1          UNITED STATES SECURITIES AND EXCHANGE COMMISSION

             2                                              (REVISED 01-17-03)

             3

             4

             5

             6              HEARING ON THE CURRENT ROLE AND FUNCTION

             7             OF CREDIT RATING AGENCIES IN THE OPERATION

             8                     OF THE SECURITIES MARKETS

             9

            10

            11

            12

            13                    Thursday, November 21, 2000

            14                             9:00 a.m.

            15

            16                          Washington, D.C.

            17

            18

            19

            20

            21        BEFORE:   HARVEY PITT, Chairman

            22                  PAUL ATKINS, Commissioner

            23                  CYNTHIA A. GLASSMAN, Commissioner

            24                  HARVEY GOLDSCHMID, Commissioner

            25                  ROEL CAMPOS, Commissioner






             1   PARTICIPANTS:

             2

             3   YASUHIRO HARADA

             4   Senior Executive Managing Director 

             5   Rating and Investment Information, Inc.

             6

             7   STEVEN W. JOYNT

             8   President and Chief Executive Officer 

             9   Fitch, Inc.

            10

            11   JAMES A. KAITZ

            12   President and Chief Executive Officer 

            13   Association for Financial Professionals

            14

            15   AMY B.R. LANCELLOTA

            16   Senior Counsel 

            17   The Investment Company Institute

            18

            19   JACK V. MALVEY

            20   Managing Director and Chief Global Fixed-Income Strategist 

            21   Lehman Brothers Inc.

            22

            23   ERWIN W. MARTENS

            24   Managing Director 

            25   Putnam Investments, LLC






             1   LARRY G. MAYEWSKI

             2   Executive Vice President and Chief Ratings Officer, Ratings

             3   Division, The A.M. Best Company

             4

             5   RAYMOND W. MCDANIEL

             6   President 

             7   Moody's Investor Services, Inc.

             8

             9   STEPHANIE B. PETERSEN

            10   Senior Vice President

            11   Taxable Money Fund and Municipal Research 

            12   Charles Schwab & Co., Inc.

            13

            14   BARRON H. PUTNAM, Ph.D.

            15   President and Financial Economist 

            16   LACE Financial Corporation

            17

            18   PAUL SALTZMAN

            19   Executive Vice President and General Counsel 

            20   The Bond Market Association

            21

            22   STEVEN L. SCHWARCZ

            23   Professor of Law

            24   Duke University School of Law 

            25






             1   DAVID L. SHEDLARZ

             2   Chief Financial Officer 

             3   Pfizer Inc.

             4

             5   NEAL E. SULLIVAN

             6   Partner 

             7   Bingham McCutchen LLP

             8   (on behalf of Rating and Investment Information, Inc.)

             9

            10   JEROME B. VAN ORMAN, JR.

            11   Vice President, Finance and CFO, North American Operations 

            12   General Motors Acceptance Corporation

            13

            14   J. BEN WATKINS, III

            15   Director, Division of Bond Finance

            16   State of Florida

            17

            18   SEC STAFF:

            19   Bob Colby

            20   Larry Harris

            21   Tom McGowan

            22   Michael A. Macchiaroli

            23   John McCarthy

            24   Annette L. Nazareth

            25






             1                          C O N T E N T S

             2                                                            PAGE

             3

             4   Session I:  THE CURRENT ROLE AND FUNCTION OF

             5        CREDIT RATING AGENCIES

             6        Annette L. Nazareth, Director, Division of

             7             Market Regulation                                8 

             8

             9   Session II:  INFORMATION FLOW IN THE CREDIT

            10        RATING PROCESS

            11        Lawrence E. Harris, Chief Economist, Office

            12             of Economic Analysis                            64 

            13

            14   Session III:  POTENTIAL CONCERNS REGARDING THE 

            15        ROLE OF CREDIT RATING AGENCIES (CONFLICTS

            16        OF INTEREST/ABUSIVE PRACTICES)

            17        John A. McCarthy, Associate Director, 

            18             Office of Compliance Inspections and 

            19             Examinations                                   129 

            20

            21   Session IV:  POTENTIAL BARRIERS TO ENTRY/REGULATORY

            22        TREATMENT

            23        Robert Colby, Deputy Director, Division of 

            24             Market Regulation                              179 

            25






             1                       P R O C E E D I N G S

             2             CHAIRMAN PITT:  Apparently the fog has delayed some

             3   of our panel.  I think we're ready to begin, so good morning. 

             4   I'd like to welcome everyone to the second round of the

             5   Commission's rating agency hearings.  And if today's hearing

             6   is anything like the last one, I'm certain everyone will find

             7   the time spent worthwhile, and certainly not boring. 

             8             As I noted in my introductory remarks at the first

             9   hearing, rating agencies have been providing opinions on the

            10   creditworthiness of issuers of securities and other financial

            11   obligations for nearly a century.  And during this time, the

            12   importance of these opinions to investors and other market

            13   participants and the influence of these opinions on the

            14   securities markets has increased exponentially, particularly

            15   with the increase in the number of issuers and the

            16   introduction of new and complex financial products.  The

            17   globalization of the financial markets also has served to

            18   expand the role of credit ratings to jurisdictions beyond

            19   just the United States.  

            20             So today credit ratings affect securities markets

            21   in a number of important ways, including an issuer's access

            22   to, and cost of, capital, the structure of financial

            23   transactions, and the ability of fiduciaries and others to

            24   invest in particular securities and instruments.  In

            25   addition, regulators such as the Securities and Exchange






             1   Commission have increasingly used credit ratings as a

             2   convenient surrogate for the measurement of risk, in

             3   assessing investments held by regulated entities. 

             4             Because of the impact of rating agencies on the

             5   investing public, and our capital markets, we announced in

             6   March that we would engage in a thorough examination of

             7   ratings agencies, to ascertain facts, conditions, practices,

             8   and other matters relating to the role of rating agencies in

             9   the U.S. capital markets.  Since then, the Sarbanes-Oxley Act

            10   has directed us to conduct a study of the rating agencies, so

            11   there's a confluence between our initially announced hearings

            12   and our legislative mandate. 

            13             These hearings represent the culmination of months

            14   of effort by the staff and the Division of Market Regulation,

            15   our Division of Investment Management, and our Office of

            16   Compliance Inspections and Examinations.  I'd like to thank

            17   the staff for their tremendous efforts in organizing these

            18   hearings.  I'd also like to thank the members of our panel

            19   for taking the time to appear with us today.  They do so

            20   donating their time and their thoughts and their expertise to

            21   us, and we're very grateful to each of you for taking that

            22   time. 

            23             And now I'll turn these proceedings over to Annette

            24   Nazareth, director of our Division of Market Regulation, who,

            25   along with Bob Colby, has been a driving force behind






             1   organizing these sessions.  Annette?

             2             MS. NAZARETH:  Thank you, Chairman Pitt.  I, too,

             3   would like to welcome all of you to the Commission's second

             4   credit rating agency hearing.  I found our first hearing,

             5   held just this past Friday, to be extraordinarily productive. 

             6   As you may know, that hearing followed the same format that

             7   we're going to use today, and our panel was comparably

             8   balanced. 

             9             Participants in our first hearing engaged in a

            10   lively and candid dialogue that shed light on many of the

            11   difficult and important issues concerning the role of rating

            12   agencies in our securities markets.  If today's discussions

            13   are comparably forthright and substantive, I have no doubt

            14   that our hearings will have achieved their goal of providing

            15   the Commission with valuable real world insights as it

            16   pursues a variety of important objectives relating to credit

            17   rating agencies. 

            18             Several initiatives currently are under way at the

            19   Commission that will benefit from these hearings.  For

            20   example, the Commission has been directed by Congress to

            21   conduct a study of the role and function of credit rating

            22   agencies in the operation of our securities markets.  This

            23   directive was issued in Section 702 of the recently enacted

            24   Sarbanes-Oxley Act of 2002, which also directs the Commission

            25   to submit a report on the study to the President and Congress






             1   by January 26, 2003.  

             2             It is our goal and expectation that these hearings

             3   will enable us to parse, in a more meaningful way, the areas

             4   of consideration set forth in Section 702.  Specifically,

             5   these areas include the role of credit rating agencies in the

             6   evaluation of issuers of securities; the importance of that

             7   role to investors and the functioning of the securities

             8   markets; any impediments to the accurate appraisal by credit

             9   rating agencies of the financial resources and risks of

            10   issuers of securities; any measures which may be required to

            11   improve the dissemination if information concerning resources

            12   and risks when credit rating agencies announce credit

            13   ratings; any barriers to entry into the business of acting as

            14   a credit rating agency and any measures needed to remove such

            15   barriers; and any conflicts of interest in the operation of

            16   credit rating agencies, and measures to prevent such

            17   conflicts, or ameliorate the consequences of such conflicts. 

            18             Another goal of these hearings is to assist the

            19   Commission in determining how its regulatory framework should

            20   best be applied to credit rating agencies.  For over 25

            21   years, the Commission has been using credit ratings from

            22   nationally recognized statistical rating organizations, also

            23   known as NRSROs, in Commission rules and regulations.  

            24             During this time, the Commission has considered a

            25   number of issues related to credit rating agencies, including






             1   the need for direct oversight authority over credit rating

             2   agencies, and the appropriate role of ratings in the federal

             3   securities laws.  Nonetheless, there remain a number of

             4   difficult issues, many of which are reflected in Section 702

             5   of Sarbanes-Oxley, that the Commission would like to review

             6   before formally considering possible changes to the rules and

             7   regulations regarding rating agencies.  Our agenda today

             8   reflects these issues. 

             9             Before I introduce today's participants, I will

            10   briefly mention some details concerning our schedule.  This

            11   morning, we'll have two sessions.  We'll begin with our

            12   opening session, with brief introductory remarks from each of

            13   the hearing participants, and we'll then discuss in some

            14   detail the current role and functioning of credit rating

            15   agencies.  This session will last 90 minutes and will be

            16   followed by a 15-minute break from about 10:30 to 10:45.  

            17             Our second session this morning will explore the

            18   information flow in the credit rating process.  That is, how

            19   rating agencies obtain and use information in the rating

            20   process, and how, and what type of information is

            21   communicated publicly and privately to issuers of credit

            22   ratings.  At 12:15 we'll break for lunch for about an hour

            23   and 15 minutes, and we'll resume with our afternoon program

            24   at 1:30.  

            25             This afternoon from 1:30 to 3:00, we will focus on






             1   concerns regarding the role of credit rating agencies, such

             2   as potential conflicts of interest and abuse of practices,

             3   and our final panel from 3:15 to 4:45 will address potential

             4   barriers to entry in the rating business, and the appropriate

             5   degree and manner of regulatory oversight of rating agencies.

             6             As you see, we have a very ambitious agenda to

             7   cover in a relatively short period of time.  So with that out

             8   of the way, I'd like to introduce each of the participants,

             9   and then circle back for any opening remarks that you may

            10   wish to make.  First, I would like to introduce our

            11   Commissioners who are here today.  In addition to Chairman

            12   Pitt, who again, we're very grateful took the leadership role

            13   in calling for these hearings, we have Commissioner Atkins,

            14   Commissioner Goldschmid, Commissioner Campos, and

            15   Commissioner Glassman.  We also have some staff at the table

            16   today.  We have Bob Colby, Larry Harris, and Tom McGowan. 

            17   And John McCarthy from OC will be joining us a little bit

            18   later.         So I'd like to introduce -- again, briefly

            19   introduce our group of participants, and then I'll come back

            20   and give each of you an opportunity, if you wish -- it's not

            21   required -- but if you wish to make an opening statement.  I

            22   notice our first panelist was intended to be Steven Schwarcz. 

            23   He's a little bit delayed.  He's a professor from Duke

            24   University School of Law.  

            25             We have Barron Putnam, who is the president and a






             1   financial economist with LACE Financial Corporation.  We have

             2   also, a little bit delayed, David Shedlarz, who is chief

             3   financial officer of Pfizer; Stephanie Petersen, who is with

             4   Taxable Money Fund and Municipal Research at Charles Schwab;

             5   Jerome Van Orman, who is vice president, finance, and CFO,

             6   North American operations of General Motors Acceptance

             7   Corporation; Larry Mayewski, who is executive vice president

             8   and chief ratings officer of the ratings division of A.M. 

