr. Kanjorski?
Mr. Kanjorski. Mr. Chairman, what I love about you is you
make me look like a flaming conservative.
[Laughter.]
I think we are pretty much in agreement that the committee
wants to do something that will arm the SEC with the authority
to accomplish its end. I do not know I am as far as the
Chairman on these conclusions, but certainly we are both
thinking along those lines.
Chairman Baker. I will give you a little time. You will get
there.
[Laughter.]
Mr. Kanjorski. I will come there.
The one question I did want you, Ms. Nazareth, to address,
in the 1990s the Commission came very close to issuing rules
and regulations regarding the control of the credit rating
agencies, and then they did not act. At that time, therefore
they must have made the conclusion that they had the legal
authority to do that. Has anybody revisited why that has
changed? I know at the time I do not think they could get a
majority of the Commission to adopt the rule, but somebody must
have structured the legal authority there in existing law.
Ms. Nazareth. Even in the 1990s, the proposal from 1997 was
quite similar to the proposal that the Commission put out for
comment last month. It was marginally more aggressive on the
authority side, but not terribly so. I think that in light of
various challenges to the Commission's authority and in light
particularly of the First Amendment issues that have been
raised, we think it would be prudent to wait for authority to
do anything beyond the definitional term.
Mr. Kanjorski. The comments that the Chairman made
regarding almost extortion, have you heard complaints of this
or factual information that would support that in some
instances these entities have acted in that regard?
Ms. Nazareth. I think historically there were complaints
about unsolicited ratings. My understanding was that several
years ago the Department of Justice actually looked at it and
took no action. My understanding is also that since that time,
the rating agencies became I think more sensitive to the issue.
I have not heard quite the number of complaints in recent years
that we did in the past. I think that there has been more of a
sensitivity to indicating on the rating itself that it was
unsolicited. But I think unsolicited ratings do still exist,
but I am not sure at quite the same magnitude that they did in
the past.
Mr. Kanjorski. Okay. The only other question that I have
is, you talked about a remedy as releasing the use letter? Or
withdrawing the use letter?
Ms. Nazareth. Withdrawing the letter, yes.
Mr. Kanjorski. How could you do that if you have no
criteria on which it is issued?
Ms. Nazareth. The criteria was always articulated in the
area, what we had looked at in order to issue the letter. So
certainly if we became aware of the fact that the basis on
which the letter was issued no longer applied, we could
withdraw the letter. The question is how much comes to our
attention and whether there is an ongoing process to examine
for that.
Mr. Kanjorski. There is no question, though, that we should
get involved in this area.
Ms. Nazareth. I think Chairman Donaldson was quoted that we
welcome your involvement.
Mr. Kanjorski. Thank you very much, Mr. Chairman.
Chairman Baker. I thank the gentleman.
Ms. Kelly?
Mrs. Kelly. Thank you, Mr. Chairman.
Ms. Nazareth, I received a letter that indicated, it was
actually from S&P. It indicates that S&P ratings was designated
as an NRSRO in 1976, although it did not affirmatively seek
that status. If they could be declared an NRSRO without
applying and without affirmatively seeking that status, can't
the SEC just declare a company an NRSRO without asking the
designee?
Ms. Nazareth. At that time, the request was made by members
of the brokerage industry who wanted to be able to rely on S&P
ratings for purposes of the capital rule. So there was a
request. It was not made directly by S&P.
Mrs. Kelly. If other agencies now, credit rating agencies,
had the same event happen, couldn't the SEC declare a company
an NRSRO without the designee asking?
Ms. Nazareth. It is a little difficult because it still
requires the cooperation of the entity because there are a
number of things, as the definition of the proposed rule would
imply, that we would have to look at. There is a lot of
proprietary information that we would only be able to get if we
had the cooperation of the entity. But certainly, more recently
I think the requests have come directly from the credit rating
agencies themselves, but originally the procedure was that the
securities industry would ask whether they could rely on the
ratings of a particular credit rating agency for purposes of
the rules.
Mrs. Kelly. What if a consumer asked for a credit agency to
be rated? What you implied by your answer to me, if I
understand you correctly, is yes, the SEC could if the person
who someone has asked to be rated an NRSRO, if they cooperated
with you, you could go ahead and rate them as an NRSRO if
someone came forward and said, I would like to see this agency
put in. Can the consumer do that?
Ms. Nazareth. We have two different ways. Either the credit
rating agency that wishes to be considered an NRSRO asks
directly, or an entity that has to make use of the term for our
rules has to ask for it. So it is not just a consumer asking
for it. A consumer I do not believe would have standing here.
It would either be in this case S&P or someone who has to use
the term for purposes of the rules.