             9   Best Company; Erwin Martens, who is a managing director of

            10   Putnam Investments; Paul Saltzman, executive vice president

            11   and general counsel of the Bond Market Association; Raymond

            12   McDaniel, who is the president of Moody's Investor Services,

            13   Inc.; Steven Joynt, who's president and chief executive

            14   officer of Fitch; Amy Lancellota, who is a senior counsel

            15   with the Investment Company Institute.  

            16             I guess we have one other person who's late.  Is

            17   that right?  Jack Malvey will be joining us.  He's a managing

            18   director and chief global fixed-income strategist at Lehman

            19   Brothers.  We have James Kaitz, who is president and chief

            20   executive officer of the Association of Financial

            21   Professionals.  We have Yasuhiro Harada, who is senior

            22   executive managing director of Rating and Investment

            23   Information, Inc.; Neal Sullivan, who's a partner at Bingham

            24   McCutchen, who's here on behalf of Rating and Investment

            25   Information; Ben Watkins, who is director of the state of






             1   Florida division of bond finance.  

             2             I thank you all very much for making the time to

             3   spend the whole day with us.  So I'll turn back and start

             4   with Mr. Putnam, and give you an opportunity to make an

             5   opening statement. 

             6             MR. PUTNAM:  Thank you.  I greatly appreciate the

             7   opportunity to be able to come and discuss these issues with

             8   you.  First, I'd like to talk about the application process

             9   for NRSRO status.  I believe, in our case, anyway, it can be

            10   greatly expedited.  I think the -- if the SEC recognizes that

            11   there is, indeed, need for competition in this industry, then

            12   it should do all it can to help new entrants into the

            13   industry itself.  I don't feel that my company, LACE

            14   Financial Corporation -- I feel we need all the current

            15   standards, and the past standards for NRSRO status.  However,

            16   those standards are tight for a relatively new company trying

            17   to enter into the business. 

            18             And I think, at best, you could take more of a

            19   positive approach to helping applicants gain status.  In

            20   other words, if you feel there's a problem with their

            21   application, you should be clear and up-front with them, and

            22   tell them as such.  I also feel there should be more

            23   transparency in the whole process. 

            24             In our case, over the eight years that we had our

            25   application in at the SEC, we received two letters.  The






             1   first letter in 1992 acknowledged we had submitted our

             2   application.  I might add that we tried to obtain -- join

             3   that process two years even prior to that period.  And then

             4   eight years later, we received a telephone call from Mr.

             5   McGowan here, stating that our application was denied. 

             6             I had to ask him to, in fact, send us a letter

             7   stating the denial.  I also asked for the reason for the

             8   denial.  And we never really received a clear reason for the

             9   denial, as such.  So I basically feel that the greatest

            10   barrier for entry into this industry is the SEC itself.  

            11             The net capital rules dissuade brokerage houses on

            12   Wall Street to hold securities of NRSRO companies, because

            13   there's a penalty as such.  The application process is in

            14   fact a barrier.  Without NRSRO status, it is very, very

            15   difficult to compete with the likes of Moody's, Standard &

            16   Poors and Fitch.  They're a tough bunch.  They have very good

            17   name recognition and such.  But if you don't -- if you're not

            18   on a level playing field, it's very difficult. 

            19             About 10 years ago, when Thomson Bankwatch received

            20   NRSRO status, they were our main competitor.  Now think

            21   Fitch, to some degree, in what we do.  When they received

            22   that status, our company just stopped growing, and we really

            23   haven't grown much since that time.  And if you -- and that's

            24   really a 10-year delay in trying to come up with a competitor

            25   to compete with the larger rating agencies.  And I think you






             1   need to do this, if you feel competition is needed.

             2             Now, that's not something for me to suggest.  There

             3   are others here for that purpose.  But you need to help the

             4   applicants that come to your door if they are, in fact,

             5   credible rating agencies.  I think I do believe in the NRSRO

             6   criteria.  I think that you need to make sure that you have

             7   quality people rating financial institutions as a whole. 

             8   They have to not only -- and they have to have the

             9   credibility.  To me, credibility is everything.  And if you

            10   don't have it, you shouldn't be in the business. 

            11             Just one other remark.  As to whether the industry

            12   should be regulated.  I do think that some regulation is

            13   needed.  I think there needs to be a group of persons, or an

            14   institute, in fact, that someone, like particularly the small

            15   investor, can complain to, and someone that can look into

            16   those complaints.  And in fact, if they're very serious,

            17   refer them to such places as the Justice Department.  

            18             I think this is very important.  But I think you

            19   have to be very careful in regulating the industry in how you

            20   do it.  That it, itself, doesn't become a barrier to entry. 

            21   Thank you. 

            22             MS. NAZARETH:  Thank you.  Stephanie?

            23             MS. PETERSEN:  Thank you.  On behalf of the Charles

            24   Schwab Corporation and its affiliates and subsidiaries,

            25   including U.S. Trust Corporation, collectively referred to as






             1   Schwab, I thank the Commission for giving me an opportunity

             2   to participate in these hearings.  

             3             Schwab has approximately 8 million active

             4   customers, most of which are individual retail investors. 

             5   These customers place their assets in a wide variety of

             6   financial products, including 57 proprietary mutual funds,

             7   known as Schwab funds, aggregating more than $140 billion in

             8   total assets. 

             9             Within that 57 there are 19 money market funds,

            10   aggregating approximately $120 billion, and several bond

            11   funds totaling about $3 billion.  Separately, through our

            12   U.S. Trust subsidiary, customers may invest in one of 29

            13   funds, with approximately $12 billion in assets.  

            14             There are two principal areas with Schwab where the

            15   rating agency data is used on a consistent basis; management

            16   of the various Schwab and Excelsior funds, as well as

            17   recommending individual fixed income securities to our

            18   customers.  

            19             As you know, the rating agencies have a prominent

            20   role in the fixed income markets, from contributing to the

            21   efficiency of the market, to setting standards for risk and

            22   credit structures.  Within the money market arena, the SEC

            23   has given NRSROs a quasi-regulatory role by incorporating

            24   their ratings into rule Rule 2a-7.  Further, ratings have

            25   become more widely used as triggers that can affect






             1   marketability of some securities.  

             2             With more than $120 billion in money fund assets

             3   under management, we at Schwab closely track the ratings and

             4   opinions each NRSRO publishes on more than 3,000 securities. 

             5   Our experience has generally been a positive one, with rating

             6   agency analysts adding valuable information and insight to

             7   our own independent credit monitoring process.  I, it's our

             8   ability to understand and anticipate the changes in the

             9   rating agencies' views as one of the key factors in

            10   maximizing returns for our customer assets.  

            11             This is not only true for a specific credit, like a

            12   bank or an asset-backed security.  It's important in

            13   monitoring the creditworthiness of other deals, such as those

            14   where rating triggers may cause an issuer to lose funding, or

            15   be forced to increase reserves or capital to maintain a

            16   certain credit rating.  

            17             While our experience has been generally very good,

            18   we believe that there are opportunities for improving the

            19   overall effectiveness of the rating agency system.  I agree

            20   with Mr. Putnam, in that increased competition is an area to

            21   be focused on.  Over the last several years, mergers have

            22   reduced the number of NRSROs from seven to three.  This

            23   consolidation has all but eliminated price competition for

            24   both issuers, and users of the date, and significantly

            25   reduced the opportunity for hearing various points of view. 






             1             Opening the market to additional NRSROs, perhaps by

             2   allowing others to enter, entirely or on a niche basis, would

             3   allow for other views to be heard and recognized. 

             4   Introducing additional NRSROs may also serve to increase the

             5   competitiveness of pricing and overall market efficiency.  

             6             The second big area for us is transparency.  Again,

             7   I know you've heard this from many others, but we'd like to

             8   get a better feel for the actual information that the

             9   agencies use as a basis for establishing or changing ratings

            10   at the time that they're initially given, or as they change. 

            11   What we've noticed of late is that there seems to be a cliff,

            12   where ratings change instantaneously, as opposed to taking

            13   advantage of putting things on watch or outlook, to give us

            14   some idea of the general direction. 

            15             And lastly, accountability.  It would be helpful

            16   and enlightening to see disclosure of exactly how well each

            17   agency anticipates the changes in creditworthiness of the

            18   entities and securities that it rates, as well as the

            19   relative timeliness of any changes.  Thank you. 

            20             CHAIRMAN PITT:  Before we move on, Dr. Putnam, I am

            21   curious about when you were notified about a rejection of

            22   NRSRO status. 

            23             MR. PUTNAM:  That was about in 2000.  I'm not sure

            24   exactly the date.  I can go back and find that out.  The

            25   division of market regulation probably knows that date.  I'm






             1   sorry, I don't know the month, but it was in the year 2000,

             2   sir. 

             3             MS. NAZARETH:  Why don't we go next to Mr. Van

             4   Orman, and then we'll give Mr. Shedlarz a couple minutes to

             5   get settled in. 

             6             MR. VAN ORMAN:  Good morning.  My name is Jerome

             7   Van Orman.  I am vice president of finance for General Motors

             8   Acceptance Corporation in Detroit, Michigan, as well as chief

             9   financial officer of its North American automotive financing

            10   operations.  In a prior executive position, I served as vice

            11   president of borrowings for GMAC, responsible for GMAC's

            12   global funding activities.  I'm a member of GMAC's liability

            13   risk committee, and have been an active participant since

            14   1986 in GMAC's semiannual meetings with U.S. and Canadian

            15   rating agencies.  

            16             I have submitted a written statement discussing

            17   commercial paper credit ratings.  In my statement I argue

            18   that in today's U.S. money and capital markets, there is a

            19   credit cliff in the commercial paper market, which does not

            20   exist to the same extent in the term debt capital market. 

            21   From personal experience, I can say that it is possible for

            22   an A minus-rated company to more easily issue five-year notes

            23   than 30-day commercial paper.  

            24             In my opinion, the current rating agency practice

            25   of tightly linking or correlating commercial paper rating






             1   tiers with term debt ratings tiers has contributed to the

             2   credit cliff situation.  Put another way, the effect of

             3   comparable short- and long-term credit ratings on the

             4   availability and cost of funds across the yield curve in

             5   today's credit markets is inconsistent with attendant

             6   negative consequences for the financial system and the

             7   economy. 

             8             I believe the credit rating agencies should

             9   consider changes to existing commercial paper rating

            10   practices, to help alleviate the credit cliff situation.  I

            11   wish to thank the SEC for conducting this hearing, and

            12   eliciting the views of market participants.  I appreciate the

            13   opportunity. 

            14             MS. NAZARETH:  Thank you.  Should we circle back to

            15   Mr. Shedlarz?  Would you like to make a statement?

            16             MR. SHEDLARZ:  Surely.  Thank you.  The best laid

            17   plans are always tripped up by fog, even in Washington.  So I

            18   apologize for being late.  Good morning, I'm David Shedlarz,

            19   chief financial officer and executive vice president of

            20   Pfizer, Inc.  

            21             The credit agency process is of substantial

            22   interest to our company, both in terms of financing and in

            23   the investment arena.  In terms of financing, Pfizer remains

            24   one of the few industrial companies awarded the highest

            25   triple A rating.  The triple A rating is an integral part of






             1   our debt financing strategy.  Our company has in excess of

             2   $10 billion in borrowings, issued in a variety of

             3   instruments, with maturities ranging over the next seven

             4   years, with the principal and interest payable in multiple

             5   currencies, and trading both in the United States, as well as

             6   in the international markets. 

             7             On the investment side, Pfizer's financial asset

             8   portfolio exceeds $15 billion.  It is comprised of financial

             9   instruments, with over 200 in individual counterparties based

            10   throughout the world.  Rating agencies provide one of the

            11   primary tools for specifying risk parameters for investment

            12   activities. 

            13             The SEC has specifically exempted nonpublic

            14   information given to rating agencies from the requirements of

            15   FD.  We are aware of the potential concern that this has

            16   raised over how the agencies might justify ratings based on

            17   nonpublic information.  We believe that the current ongoing

            18   dialogue between the rating agencies and the issuers that

            19   employ their service benefits from this exemption, in

            20   allowing the rating agencies to confirm perspectives

            21   developed from an analysis of SEC filings, press releases,

            22   and other sources of information.  

            23             The financial market's recovering from a period of

            24   unprecedented deterioration in the credit quality of

            25   investment-grade obligors.  This experience has led many to






             1   wonder about the timeliness and predictive accuracy of the

             2   rating process itself.  At the same time, there is growing

             3   transparency in the market, in terms of the pricing of any

             4   particular facility or credit.  More and more practitioners

             5   are using the results of analytical assessments to either

             6   substitute or complement the traditional rating agency

             7   assessment. 

             8             We, of course, are closely following the rating

             9   agencies, as they adapt their process to evolving in a very

            10   dynamic marketplace.  We are participants, and the change in

            11   dialogue that the rating agencies are having with --

            12   entities, and regarding concerns attendant in supplying

            13   relevant nonpublic information to facilitate the process. 

            14   And we also welcome the opportunity to participate in the

            15   SEC's panel today. 

            16             MS. NAZARETH:  Thank you.  Mr. Mayewski. 

            17             MR. MAYEWSKI:  Good morning, my name is Larry

            18   Mayewski.  I am executive vice president and chief rating

            19   officer at A.M. Best Company.  Before I offer a few brief

            20   comments, and a little background on A.M. Best, I just 

            21   want to thank the Commission for the opportunity to be here

            22   today, and hopefully, I will be able to bring some value to

            23   today's deliberations. 

            24             As way of background, the A.M. Best Company

            25   celebrated its 101st anniversary as the premier global rating






             1   agency and information source for the insurance industry last

             2   year.  The A.M. Best Company is privately held.  It was

             3   established in 1899 by Alfred M. Best.  We are currently

             4   located in Oldwick, New Jersey, and employ 550 people

             5   approximately. 

             6             For over 100 years we have been providing the

             7   public and financial services community with comprehensive

             8   and unbiased information on insurance companies.  We began

             9   rating the financial strength of property insurers in 1906

            10   and life insurers in 1928.  Prior to February of 1999, A.M.

            11   Best only assigned financial strength ratings to insurers. 

            12   However, in February of 1999, we began assigning and

            13   publishing ratings on debt, preferred securities, and

            14   commercial paper issued by insurers and insurance holding

            15   companies.  

            16             We believe the expansion of our rating activities

            17   into the securities rating arena is a logical and natural

            18   extension of what we've been doing, in providing financial

            19   strength ratings and reports on insurance companies to

            20   investors, policy holders, and analysts. 

            21             Today we assign interactive financial strength

            22   ratings on over 3,600 insurers worldwide, and rate over 450

            23   securities issued by approximately 115 insurers or insurance

            24   holding companies.  Our financial strength and securities

            25   ratings of insurers are widely recognized by virtually all






             1   parties involved in insurance matters.  

             2             In May of this year, A.M. Best formally applied for

             3   recognition as an NRSRO.  And once again, on behalf of A.M.

             4   Best, I would like to thank the Commission for the

             5   opportunity to participate in these hearings. 

             6             MS. NAZARETH:  Thank you.  Mr. Martens?

             7             MR. MARTENS:  Yes.  Good morning, my name is Erwin

             8   Martens.  I am the chief risk officer at Putnam Investments

             9   in Boston.  Putnam Investments is one of the largest mutual

            10   fund managers in the United States.  We manage over $250

            11   billion in assets.  We have 13 million plus institutional and

            12   retail clients throughout the United States and overseas.  

            13             As the chief risk officer, I'm responsible for risk

            14   management pertaining to fund management itself, as well as

            15   counterparty risk management pertaining to the trading of

            16   derivatives, over-the-counter derivatives, as well as

            17   operational risk.  We are intensive users of the rating

            18   agency information across the board.  We manage funds that

            19   range all the way from money market funds through fixed

            20   income, through the equity sphere.  We have coverage in

            21   domestic, as well as international areas, and as well as

            22   emerging market funds. 

            23             We have found our relationship with the rating

            24   agencies to be very fruitful.  We do maintain our own

            25   independent assessment of issuers, and we use the rating






             1   agency information to augment our approaches.  I would echo

             2   the fact that recently there have been significant

             3   developments on the analytical side, in terms of advancing

             4   the science pertaining to rating agency work, and we feel

             5   that that's been very beneficial to the industry. 

             6             MS. NAZARETH:  Paul Saltzman?

             7             MR. SALTZMAN:  Thank you.  My name is Paul

             8   Saltzman, and I'm executive vice president and general

             9   counsel of the Bond Market Association.  We are the global

            10   trade association that represents banks and broker-dealers

            11   active in the international fixed-income markets.  And I'd

            12   like to echo other thoughts of my fellow panelists here, to

            13   commend the staff and the Commission on these hearings.  

            14             As you will see from our statement, one of the main

            15   points that the association believes can be brought to bear

            16   is increased transparency.  We are very comfortable with the 

            17   current regulatory framework, although we do believe that

            18   rating the NRSRO designation process, as well as an

            19   understanding of ratings and what they're used for, can be

            20   more transparent, and our submitted paper suggests a few

            21   things in that regard. 

            22             Ratings are also ubiquitous, certainly in the

            23   fixed-income market, but it's also important to understand

            24   that they are simply one part of an overall mix of

            25   information that both the investment, and bank, and broker-






             1   dealer community rely upon.  I look forward to participating

             2   in the hearings today.  Thank you. 

             3             MS. NAZARETH:  Thank you.  Mr. McDaniel?

             4             MR. MCDANIEL:  Thank you.  I'm Ray McDaniel, the

             5   president of Moody's Investor Service.  On behalf of my

             6   colleagues from Moody's, I thank the Securities and Exchange

             7   Commission for the opportunity to participate in today's

             8   panel.  Moody's believes that this examination will encourage

             9   best practices in our industry, and will support the

            10   integrity of the service that we provide.  

            11             Ratings and rating agencies have, obviously, been

            12   visible participants in the capital markets, especially over

            13   the past year.  As such, and now as market participants

            14   formally contribute their observations and opinions about

            15   ratings, it's useful to acknowledge the competing views.  For

            16   example, in various commentaries, I believe the Commission

            17   has now heard that rating agencies are too slow in lowering

            18   ratings or deteriorating credits; rating agencies are too

            19   quick to lower ratings, and otherwise cause healthy companies

            20   to fail, or cause them harm; rating agencies rate issuers too

            21   high, because we're compromised by receipt of fees from

            22   issuers; and rating agencies rate issuers too low, because

            23   we're overly conservative and reactionary. 

            24             In Moody's opinion, the commentary has been

            25   thoughtful and in good faith, but the diversity of views






             1   highlights the proliferation of users, uses, and expectations

             2   that have been placed on ratings.  Let me, therefore, offer

             3   Moody's view on what a Moody's rating is, and how a Moody's

             4   rating should be used. 

             5             Moody's ratings provide predictive opinions on a

             6   borrower's likelihood to repay debt in a timely manner.  Our

             7   ratings reduce information asymmetry between borrowers and

             8   lenders, and fulfill their role through broad, free

             9   dissemination to the general public.  Our methodology is

            10   based on analysis of financial statements, together with

            11   management, industry, and macroeconomic information.  And

            12   compared with alternative measures of credit risk, our

            13   ratings are relatively stable, because they attempt to

            14   respond not to transitory events, but rather, to more basic

            15   and lasting changes in creditworthiness. 

            16             Certain characteristics of our ratings, including

            17   public dissemination, predictive content, breadth of

            18   coverage, and objectivity, have encouraged the use of ratings

            19   as proxy tools across a wide range of functions, employed by

            20   numerous groups, with different intended goals.  We,

            21   therefore, believe that the decision to study and,

            22   potentially, to act to improve the quality of ratings

            23   necessarily hinges on the ultimate goal of the rating system,

            24   and the adequacy of market mechanisms already in place which

            25   advance the realization of that goal. 






             1             We hope and expect that any formal adjustments to

             2   industry oversight or structure align with our existing

             3   market service objections.  We have succeeded as a business,

             4   and have served the financial markets for 102 years.  We have

             5   done so first inside the U.S., and now internationally, in

             6   jurisdictions that license rating agencies, and in those that

             7   do not, and against the landscape of continuously and rapidly

             8   evolving financial markets. 

             9             We are dedicated to offering the best quality

            10   credit assessments available globally, and our published,

            11   verifiable track record indicates that we've done a good job. 

            12   I look forward to participating in today's panel, and again

            13   thank you. 

            14             MS. NAZARETH:  Thank you.  Steven Joynt?

            15             MR. JOYNT:  Thank you for having me come and

            16   participate today in this panel discussion.  We have

            17   exhibited our ten-page letter describing many of our views,

            18   so I'll try to make my introductory comments relatively

            19   brief.  

            20             My name is Steven Joynt.  I'm president and chief

            21   executive officer of Fitch Ratings.  Our roots trace to Fitch

            22   Publishing Company, which was established in 1913.  Fitch was

            23   first recognized as an NRSRO in 1975.  Since 1989, when the

            24   company was recapitalized, and a new management team was

            25   brought in, Fitch has expanded significantly through both






             1   internal growth, and through mergers with other smaller

             2   NSRSOs. 

             3             Our goal has been to create a global, full-service

             4   rating agency competent in producing independent research and

             5   ratings, with a fundamental analysis focus, providing

             6   competition, and promoting investor choice.  Fitch Ratings

             7   has made, and is making, an important contribution as an

             8   NRSRO, and provides many public benefits.  Fitch Ratings has

             9   400,000 ratings available publicly to all securities

            10   investors.  Fitch has created original research, new analytic

            11   models, and promoted greater transparency in the ratings

            12   industry.  

            13             Fitch Ratings has an open website, with press

            14   releases, ratings, presale reports, and general research, all

            15   available for free.  We believe that investors value our

            16   rating, because the ratings provide a convenient, reliable

            17   way to assess the credit quality of an investment. 

            18             Through the years, ratings have been increasingly

            19   used in regulation.  And while the use of ratings in

            20   regulation has not been without controversy, we believe that

            21   regulators rely on NRSRO ratings for the same reason that

            22   many investors do.  They're easy to use, there's a widespread

            23   availability, and there's proven performance over time. 

            24             Fitch Ratings meets the standard of benchmarking

            25   that the market seeks.  Default studies of ratings from Fitch






             1   show competence in differentiating credit risk, and our

             2   ratings transition studies and default results are comparable

             3   to other rating agencies. 

             4             I think it's important to note that 50 percent or

             5   more of Fitch's activities and revenues in the last 13 years

             6   has come from activity in securitization analysis, and Fitch

             7   has an excellent reputation among securitization investors. 

             8   It may be valuable today to spend more time discussing the

             9   role of NRSROs as it relates to securitization and public

            10   finance markets, and the implication for those markets, than

            11   in last week's session, where more time was spent on

            12   corporate credit analysis and corporate ratings. 

            13             We would suggest there are at least four things to

            14   talk about today that could be done better, as you were

            15   seeking to discover last week.  One is to demand more

            16   transparency from issuers, which I know the SEC is working

            17   on, and also from rating agencies, which we have been a

            18   proponent of.  We would not suggest that you throw out the

            19   NRSRO designation, or the requirements and the qualifications

            20   that go along with it.  We think that those are constructive

            21   for the market, and it would be destructive, and eliminate

            22   competitors, were you to do that. 

            23             We also feel that ratings are better because of the

            24   Reg D exemptions that rating agencies have, and would suggest

            25   that you not eliminate them.  And I'd be happy to talk about






             1   that more later.  

             2             We also would suggest that you would do better by

             3   not allowing NRSROs to discriminate among the other NRSRO

             4   ratings, and also that you prohibit anticompetitive conduct

             5   among the rating agencies. 