Mrs. Kelly. I am just thinking of a group of schools or
colleges. If they banded together and said, look, we would like
you to declare this credit rating agency, which is currently
not an NRSRO, to be an NRSRO, and that credit rating agency
worked with you, you could in fact declare them to be an NRSRO.
Is that correct?
Ms. Nazareth. Yes. Any credit rating agency could apply. As
long as they cooperate, we could treat it as if they had
applied themselves.
Mrs. Kelly. I have another question about the rule that has
not yet been published. Basically, from what I understand,
there are a bunch of different prongs. One of them says that an
NRSRO must be ``generally accepted'' as an issuer of credible
and reliable ratings. Another one says an NRSRO must use
systematic procedures to ensure ratings quality, manage
conflicts, prevent misuse, et cetera, et cetera.
My question is that both of those terms, ``generally
accepted,'' ``systematic procedures,'' are very difficult to
define. Without very precise wording on the definitions, I do
not see the transparency needed here for people to understand
what your rule is going to say. Are there going to be very
specific definitions beyond just these two terms?
Ms. Nazareth. Those are the definitions that the release,
which you have not had the opportunity to read, will set forth
on how one would go about satisfying the various prongs. It
would give examples of what a credit rating agency could show
the Commission to evidence that it meets that criteria. It asks
whether, because it is a proposal, it asks whether other
indicia should be considered as well. So at this point,
obviously it is a proposal. It is not the final rule, but it
does give a lot more meat to the definition and asks for
comment on additional criteria.
Mrs. Kelly. I think the most important thing here is that
we make sure that anything that happens with regard to
oversight, and it is clear to me, I agree with our chairman and
Mr. Kanjorski, I think there is a need for us to really examine
this and get it right. But we definitely need transparency, and
I am very concerned about reducing regulatory barriers because
to do that opens up the market which I think can only be good.
I am a true believer in free markets.
Thank you very much for testifying today.
Ms. Nazareth. Thank you.
Chairman Baker. Thank you, Ms. Kelly.
Ms. Wasserman Schultz?
Ms. Wasserman Schultz. Thank you, Mr. Chairman.
Ms. Nazareth, I just wanted to ask you to clear up some
confusion because a couple of minutes ago in response to a
question you said that you would welcome, as a result of
Chairman Donaldson's indication, our involvement, but you are
in the process of preparing a voluntary framework.
So I guess I want to have you clarify the seemingly
conflicting statements. Do you think a voluntary framework is
enough and how would it work? Or do you think we should get
involved as a congress and statutorily require regulation?
Ms. Nazareth. We have not arrived at a final voluntary
framework, so it is not possible for us to say whether that
would be sufficient. I do think that this committee has
expressed enough concern about the issue that I think it would
be inappropriate to say that the committee should not on its
own consider the issue, particularly since it is a very nuanced
one. It does go beyond simply regulating an entity. It does
raise First Amendment and other issues that have to be balanced
in the process. That is why I think it is an appropriate issue
for Congress to address.
Ms. Wasserman Schultz. Do you have an opinion on whether or
not you think a voluntary framework is enough? It is not that
it is not appropriate for you to comment. You are in the
process of developing a voluntary framework.
Ms. Nazareth. I cannot speak for the Commission on the
issue, and frankly I do not think the Commission has really
been able to fully vet the issue either. But I guess what I am
concerned about is that, or at least to be cautious about, is
that Congress rightfully has high expectations of what they
expect to happen in this area, and if you are looking, frankly,
for a regime that is most similar to other regulatory regimes
we have, it would be very difficult for a voluntary initiative
to meet all of those criteria.
For instance, to require people to maintain books and
records similar to what a broker-dealer would require or to
permit our examiners to go in and request emails, all the
things that we do with broker-dealers I think would be unlikely
to be achieved through a voluntary initiative.
On the other hand, I am sure there are some real benefits
that we could achieve through a voluntary initiative. So it
partly depends on what people's expectations are, whether they
want to do it in a two-step process to see how a voluntary
initiative goes, or whether they think now is the time to go
consider a more full-blown regulatory program.
Ms. Wasserman Schultz. Okay, thank you.
I yield back the balance of my time.
Chairman Baker. I thank the gentlelady.
I certainly want to express my appreciation to Ms. Nazareth
for appearing here today. As is evidenced, the various members
have different perspectives on the issue, but suffice it to say
there is concern about moving forward. We certainly wish to be
cooperative with and of assistance to the SEC in its
deliberations.
We look forward to working with you in the coming days.
Ms. Nazareth. Thank you very much.
Chairman Baker. Our meeting stands adjourned. Thank you.
[Whereupon, at 3:19 p.m., the subcommittee was adjourned.]
A P P E N D I X
April 12, 2005
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