             6             In summary, Fitch Ratings feels the NRSRO system

             7   has provided value, and that Fitch is a competent,

             8   independent, and valuable global rating agency, but we appear

             9   here today open to all suggestions on how to improve our

            10   industry's performance and our performance.  Thank you. 

            11             MS. NAZARETH:  Thank you.  Amy Lancellota?

            12             MS. LANCELLOTA:  Good morning.  I'm Amy Lancellota,

            13   senior counsel of the Investment Company Institute.  The ICI

            14   is the national association of the American investment

            15   company industry.  We, too, commend the SEC for holding these

            16   hearings.  We believe they will provide a better

            17   understanding of the role of credit rating agencies in our

            18   nations securities markets, and will assist in evaluating the

            19   adequacy of existing regulation of those agencies. 

            20             NRSRO ratings play a significant role in the

            21   investment decisions of retail and institutional investors. 

            22   The Commission and other regulatory agencies also rely upon

            23   these ratings as assessments of investment risk for

            24   regulatory purposes.  In view of the NRSROs' importance in

            25   the marketplace, and significant reliance by investors and






             1   regulators on the ratings, the ICI believes that they should

             2   be subject to greater regulatory oversight. 

             3             The designation of NRSRO status should be the

             4   beginning, and not the end, of the SEC's oversight.  No-

             5   action letters designating agencies as NRSROs leave it to

             6   them to self-police their own activities.  But because of the

             7   financial impact that withdrawal of NRSRO designation could

             8   have on a rating agency, the NRSROs have a strong

             9   disincentive to report any such changes in circumstances. 

            10             In addition, the investment advisor registration

            11   and regulatory scheme applies awkwardly to NRSROs, and does

            12   not provide adequate regulatory oversight.  Therefore, to

            13   improve the system, we recommend the following: 

            14             First, the SEC should more vigorously monitor

            15   compliance with the criteria it employs in the initiation

            16   designation of an NRSRO.  To accomplish this, the SEC's

            17   inspection staff should schedule more frequent examinations

            18   of the NRSROs, and they should focus on whether the agencies

            19   have the necessary national recognition, staffing, resources, 

            20   structure, internal procedures, and issuer contacts to serve

            21   as NRSROs.  

            22             Second, there should be greater transparency of the

            23   NRSROs' operations and methodologies.  The SEC should require

            24   NRSROs to disclose various types of information, such as

            25   their policies and procedures addressing conflicts of






             1   interest. 

             2             Third, the SEC should establish a periodic public

             3   comment and review process, something perhaps modeled along

             4   the lines of what the FCC does with respect to their

             5   broadcast license renewal process, under which licensees must

             6   periodically reapply, and the FCC solicits public comment on

             7   the licensee's performance.  

             8             It seems that the best way to ensure that an NRSRO

             9   continues to meet the most critical attribute for an NRSRO,

            10   which is that it is a nationally recognized issuer of

            11   credible and reliable credit ratings by the users of those

            12   ratings, would be to periodically solicit public comment on

            13   that particular rating agency. 

            14             And finally, we believe that NRSROs should be

            15   accountable for their ratings.  In addition to being free

            16   from all but minimal regulation, the rating agencies are also

            17   relieved of any legal accountability for their ratings.  The

            18   broad exemption from liability under Section 11 of the

            19   Securities Act means that NRSROs are not held to a negligence

            20   standard of care.  The rating agencies also maintain that

            21   they are members of the media that are providing their

            22   opinions, and thus claim that they can only be liable if

            23   their conduct can be said to have been reckless. 

            24             To implement our recommendations, the Commission

            25   should evaluate its existing regulatory authority.  Should






             1   they determine that the regulatory authority is insufficient

             2   to impose a more effective regulatory structure on NSRSOs, we

             3   recommend that the Commission seek such authority from the

             4   Congress.  Thank you. 

             5             MS. NAZARETH:  Thank you.  

             6             MR. MALVEY:  Thank you for inviting Lehman Brothers

             7   to participate in this fascinating discussion.  I hope that

             8   I'll be able to offer some worthwhile insights about the role

             9   of rating agencies across the global debt capital markets. 

            10             For over the past 27 years, including the past 19

            11   on the sell side, I've worked as a credit analyst, head of

            12   investment grade credit research, corporate bond strategist,

            13   and chief global fixed-income strategist at Lehman.  In the

            14   spirit of openness, I should also state that I worked as a

            15   rating analyst at Moody's from June 1978 through November 1983.

            16             In my role, the rating agencies have been an

            17   indispensable contributor to the tremendous growth of the

            18   global fixed-income market over the past century.  Based

            19   primary in the agencies' credit quality classifications,

            20   trillions of dollars of capital have been successfully

            21   channeled to economically worthy purposes. 

            22             The long-term performance of the rating agencies

            23   over the past century has been admirable.  Numerous academic

            24   studies have confirmed a very high correlation between

            25   aggregate credit risk and ratings.  There are no mortals or






             1   institutions with perfect clairvoyance.  As economists and

             2   market strategists can well attest, forecasting the future

             3   can be difficult.  Likewise, ratings cannot be perfect

             4   predictors of ultimate credit risk for every single issuer. 

             5             After each major corporate bankruptcy or sovereign

             6   default, markets engage in a natural bout of second-guessing. 

             7   This is a healthy exercise.  Through such post mortems,

             8   credit diagnostics are improved.  In my view, additional

             9   regulatory oversight of rating agencies in unnecessary. 

            10   Through the years, the rating agencies have consistently

            11   demonstrated a zeal to enhance the rating methodology, and

            12   depending upon its nature, further regulatory oversight might

            13   introduce new subjectivities to the rating process that could

            14   lead to the misallocation of capital. 

            15             The credit markets may well benefit from the

            16   presence of additional officially recognized rating agencies. 

            17   In turn, we would favor the Commission's willingness to more

            18   quickly designate applicants as NRSROs.  In the end, the

            19   markets should determine which rating agencies should be

            20   relied upon for the most accurate sorting of credit risk.  I

            21   look forward to the following discussion.  

            22             MS. NAZARETH:  Thank you.  Mr. Kaitz?

            23             MR. KAITZ:  Good morning.  I'm Jim Kaitz, president

            24   and CEO of the Association for Financial Professionals, and

            25   we appreciate the opportunity to be here today.  AFP






             1   represents approximately 14,000 finance and treasury

             2   professionals employed by over 5,000 organizations.  The

             3   organizations represented by our members are drawn generally

             4   from the Fortune 1000, and the largest of the middle market

             5   companies in a wide variety of industries.  Our members are

             6   significant users of rating agency information, and have a

             7   sizeable stake in the outcome of the current debate

             8   surrounding credit rating agencies.  

             9             Many of our members are responsible for issuing

            10   short- and long-term debt, and investing corporate cash and

            11   pension funds for their organizations.  Our members have

            12   consistently indicated to us that they are concerned about

            13   the information provided by information agencies.  

            14             In response to our members' concerns, AFP conducted

            15   a survey to learn their views on the quality of credit

            16   ratings, and the regulation of rating agencies by the SEC. 

            17   The results of the survey, which were released earlier this

            18   month, show that a significant number of corporate

            19   respondents do not believe that their companies' ratings, or

            20   the ratings of the companies in which they invest are

            21   accurate or timely. 

            22             AFP believes that the credit rating agencies are

            23   vital to the efficient operation of capital markets, and is

            24   pleased that the SEC is examining the role played by rating

            25   agencies, and the regulation by the SEC.  We hope that these






             1   hearings will bring to light opportunities to increase

             2   competition in the market for credit ratings, and improve the

             3   quality of the information provided by credit rating

             4   agencies, for the benefit of issuers and investors in the

             5   securities markets in the United States.  Thank you. 

             6             MS. NAZARETH:  Thank you.  Mr. Harada?

             7             MR. HARADA:  Thank you very much.  Good morning. 

             8   Rating and Investment Information, Inc. and I appreciate the

             9   opportunity to participate in this hearing on credit rating

            10   agencies organized by the SEC.  We believe that the area

            11   identified in the Sarbanes-Oxley Act for consideration

            12   deserve thorough examination for the benefit of the investing

            13   public and the healthy growth of the global capital market. 

            14   We are honored to be part of this process. 

            15             As the largest rating agency in Asia, providing

            16   rating services to issuers and investors worldwide, R&I

            17   provides ongoing rating services to 795 issuers, including

            18   104 non-Japanese entities in connection with 4,625 issues. 

            19   R&I's rating process and issuers' analysis are geared toward

            20   one purpose.  That is to ensure credible and consistent

            21   ratings.  

            22             As an example of R&I's demonstrated ability to

            23   provide consistently high credit quality ratings, Morgan

            24   Stanley Dean Witter Japan has rated R&I as the best overall

            25   rating agency in yen-denominated securities for the last two






             1   years.  Morgan Stanley studies agencies' rating methodologies

             2   -- the correlation between the security rating and the spread

             3   over the Japanese government bond in the secondary market,

             4   and finally, the persuasiveness of the rationale supporting

             5   the firm's rating. 

             6             R&I is proud of its 25-year track record,

             7   demonstrating its consistent relation between the default

             8   ratio and these ratings.  Today R&I is a respected

             9   independent source of the financial information for the

            10   overwhelming majority of the U.S. broker/dealers and the

            11   financial institutions that conduct operations in Japan, and

            12   provides a variety of the rating services to U.S. and foreign

            13   companies. 

            14             Ratings services strictly serve to increase the

            15   efficiency of the capital market by providing useful credit

            16   risk references.  The demand for the reliable rating has

            17   dramatically increased as the global integration of the

            18   capital market has progressed in recent years.  The rating

            19   agency must meet such demand in a way that contributes to the

            20   sustained growth of the market.  

            21             Although a rating agency with the expertise in a

            22   particular area, such as R&I, already provides rating

            23   services to the U.S.-based financial institutions, the

            24   current U.S. regulatory framework discourages many issuers

            25   and investors in the United States from realizing the benefit






             1   of the expanded source of the expertise, simply because they

             2   have not been recognized by the SEC. 

             3             As the SEC has determined to rely on ratings in

             4   many of these regulations, R&I acknowledges the need for some

             5   regulatory growth for the SEC to recognize highly qualified

             6   rating agencies.  But the current no-action process should be

             7   replaced.  The application procedure proposed by the SEC in

             8   1997 is a step in the right direction.  It provides a formal

             9   procedure with specific criteria in order to be recognized as

            10   an approved rating agency.  We concur with most of the

            11   criteria proposed.  

            12             Nevertheless, we are concerned that the national

            13   recognition criterion imposes a barrier for a rating

            14   organization that has an established record but has not been

            15   nationally recognized in the opinion of the staff of the SEC.

            16             Investors and issuers alike must be allowed to have

            17   ready access to high quality ratings by the agencies that

            18   have demonstrated their ability to provide consistent and

            19   reliable ratings.  Additionally, the SEC procedure must

            20   permit the approval of the rating agency with a demonstrated

            21   expertise in the discrete area of the rating services. 

            22             Finally, in order to ensure the timely designation,

            23   the application procedure should have a specific time

            24   schedule of the SEC action.  We hope today's discussion will

            25   assist the SEC in the effort to bring the U.S. regulatory






             1   framework commensurate with the current demand of the global

             2   capital market.  Thank you very much. 

             3             MS. NAZARETH:  Thank you.  Next I'll ask Ben

             4   Watkins. 

             5             MR. WATKINS:  Good morning.  I'm Ben Watkins, with

             6   the division -- director of division of bond finance for the

             7   state of Florida, and our primary business function is to

             8   borrow money on behalf of the state.  And as such, we have

             9   ongoing interaction with rating agencies.  

            10             Perhaps the most meaningful contribution that I can

            11   make this morning is to contrast the municipal market with

            12   other sectors of the fixed-income industry, because they're -

            13   - and to highlight some of the significant differences that

            14   are important to understand from a regulatory perspective. 

            15             First and foremost, the nature of the municipal

            16   market is just different.  The organic makeup of the

            17   municipal market is unique, and it reflects a tremendous

            18   diversity of the issuer base and the securities that they

            19   issue.  Over 50,000 issuers make up the municipal market,

            20   with over 150,000 different bond issues outstanding for those

            21   50,000 issuers.  And they come in all different shapes,

            22   sizes, and colors.  Everything from large, frequent issuers,

            23   who are relatively sophisticated in accessing the capital

            24   markets, to very small and infrequent issuers, who don't have

            25   the same experience and familiarity with the process. 






             1        Q    In addition to the disparity of size and

             2   sophistication of issuers, you also have different segment --

             3   the issuer base is made of both general governments, and

             4   conduit issuers.  General governments being made up of

             5   states, cities, counties, towns, school districts.  Versus

             6   conduit issuers, which are authorities such as industrial

             7   development authorities, housing authorities, hospital

             8   authorities and the like, who I characterize as corporate

             9   borrowers in the government markets.  They are typically

            10   single-purpose entities who enjoy the benefits of tax-exempt

            11   financing, and exemptions from the securities regulation.  My

            12   perspective in the discussions this morning is going to be

            13   from a general governmental issuer. 

            14             Secondly, the dynamics that led to the blowup in

            15   the corporate markets and precipitated Sarbanes-Oxley and the

            16   forum here today simply do not exist in the municipal market. 

            17   There is no profit motive for governments.  There is no

            18   incentive to have things appear as they are not. 

            19             Secondly, the command and control structure is

            20   decentralized.  The governing boards of these governmental

            21   issuers are public bodies, elected officials, whose

            22   proceedings and deliberations are open to the public, and

            23   whose decisions are subject to public scrutiny.  So it is a

            24   very transparent process, with checks and balances in place.

            25             And lastly, the default rate in the municipal






             1   market for general governmental issuers is extraordinarily

             2   low.  Over the last 20 years, the default rate has ranged

             3   from 100th of 1 percent up to four-tenths of one percent,

             4   depending on the type of bond we are talking about.  And that

             5   is a significant difference between governmental bonds and

             6   other sectors of the municipal market. 

             7             The rating agencies have played a central role in

             8   the municipal market, by serving as a gatekeeper, in a sense,

             9   and assuring the quality of paper that's distributed in the

            10   municipal markets.  Also, the rating agencies, through their

            11   surveillance activities, provide significant meaningful

            12   information to the secondary market.  

            13             The default risk in the municipal market is further

            14   reduced by the tremendous growth in the use of bond

            15   insurance.  Last year over half of all new issues brought to

            16   the municipal market were credit enhanced with bond

            17   insurance.  These firms have very qualified analysts who

            18   evaluate credit risk, and do ongoing surveillance,

            19   independent of the rating agencies, who are truly motivated

            20   because their employers have capital at risk.  Also,

            21   analytical staff exists in the mutual fund industries as

            22   proxies for retail investors. 

            23             So there are multiple layers of protections in the

            24   municipal market, and significantly, inherently less risky

            25   securities embedded in the structure of the municipal market. 






             1   So although this is a little off center from the primary

             2   purpose of the meetings here today, I think it's important to

             3   understand some of the distinctions and the differences from

             4   a regulatory perspective. 

             5             MS. NAZARETH:  Thank you.  I think these remarks

             6   have been very helpful.  I'm also impressed with the fact

             7   that a number of you seem to have listened to the last

             8   hearing that we had, and have made some good suggestions on

             9   areas that we might focus on, that would be a little bit

            10   different than the last time, or perhaps to have a little bit

            11   more emphasis.  I've heard more interest again in talking

            12   about securitized products, the municipal market.  Perhaps we

            13   can have a little more focus in our conversations on issues

            14   of accuracy and timeliness, greater transparency of issuers,

            15   and rating agencies themselves.  If we can, we would like to

            16   talk a little more than perhaps we did last time about

            17   potential anticompetitive practices and the like. 

            18             But to get started, I thought it would be useful

            19   for us to hear -- again, it's hard to do briefly, but try to

            20   be brief -- from the rating agency representatives here about

            21   what the process is for issuing and monitoring credit

            22   ratings, again, keeping in mind that we would need you to

            23   distinguish between the types of products.  We did hear a lot

            24   in the last hearing about the corporate markets.  So by all

            25   means, we would be interested in hearing, to the extent that






             1   your firm does provide ratings for municipals or securitized

             2   products, as well, and what procedures your agency uses to

             3   rate the different types of issuers.  

             4             Why don't I just go in order, and start with Mr.

             5   Putnam. 

             6             MR. PUTNAM:  Well, LACE Financial really is kind of

             7   a small company that specializes in the rating of financial

             8   institutions, and the criteria that we use, developed a long

             9   time ago out of the Federal Reserve Board, and with the other

            10   agencies, I chaired the committee that put together the

            11   rating system for the Fed, the FDIC, and the comptroller of

            12   the currency.  And it was all a surveillance program.  It was

            13   new technology that came into being that day, where we had

            14   standardized items and definitions for items, and we used

            15   regulatory reports. 

            16             We like regulatory reports, mainly because, one,

            17   they're signed by the -- usually the chief financial officer

            18   of the institution, and if they're not correct, or if they're

            19   -- people can go to jail over these, particularly if they do

            20   not fulfill these requirements correctly.  So we have a lot

            21   of -- we take as long as value from these particular reports.

            22             But we follow every other type of releases.  We

            23   take the releases on the larger banks.  We also rate foreign

            24   banks, and have done so for about 15 years now, and receive

            25   any information we can from these institutions, as well as






             1   from SEC filings and things of that sort.  But we do not

             2   charge banks to rate them.  That's why -- that's where we're

             3   different from the existing NRSRO companies.  And I think

             4   that's always been a problem in our application process.  We

             5   just come at it from a different angle.  

             6             The process that we use is, going through, and just

             7   like any standard financial analysis that one does, we use

             8   the computer a lot, but we have three financial analysts that

             9   go over every rating before it's established.  But you go

            10   through the balance sheet and income statement, like any

            11   analyst would, and determine an overall financial soundness

            12   rating.  

            13             Now, we do this -- and this is something, I think,

            14   where we add benefit, particularly for bank -- for issuing

            15   bank ratings -- that we do this quarterly.  So that you can

            16   see a trend in the rating process.  If -- our ratings go from

            17   A to E, and if you see it fall from A, B, C or so, investors,

            18   it's a warning.  It's a warning that the condition is

            19   declining.  

            20             We re-rate every quarter.  We do not go through and

            21   just confirm a rating.  We go through the total rating

            22   process each quarter.  Now, one of the -- I think one of the

            23   products that we're providing to Wall Street now is, is a lot

            24   of these structured preferreds for community banks, and that

            25   -- they're getting involved in this.  And what we're doing






             1   is, the whole issue -- we're following this issue every

             2   quarter for these -- in other words, the pool.  It's a pool,

             3   and we take a look at every member of that pool, and

             4   reevaluate it every quarter, so that they know exactly what

             5   the problems they have are within that pool. 

             6             So I don't know if I'm completely answering the

             7   question.  I don't want to take too much time. 

             8             MS. NAZARETH:  That's very helpful.  Thank you. 

             9             COMMISSIONER GLASSMAN:  I have a question before

            10   you move on.  If you're not charging the issuers, how do you

            11   get paid, and why did you choose that model?

            12             MR. PUTNAM:  Well, Cynthia, we did this because the

            13   -- I'm, as you know, from the Fed, and I was in the division

            14   of bank supervision and regulation, and I had trouble doing

            15   that.  I always felt that there was a bias when money is

            16   exchanged for a rating.  That may or may not be the case, but

            17   I had that feeling.  And I felt that if my product is good

            18   enough, people will pay for it.  In other words, they pay for

            19   the services that we provide.  I believe the other agencies

            20   also charge for their ratings in some capacity or not, but

            21   they also charge to issue that rating.  We just don't charge

            22   to issue that rating.  

            23             Now, we may charge on a special, when it's not part

            24   of the formal rating process, but we issue -- we have issued

            25   over a period of time about a million financial soundness






             1   ratings over the 18 years that we've been in business, and

             2   we've never had any serious problems, never had a threat of a

             3   lawsuit, never had a complaint from a regulator, as such. 

             4             MR. COLBY:  Mr. Putnam, could I ask how large is

             5   your organization?

             6             MR. PUTNAM:  It's not large at all.  We have 10

             7   financial analysts.  The SEC has been out, and actually

             8   visited our headquarters in Frederick. 

             9             COMMISSIONER GOLDSCHMID:  How -- 

            10             MR. PUTNAM:  Well, in the first place, the source

            11   of the information is regulatory data that we get from the

            12   Feds on computer tape, but we will -- all the larger

            13   institutions submit releases.  We get their releases and

            14   such, the same as the other agencies do.  And we visit banks,

            15   more when there's financial problems than anything else.  We

            16   don't visit them if it's in good condition.  We just don't do

            17   that. 

            18             MS. NAZARETH:  Okay.  Thank you.  Larry Mayewski: 

            19             MR. MAYEWSKI:  Thank you.  The A.M. Best Company,

            20   obviously, from my opening comments, is a specialist in the

            21   insurance arena.  We assign financial strength ratings, and

            22   we assign securities ratings to insurers and insurance

            23   holding companies.  Under the securities umbrella, we

            24   obviously are looking at debt, preferred securities,

            25   commercial paper, and more recently some structured






             1   transactions and securitizations. 

             2             The process is a very rigorous process.  It

             3   incorporates all publicly available information.  All of the

             4   filed documents, statutory filings, GAAP filings, and any

             5   other filings that are public.  It also involves interactive

             6   discussions with management on every company that we rate. 

             7   So we meet with, generally, the CEOs and CFOs of all of the

             8   companies that we assign rating opinions to.  

             9             Clearly there's a lot of information flow we get

            10   out of the management meetings that we believe is important

            11   to a credible rating.  We rate companies formally once a

            12   year, but we monitor them throughout the year.  They're under

            13   constant surveillance.  But even companies that are under

            14   constant surveillance, even if there's no changes, we will

            15   once a year put out a public affirmation of that company, to

            16   indicate we've completed, again, the thorough review of that

            17   company. 

            18             We do charge for our ratings.  We believe that

            19   clearly the bottom line for any rating agency is credibility. 

            20   If, in any way, shape or form that's a conflict there and it

            21   affects a company's credibility, you're basically not in the

            22   rating business.  And the A.M. Best Company only started

            23   charging, I would say, less than 10 years ago for its

            24   ratings.  Prior to that it was based on a subscription model. 

            25   But clearly, with some of the competitors getting into the






             1   business, that opened the door, from A.M. Best's perspective,

             2   to start charging for its ratings. 

             3             MS. NAZARETH:  Thank you.  

             4             MR. COLBY:  Could I ask you the same question?  How

             5   large is your organization?

             6             MR. MAYEWSKI:  We have 550 people involved in

             7   Oldwick, New Jersey.  Just under 200 of them involved in the

             8   rating analysis process. 

             9             MS. NAZARETH:  Thank you.  Ray McDaniel?

            10             MR. MCDANIEL:  Thank you.  For company and

            11   municipal ratings, the process would typically be initiated

            12   by contact with Moody's from either the issuer or a rating

            13   advisor working in an intermediary institution or a financial

            14   advisor in the municipal sector.  That would be followed by a

            15   submission of financial information and collection by Moody's

            16   of financial industry market information about the company. 

            17             We would designate a rating team, which, in the

            18   initial stages, would include a lead analyst.  And that lead

            19   analyst would be chosen based on the industry that the

            20   company requesting a rating is operating in.  And the lead

            21   analyst would have a backup analyst, and both would be

            22   operating under the guidance of a managing director. 

            23             Following the designation of the rating team, we

            24   would typically meet with the company and its advisor.  The

            25   meeting would take place either at the company's offices or






             1   at Moody's, or both.  And that would be followed -- there

             2   would be a discussion of the company's financial profile, its

             3   position in the industry, its -- the financial statements

             4   that it has filed, its management strategy, et cetera.  

             5             The analyst takes that information back, and

             6   conducts what we would call a fundamental analysis of the

             7   company, and creates a written rating recommendation.  That

             8   written rating recommendation then is taken to a rating

             9   committee.  The rating committee has a discussion and debate

            10   about the recommendation for the company, and that concludes

            11   with a vote.  And the majority vote wins. 

            12             And finally, that vote is memorialized, and we

            13   write a press release, which includes both the rating, and

            14   our rationale for the rating, which we would share with the

            15   company, and with the company's advisors.  

            16             In the structured finance asset securitization

            17   area, the process is, in some respects, the same, and in some

            18   respects different.  The main difference is that because in

            19   an asset securitization, the issuer or the special purpose

            20   company typically does not yet exist, there is an iterative

            21   process in which there's a discussion between the Moody's

            22   analysts and the sponsor or its advisors as to the

            23   appropriate structure and necessary collateral to achieve the

            24   rating levels desired by the sponsor of the securitization. 

            25             MS. NAZARETH:  Thank you.  Steven Joynt?






             1             MR. COLBY:  May I just ask the same question? 

             2   Number of financial analysts?

             3             MR. MCDANIEL:  The number of financial analysts at

             4   Moody's is about 800.  Our total Moody's Investor Service

             5   staff is about 1,700. 

             6             MR. JOYNT:  The number of analysts at Fitch --

             7             MS. NAZARETH:  Let's get it out of the way, right

             8   up-front. 

             9             (Laughter.)

            10             MR. JOYNT:  I think it's about 700, with a total

            11   employee count of about 1,200.  I think we have 650 employees

            12   in the U.S., maybe a little bit more, the remainder

            13   internationally.  We have about 200 in Europe, most of them

            14   in London.  From our merger with Duff & Phelps, we have, I

            15   think, 180 in Chicago.  The remainder of our staff -- or the

            16   majority of our staff -- analytical staff -- is in New York,

            17   and then spread around Asia, Latin America, and other places.

            18             I'll try not to repeat everything that Ray has

            19   said.  I have -- my past -- I was with Standard & Poors for

            20   12 years.  Our vice-chairman, Claire Cohen, was with Moody's

            21   for probably more years than Ray has been with Moody's, and

            22   has been with us for 12 years.  And other executives in our

            23   team have been with the rating agencies.  So we think the

            24   process that we follow is very comparable to other rating

            25   agencies, and it's a good process.  






             1             We also have a lead and a backup analyst approach

             2   to analyzing companies and municipalities, and in structured

             3   finance.  The ratings are also done by a committee of people. 

             4   We try to bring specialists in from whatever the appropriate

             5   area is, to sit down, whether it's in public finance and we

             6   need a GO specialist, and a hospital specialist, and somebody

             7   that specializes in the region of the Southwest, or in

             8   corporates, where we need a specialist in commercial banking

             9   and investment banking and mortgage banking financial

            10   disclosure the large, complicated financial institutions that

            11   we rate today.  

            12             I might add one thing about the committee process

            13   itself, and that's that there is an appeal process in the

            14   company that says that, if we sat on a committee -- and

            15   people have a variety of views, and you know, committees are

            16   a changing thing, there could be 12 people, of which six are

            17   very junior and are there to learn how things work in the

            18   process.  

            19             But of the voting members and the senior people

            20   that would sit on the committee, if there's any one

            21   individual that has a strong exception to the conclusion of

            22   the majority, they are able to appeal it on to a higher

            23   person, the more senior person in that department.  And

            24   there's sort of a chain, depending on how serious the appeal

            25   is, and how great the exception is to the final decision, all






             1   the way up to the chief credit officer of our company -- and

             2   myself.  So it rarely happens, but it's happened on occasion,

             3   and it happens more as you go farther down.  

             4             And when I say, "a major exception," if the

             5   committee sat and had to decide, and some of the votes were A

             6   plus, or A, or A minus, I doubt there would be a major

             7   exception there.  But if two senior members of a five-person

             8   committee felt strongly that this credit should be

             9   noninvestment grade, while three others felt it should be

            10   triple B minus, that might be something that they would take

            11   to a higher authority, or recompose another committee of more

            12   senior people with broader expertise, or bring in some

            13   others.  So I think that's also helpful in the process if

            14   that's available. 

            15             Regarding -- I'd like to just focus on

            16   securitization for a minute, then, because I do think that

            17   process is very different.  And I'd ask you to think about

            18   this as we talk during the rest of the day about some of the

            19   issues, the issues of Reg FD, do we get confidential

            20   information, and when?  

            21             You know, often you think just about corporations,

            22   but for example, in securitization, we receive a lot of

            23   pooled data and information from General Motors, Ford, and

            24   many other asset-backed issuers.  We receive property

            25   information and rent rolls from commercial mortgage real






             1   estate developers that are putting together commercial

             2   mortgage securitization.  We receive FICO scores on asset-

             3   backed issues, and for mortgage-backed transactions. 

             4             So we usually get a large portfolio of data, which

             5   one could consider to be the private data of the company

             6   that's putting together the securitization, and provided to

             7   our analysts in order to analyze the default probabilities

             8   and the appropriate credit support levels in analyzing these

             9   transactions.  

            10             That's a complicated job.  It requires us to have

            11   more modeling expertise, more mathematical expertise.  It's

            12   not what you would typically think of when you think of a

            13   rating agency rating a company, and an industry analyst with

            14   a certain kind of expertise.  So I point that out as maybe a

            15   different perspective for you to think about as we consider

            16   some of these issues.  

            17             Also, I would say, as it relates to a committee

            18   process for securitization, that even more of the information

            19   is embodied in the analyst, his model, and his thinking.  So

            20   it's not quite as even a committee process.  So therefore, we

            21   bring to that committee process most of the expertise

            22   resident within one area, and we have to challenge ourselves

            23   about how much of the decision we're making because of the

            24   quantity -- or the qualitative -- the quantitative analysis

            25   of the information, versus what qualitative judgment we might






             1   bring to that about the servicer or the originator.  The

             2   company aspect of it.  There is a qualitative aspect, so we

             3   do have -- we do service ratings.  So they're not traditional

             4   bond ratings, as you might be thinking about for corporates. 

             5   They're ratings that go out and analyze the capability of

             6   these servicers and monitoring these financial assets that

             7   are being put into these pools.  And so we have different

             8   kinds of ratings for that.  Above average, high.  Each of the

             9   rating agencies has more than just the array of ratings that

            10   we've talked about that are the bond ratings themselves.  So

            11   there is a qualitative aspect to that part of the process, as

            12   well. 

            13             COMMISSIONER GLASSMAN:  Could I just ask before we

            14   move on to Mr. Harada, because you've talked a lot about

            15   models, and things like that, how do you surveil or test your

            16   models, the appropriateness of your ratings over time?  Is

            17   there a sort of continuous process that goes on?  Or a

            18   periodic evaluation?  How does that work?

            19             MR. JOYNT:  Sure.  There's a -- well, the original

            20   models are created from a broad perspective.  Let me use

            21   residential mortgage as an example, because it's a place that

            22   Fitch distinguished itself when we first started in 1989 and

            23   1990.  We completed a brand new study of default experience

            24   in the mortgage market in Texas.  And based on that, and

            25   extrapolations from that, we reached the conclusion about






             1   what credit support levels we thought were appropriate in

             2   mortgage-backed securities.  Those levels were different from

             3   the levels of the other two rating agencies.  

             4             We did -- we presented that research to investors. 

             5   It gained credibility with investors.  They started asking

             6   for our opinion on our rating on those securities.  In the

             7   beginning, in addition to Moody's and Standard & Poors.  And

             8   subsequently, in replacement of one or the other over the

             9   last 13 years.  

            10             So we had to start first with our original research

            11   tested against investor expectations, and presenting our

            12   research to them.  So since then, of course, every week,

            13   month, and year, those expectations are tested against the

            14   actual results in the market.  So residential mortgage market

            15   performance has been exceptional, so there haven't been great

            16   tests.  Commercial real estate mortgage markets have been

            17   exceptional, so there haven't been great tests in the market.

            18             In the asset-backed area, there have been some

            19   tests in subprime.  And we can talk about that more later. 

            20   And so the adjustments that are made in the model, and the

            21   credit expectations would be based on the results that we see

            22   over time.  And so adjustments today I would tell you have

            23   been in asset-backed, very little in commercial and

            24   residential.  Does that address that?

            25             MS. NAZARETH:  Yes, that's helpful.  Thank you. 






             1             COMMISSIONER GLASSMAN:  Before we go on, can I just

             2   ask a follow-up question to Ray and Steve?  This is to put

             3   numbers of analysts and some numbers of analysts in some

             4   context.  Do you have subgroups?  For example, a sub group on

             5   financial institutions and a subgroup on insurance?  And if

             6   you do, how many analysts are in those groups?  How many

             7   financial institutions analysts do you have?

             8             MR. MCDANIEL:  The organizational answer is that we

             9   do have subgroup.  Our broad business unit organization is

            10   structured finance, public finance, or municipal finance,

            11   corporate finance, and financial institutions.  Then, within

            12   those broad categories, we would have smaller teams that

            13   follow banking, insurance, nonbank financial institutions, et

            14   cetera.  We also have industry teams on the corporate side. 

            15   To be honest with you, I can't quote you the number of

            16   analysts in each of the subteams off the top of my head, but

            17   I would be very happy to get that information to you. 

            18             COMMISSIONER GLASSMAN:  I'd appreciate that. 

            19             MR. JOYNT:  I also will have -- I'll take a guess,

            20   so I'll have trouble.  I'll be happy to provide you with

            21   specific information, but in public finance, I think we have

            22   around 70 employees, almost all of which are analysts.  So

            23   I'd say at least 60 analysts.  In commercial real estate,

            24   probably 50.  In asset-backed research analysis, probably 40. 

            25   Same in residential mortgage.  Right around those numbers.






             1   And corporate, I think the total number of analysts we have

             2   probably approaches 120.  And there's probably at least 25 in

             3   financial institutions.  We have a smaller team in insurance,

             4   where our coverage is not as broad as, probably, an investor

             5   -- maybe even Standard & Poors.  And I'd be guessing.  I

             6   think the number is around 25.  Is that a helpful

             7   perspective?

             8             COMMISSIONER GLASSMAN.  Yes, thank you. 

             9             MR. MACCHIAROLI:  Could I ask a follow-up question? 

            10   Is there a consistent ratio of analysts to the number of

            11   issuers that they rate for issues?  Can you tell me what the

            12   ratio is?  And does it vary among product groups?

            13             MR. JOYNT:  Actually, that's an excellent question. 

            14   I often wonder if we're inflating our analyst figures,

            15   because we always include a number of the technical people

            16   and modelers that we have in our IT department, because

            17   they're working on models.  So I can never understand how we

            18   a third of the size, in terms of ratings of S&P and Moody's,

            19   but we have 700 analysts and they have 800.  I don't

            20   understand it.  So something's funny about the numbers. 

            21             Typically, in the corporates, which is the easiest

            22   to answer you, our ratio of analysts to corporate coverage

            23   would be about 10 or 12 companies per person.  Now, that's a

            24   mix of senior and junior people, but that would be the

            25   average.  






             1             It's much more difficult to tell you in

             2   securitization.  So for example, in our commercial mortgage

             3   department, where we have, I'd say, 50 people, we may rate

             4   only five transactions in any given month, but those

             5   transactions could be, in size, $1.2 billion each, and

             6   composed of 60 different properties.  And our analysts went

             7   out across the country to go analyze those properties, and

             8   those specifics, and ran five models, not one model.  So it's

             9   very difficult to -- in residential mortgage, I believe last

            10   month we probably rated 42 transactions of residential

            11   mortgages.  Commercial 5.  And yet the size of the staff is -

            12   - is that helpful?

            13             COMMISSIONER GLASSMAN:  Yes. 

            14             MS. NAZARETH:  Mr. Harada, you've been very

            15   patient.  

            16             MR. HARADA:  Thank you very much.  As for the

            17   numbers of the analysts in R&I, 60 persons are purely rating

            18   analysts.  Of the total numbers of employees of 140.  And

            19   just like the Japanese tradition, we do not recruit directly

            20   as for the analyst -- rating analysts -- we do not directly

            21   recruit from the newly graduated from university.  We recruit

            22   so-called from the other investment management corporations,

            23   or other security firms, investment banks.  So that we -- of

            24   course, we recruit very few numbers from the university, very

            25   few, but most of the people were hired from the other so-






             1   called experienced persons, maybe.  So that a large share of

             2   our work firms has enough professional experience.  

             3             And as for the relation between the numbers of the

             4   corporation and the analysts, in our company, one analyst

             5   will take responsibility, in average, of almost 13 or 12

             6   companies.  And as for the committee in the process of the

             7   rating, we established within our firm the independent rating

             8   committee.  That is, we -- I -- I am the number two ranking

             9   officer of R&I, but I couldn't -- I cannot participate in

            10   that rating committee, with very few exceptions.  With the

            11   authority, with the agreement of the board members -- the

            12   board of directors -- I can participate in that rating

            13   committee, but we cannot -- we don't have any voting power,

            14   only purely as the observer I can participate in that rating

            15   committee.  

            16             And in that rating committee, that decision will be

            17   made under the basis of the so-called unanimous basis,

            18   because this means that one leading analyst could not --

            19   cannot lead all the context, all the discussion of the

            20   assessment of the rating.  So that we reiterate the

            21   discussion.  And after the very condensed discussion, we can

            22   reach the final decision of the rating. 

            23             And of course, we also respect very much the

            24   dialogue with the issuers, because of course, we have the --

            25   ultimately, we have the right to decide the rating, without






             1   any agreement of the issuers, but beforehand, we'd like to

             2   continue -- we make a very close dialogue with the issuers,

             3   because whether -- in one sense, with the cooperation of the

             4   issuers, we can make a very good assessment.  

             5             Of course, we exchange views very much, and we can

             6   obtain the so-called non-public information.  Of course.  But

             7   this is quite different.  The cross-correlation is quite

             8   different from such an independent rating, because we keep

             9   the very much independence of the rating.  And because we --

            10   as for the capital structure of the R&I, we -- our majority

            11   equity is held by the Nihon Keiza Shimbun -- that is, in the

            12   media industry, not the financial industry.  

            13             So that -- and -- Nihon Keiza Shimbun, leading

            14   financial paper, have the so-called private equity company,

            15   but they haven't listed their equities in the market.  And in

            16   the exchange, the equity holder is the members of the -- the

            17   board of the members -- or the board -- and members of the

            18   journalists.  So that we can -- from the point of view of the

            19   capital structure, we can keep the independence of the

            20   rating. 

            21             And also, that I -- in order to make a proper

            22   rating, the accumulation of the professional knowledge is the

            23   most important.  So that we -- of course, we assign the

            24   analyst to the individual sector.  And we make the thorough -

            25   - individual sectorial study, and we establish some benchmark






             1   or criteria, in sectorial criteria, sectorial benchmark, in

             2   order to keep our ratings consistent. 

             3             And so that after that, we will make a very --

             4   check the so-called default study with our consistency of the

             5   rating, whether default study -- we continuously made -- we

             6   have made a default study, and we opened up -- we disclosed

             7   all the results of default study to the public through the

             8   website.  And we can keep the very good consistency between

             9   the -- a consistent relation between the default ratio and

            10   the ratings, because that is -- over 25 years, the rating

            11   higher is -- the default ratio is very low.  And these

            12   consistent relations have kept throughout the 25 years

            13   writing history.  

            14             And as for the structured finance rating, the way

            15   of the rating is quite identical to what Fitch -- Mr. Joynt

            16   and Moody's.  And we share almost the same manners of the

            17   assessment of the structured finance.  The structured finance

            18   is -- the rating of the structured finance is the so-called

            19   targeting rating.  That is, it would depend upon the so-

            20   called tranching of the quality of the borrowers, or the

            21   obligations, that we can establish so-called subordinated

            22   status and preferred status; with a combination of these

            23   preferred status and subordinated status, we can set the so-

            24   called rating of that, triple A, or double A, or single A. 

            25   Also that we -- I think that we share quite the same manners






             1   with the -- and for the rating of the structured finance with

             2   Moody and Fitch.

             3             Thank you.

             4             MS. NAZARETH:  Thank you.  Do we have any follow-up

             5   questions?  Yes. 

             6             MR. PUTNAM:  Yes.  I'd like to comment,

             7   particularly to the Commissioners here, that I feel a little

             8   at a disadvantage, because I have the smallest number of

             9   analysts in the group.  But I'd like to point out that it's

            10   what you do, what comes out from these analysts that's

            11   important.  How good are your ratings, okay?  Not how many

            12   analysts you have per company or such.  And I think that's

            13   very important.  

            14             We have provided to the SEC our default rates on

            15   banks that failed over a period of time.  This was back in

            16   1995, I think we submitted, particularly all the banks that

            17   went down during the '80s and such.  And I believe, even

            18   though -- and we had fewer analysts then than we do today --

            19   that no one can match that record.  We specialized in this

            20   area, and you should take that into account.  If you have a

            21   small company, it's like a boutique, but it specializes in an

            22   area, and has the expertise.  It's how good that expertise

            23   is, not the number of analysts that you have.  Thank you. 

            24             MS. NAZARETH:  Okay.  Thank you.  I think we'll, as

            25   promised, take a 15-minute break and return at 10:50.  






             1             MR. HARRIS:  Let's continue.  We're now going to

             2   talk about information flow in the credit rating process. 

             3   I'll motivate our discussion with the following observations. 

             4   The government, in its statutes and its regulations, has

             5   written in the credit ratings formally into our regulatory

             6   oversight of a variety of different processes. 

             7             At the time that that was done, people who drafted

             8   those statutes and regulations presumably made the following

             9   choice:  The said, well, we can -- we need to discriminate

            10   among various instruments for the purpose of understanding

            11   what's risky and what's not risky.  We could specify the

            12   instruments ourselves.  And, I think, quite fortunately, they

            13   decided not to do that.  We could hire somebody to specify

            14   them for us.  And I think many of us probably agree that it

            15   was probably wise that the government do that.  Or we could

            16   free ride on the efforts of existing agencies out there that

            17   were making these discriminations. 

            18             And of course, that's what did happen.  And in the

            19   process, we created the NRSRO process, and that brings us to

            20   this meeting.  Our interest is in understanding that process,

            21   and it flows from our need in the regulations and the

            22   statutes to discriminate among various instruments.  And

            23   therefore, we're very interested in the ability of the

            24   regulations to discriminate effectively with respect to risk,

            25   which is normally what these regulations are concerned about.






             1             In addition, we have concerns about the quality of

             2   information that's available to analysts, in general, for

             3   which the credit rating agencies are very involved in the

             4   acquisition, collection, processing, and production of

             5   information that investors use.  We have specifically given

             6   some privilege to the credit rating agencies, in general. 

             7   Not just the NSRSOs, but everybody who is doing credit

             8   rating, with respect to Regulation FD.  As you are all

             9   undoubtedly aware, issuers that reveal information in

            10   general, under FD, have to reveal material information to the

            11   market, as a whole, but with the exception that they may

            12   reveal private material information to credit rating

            13   agencies, so that those agencies, presumably, can produce

            14   more valuable ratings. 

            15             And our interest, therefore, in the flow of

            16   information stems also from, most generally, our interest in

            17   ensuring that investors get the best and most timely

            18   information.  But more specifically, also in understanding

            19   whether the exemption that we've provided to the credit

            20   rating agencies is appropriate and fair. 

            21             So with that preface, we'll now examine the

            22   information flow in the credit rating agencies.  And I'd like

            23   to start off by asking of what value these ratings are to the

            24   buy side, and by exploring the value of the ratings, we'll

            25   have some sense of what's required by the investors.  I think






             1   all of us are aware of what's required by the regulations. 

             2   And in this way, we'll start understanding what's necessary

             3   to produce the high-quality information that we hope this

             4   industry can provide the public.  

             5             So we'll start with the buy side.  I'll ask Erwin

             6   from Putnam, how would the world be different without credit

             7   ratings?  I mean, how do you use these things?  Why are they

             8   important to you?

             9             MR. MARTENS:  This is excellent.  This is actually

            10   an area -- as the chief risk officer, this is near and dear

            11   to me, actually, all of this consumption of information,

            12   because we pore through absolutely reams of it every day, to

            13   come up with risk ratings for our own portfolio managers.  

            14             So we encounter an actual flood of information, and

            15   we manage over 60 billion in bond area of municipals, as well

            16   as corporate and government.  We're inundated with

            17   information, and we spend a lot of time parsing through it. 

            18   And I've got some notes here about areas that are very

            19   sensitive for us.  

            20             And one particular area is what we call issuer

            21   roll-up.  We have a lot of concerns with respect to getting

            22   ratings that we deem to be, actually, quite valuable, but

            23   then taking a look at them and saying, "In the context of all

            24   of the other issuances that we own of this issuer, where does

            25   the various issues reside inside of all of our portfolios? 






             1   And how do we roll them up effectively?"  The whole idea of

             2   identification of an issuance.  Where does it reside in the

             3   corporate structure of that particular company? 

             4             And a perfect example.  Say, Ford, for example, or

             5   Conseco, or WorldCom, or any of the other bond issuances that

             6   have come up into prominence in the last year, be it on

             7   price, or be it on corporate governance.  How much -- a

             8   typical question from an investor is, "How much do you have,

             9   where do you have it, and what funds is it is and what

            10   different tranches do you have of that issuer?

            11             Well, all of a sudden you start taking a look at

            12   that, and they'll have very unique CUSIPs, ISINs, CLs, that

            13   we go back and try to connect back to the ratings, and take a

            14   look and say, "how does this actually come up to a holistic

            15   view of what represents our exposure to that particular

            16   issuer?"  This takes up a lot of just mundane time in

            17   tracking down linkages from within the corporate structure of

            18   a particular issuer. 

            19             The other one related, that came up in the first

            20   section, was securitization.  Now, the issuer may be the name

            21   sitting behind the securitization, but really, then, the

            22   issue becomes, what's the nature of the collateral that's

            23   benefiting that securitized issuance?  So now we're in a sort

            24   of a conflict.  There may be somebody that doesn't have a

            25   good rating as an issuer, but they've securitized or enhanced






             1   the credit to such a degree that, actually, it's a very high

             2   rated securitized product.  So now we have a conflict between

             3   what the signal is coming from the rating agency on the

             4   issuer, but the securitized asset is actually pretty good,

             5   because it's been highly collateralized. 

             6             These are the real nuts and bolts things that

             7   affect the buy-side interpretation of a lot of the

             8   information that we get coming in the door every day.  And

             9   for us, that is really the effort to take all of that on an

            10   overnight basis, process it all, and get it out in front of

            11   the portfolio managers the next morning, so they can make

            12   rational decisions based on the signals that we've got coming

            13   in. 

            14             MR. HARRIS:  Listening to you, it sounds to me

            15   that, for you, the ratings are not nearly as important as the

            16   information that the rating agencies are able to assemble

            17   that travels with those ratings. 

            18             MR. MARTENS:  Well, the ratings are very important,

            19   but I would say, since we are longer term investors, we're --

            20   how we interpret a lot of the information is more on a

            21   fundamental basis.  Obviously, we have our own independent

            22   research people on the equity side, fundamental analysis.  We

            23   also have fundamental analysts on the debt side.  So this

            24   accentuates or complements the analysis that we do

            25   internally. 






             1             We look to the rating agencies more for a longer

             2   term fundamental view, as opposed to point estimators.  And I

             3   want to point out that one of the things, I think, is, on the

             4   interpretation of rating indices, many people look at these

             5   as point estimators rather than probabilistic distributions

             6   about saying this is the most likely outcome over the next

             7   period of time.  And I think that there's been a drift to

             8   assuming that science is really so precise that that point

             9   estimator encapsulates all the last and pertinent

            10   information, as opposed to saying, that's a pretty good

            11   estimator of where it's likely to be over the next period of

            12   time, with a high degree of certainty. 

            13             MR. HARRIS:  I hope that we will be able to address

            14   those issues later, as well. 

            15             MR. MARTENS:  Okay.  Thank you. 

            16             MR. HARRIS:  Stephanie, would you like to respond,

            17   as well, on behalf of Schwab, and in particular, U.S. Trust?

            18             MS. PETERSEN:  Certainly.  Actually, I agree with a

            19   lot of the comments that Erwin just made.  With regard to the

            20   way the ratings are used, the rating agencies serve a very

            21   useful purpose, which is, helping the general market

            22   understand and appreciate the relative creditworthiness.  Not

            23   necessarily the absolute, but just the relative

            24   creditworthiness.  If we didn't have something like that,

            25   there would be no common understanding, and the market would






             1   be at risk of not understanding what's going on.  And

             2   consequently, the pricing and other things would be adversely

             3   influenced.  So having the ratings there provides some

             4   foundation. 

             5             What we're coming up against, with the

             6   consolidation among the NRSROs, however, is that the world

             7   now has a very limited view, and where there is disparity in

             8   the conclusions drawn on creditworthiness among the NRSROs,

             9   sometimes that gets reflected in the pricing of securities,

            10   sometimes it does not.  

            11             And if each of the rating agencies is receiving the

            12   same amount of information, and they reach different

            13   decisions, we on the buy side, who do not have the benefit of

            14   getting all of the same information, have to then try to pick

            15   and choose among the rating agencies, and the quality of the

            16   analysts that are employed to look at and rate those

            17   individual securities, to help us formulate what our opinion

            18   should be.  

            19             Because at the end of the day, while the rating

            20   agencies have the ability to express opinions, we're dealing

            21   with real money, and real client assets.  So we have to come

            22   to a greater understanding of the quality of the analysis. 

            23   And that's why earlier I made a comment, that transparency of

            24   the process.  Every one of the rating agencies has published

            25   some version of what their rating policy is, what the






             1   criteria is, what information they use. 

             2             But we also know that you don't always get that

             3   whole laundry list of information every time you rate

             4   something.  Or especially as you're monitoring them on an

             5   ongoing basis.  And therefore, we have to have a little leap

             6   of faith with regard to exactly what information comes into

             7   the process.  And therefore, our ability to anticipate where

             8   the rating agency is going to go has to be based more on what

             9   our perception is of the quality of their analysis. 

            10             So again, we don't want them to go away.  That's

            11   not the right answer.  But I think that being able to

            12   increase competition, allow for niche players to have,

            13   perhaps, the opportunity to come in and highlight where there

            14   might be differences of opinion, based, again, on the

            15   information that they're receiving is very important. 

            16             MR. HARRIS:  And I'd also like to ask Jack, of what

            17   value are ratings in your business and to your clients?

            18             MR. MALVEY:  Well, ratings are embedded in the very

            19   fabric of the global credit markets.  A world without ratings

            20   would be almost unthinkable.  It would restrict severely the

            21   ability of the institutional investors, and individual

            22   investors around the world to fully participate in the credit

            23   markets.  

            24             Ponder the dynamics and economics for a moment of

            25   the buy side.  There are no buy-side firms who have the






             1   luxury of Moody's, with 800 analysts, or Fitch, with 700

             2   analysts to parse the global credit markets.  The rating

             3   agencies form a very convenient starting point for

             4   institutional investors to begin to then give consideration

             5   to, among a certain choice set of issuers, where they

             6   possibly want to invest. 

             7             Ratings, as often highlighted by the agencies,

             8   should be viewed as a reference opinion.  They're not

             9   necessarily an investment opinion.  That's really the task of

            10   the asset manager.  To take the ratings as a starting point,

            11   and then decide, within a certain subset of a credit quality

            12   grid, whether they want to possibly own a security or sell a

            13   security which they already own. 

            14             So from that function, providing a starting point

            15   throughout a global credit market, which, just on the U.S.

            16   side, parenthetically let me add, the U.S. side, we have

            17   about 800 different borrowers today in the U.S. investment-

            18   grade public corporate bond market, and we have about 400 in

            19   the high-yield corporate bond market, and when we expand to a

            20   global choice set, an order of magnitude about 2,500

            21   different institutions.  So the agencies form a way to get in

            22   and figure out who or what among those 2,500 entities an

            23   institutional investor would like to possibly invest in. 

            24             MR. HARRIS:  Thank you.  

            25             COMMISSIONER GOLDSCHMID:  Can I pick up on one






             1   point?

             2             MR. HARRIS:  Please. 

             3             COMMISSIONER GOLDSCHMID:  We're going to talk about

             4   it later, but why is it really better to have six or seven or

             5   eight to look at, than two or three, in terms of rating

             6   agencies?  When I pick a movie, to use a perfectly imperfect

             7   analogy, I'd like to pick one reviewer I trust, and having

             8   seven or eight may make it more confusing.  I just want to

             9   make sure that I understand the point being made.  Stephanie?

            10             MS. PETERSEN:  I think the real point that we're

            11   trying to drive home is that homogenization is not possible

            12   in this market.  And therefore, if you opened it up to

            13   competition, especially among niche players, perhaps, what

            14   you might be able to do is, find the kind of differentiation

            15   that would allow us to say, "We would like to buy the

            16   insurance rating information from Best, we'd like to buy

            17   financial institutions from Fitch, we'd like to buy

            18   municipals from Moody's, asset-backed securities from S&P." 

            19   That kind of thing.  

            20             And right now, we subscribe to a lot of various

            21   information sources, although the only ones that we can use

            22   or rely on, for regulatory purposes, especially in the money

            23   fund arena, are the NRSROs.  So we don't have the luxury of

            24   being able to look at a broader universe. 

            25             MR. HARRIS:  Okay.  I would like to jump over now






             1   from the users of the ratings.  We'll jump over the ratings

             2   agencies, and go to the other side, to the issuers, and ask

             3   them what information do they provide to the credit rating

             4   agencies, and in general, how do they use the credit rating

             5   agencies, either explicitly, or how are they used by the

             6   credit rating agencies to provide better information to the

             7   public.  So let's start with, how about Jerry from GM?

             8             MR. VAN ORMAN:  Well, we meet twice a year with

             9   each of the U.S. rating agencies, and as part of that

            10   process, we provide a standard set of information time and

            11   again.  It changes -- evolves over time.  And from that

            12   information which we provide, it's used as a basis by which

            13   we discuss the issues that are important to the rating

            14   agencies.  And usually there are follow-up requests for

            15   information and the like, commentary that we provide at the

            16   time. 

            17              MR. VAN ORMAN:  In many respects, we have a

            18   package that we think is a good overview of our business, and

            19   then we respond to the three agencies, to the extent that

            20   they wish to have more. 

            21             MR. HARRIS:  To what extent is that information 

            22   that is not presently available to the public?

            23             MR. VAN ORMAN:  For the most part it is -- I would

            24   say it's generally available to the public.  We probably

            25   provide more detail in the set package I'm talking about than






             1   we may in some of our published documents, or even speeches

             2   to different groups. 

             3             MR. HARRIS:  And when the analysts meet with you, I

             4   presume that they will frequently ask questions, and I

             5   imagine, of course, that they're asking about information

             6   that's not in the public domain.  When they do that, how

             7   willingly do you offer it?  What is your perception of the

             8   value of their questioning of that process in general?

             9             MR. VAN ORMAN:  Well, I would say that -- you used

            10   the adverb "willingly."  I mean, there are times when we

            11   think, "Oh no."  But we will -- we tend to comply with the

            12   requests they have, and it's important to us that, at the end

            13   of the day, they are satisfied that we have answered their

            14   question. 

            15             MR. HARRIS:  Let me ask the same question of David

            16   from Pfizer.  David, are you finding that you are more

            17   comfortable?  Or are you willing to provide proprietary

            18   information?  Do you believe that the confidentiality that

            19   you expect of the credit rating agencies can be relied upon? 

            20   Undoubtedly, in the development of many new products, they

            21   must ask many questions like this. 

            22             MR. SHEDLARZ:  Well, the nature of the

            23   conversations has changed fairly dramatically over time.  And

            24   I'll use more contemporary dialogues to kind of get to the

            25   answer to your question.  While they take a very formulaic






             1   approach, in part, in terms of assessing most companies,

             2   including Pfizer, as you point out, they also want to get

             3   into the richness of what's happening operationally, and what

             4   are the enterprise-wide risk factors that they should be

             5   concerned about?  

             6        So I take a look at this formulaic approach.  I have a

             7   set of numbers.  "I want to stress test this," is basically

             8   the message they're giving us.  And in order to do so, I need

             9   to have a clear sense, an open dialogue, and an understanding

            10   of your operations, just not a financial characterization of

            11   the company.  And so you'll spend a fair amount of time

            12   confirming perspectives that they have, in terms of the major

            13   risk factors, and how far they should stress them.  

            14             To make it real, they'll focus in on, classically,

            15   things like new product availability, new product

            16   competition, product liability, environmental liability, and

            17   they'll try and dig as deep as they possibly can in terms of,

            18   in particular, trying to confirm the relevant range of

            19   possible outcomes.  So rather than digging into a specific

            20   issue, just in the interest of time, to deal with that

            21   particular issue.  

            22             I think it's very targeted, in a utilitarian way,

            23   to understand, what's the risk factor around the operating

            24   and financial results of the company.  And the nature of

            25   those discussions, the depth of those discussions, as you can






             1   imagine, in the recent past has increased quite dramatically.

             2             COMMISSIONER GLASSMAN:  I have a question just to

             3   follow up.  I'm sorry.  You're talking about proprietary

             4   information, but are you talking about nonpublic information

             5   or truly proprietary information?  Is it information you just

             6   haven't told the public yet?  Or is it information that is

             7   truly proprietary for competitive reasons, or other reasons?

             8             MR. SHEDLARZ:  I think it depends on the subject

             9   matter, but it can be both.  Obviously, talking at great

            10   length about some of the liabilities you have would be of

            11   great interest to various audiences.  Your prospects for new

            12   product, and the introduction into the marketplace would be

            13   very interesting to our competitors, as well.  

            14             So you tend to delve into both, but again, they do

            15   so, I think, in a very responsible way.  Not necessarily to

            16   get an advantage on any particular point, but to be in a

            17   better position to stress test the assumptions they put in

            18   place, and to complement the formulaic approach they have, in

            19   terms of understanding your financials, your liquidity, your

            20   cash flow capabilities, and other things that they're judging

            21   in terms of coming up with their ratings. 

            22             I actually think it's quite healthy in terms of

            23   understanding the operational factors that drive the numbers.

            24             MR. HARRIS:  In the present Reg FD environment, are

            25   these discussions that you would be 






             1   unwilling to have with analysts in general?

             2             MR. SHEDLARZ:  Some of the discussions we would not

             3   have with analysts, in general.  In some cases, in the

             4   interest of making sure we're not compromising the company,

             5   from a competitive point of view.  

             6             MR. HARRIS:  And I presume that would have applied,

             7   as well, before Reg FD; is that correct? 

             8             MR. SHEDLARZ:  That's correct. 

             9             MR. HARRIS:  Okay. 

            10             MR. VAN ORMAN:  Could I add something?

            11             MR. HARRIS:  Please. 

            12             MR. VAN ORMAN:  As Steve mentioned the

            13   securitization area being separate, when the three U.S.

            14   rating agencies come in to evaluate our securitization,

            15   they're essentially looking at the quality of our assets and

            16   our quality, as a servicer.  And in terms of the -- in

            17   particular, say, the asset quality, we provide much more

            18   detailed information in terms of our internal scoring, how we

            19   collect than we would in the public, in general. 

            20             Having said that, that information we provide them

            21   in much greater detail for their evaluation ultimately is

            22   provided publicly in terms of our loss numbers, our

            23   delinquencies.  But it's just done in a much greater detail

            24   for their purposes. 

            25             MR. HARRIS:  Let me also turn to Ben from Florida. 






             1   Ben, you represent Florida, working for Florida.  And more

             2   generally, you represent a class of issuers that are largely

             3   transparent.  But I was wondering, what is your relationship

             4   to the credit rating agencies?  What sort of information are

             5   they asking of you, and of the various municipalities over

             6   which you some relation?

             7             MR. WATKINS:  Well, in keeping with the theme of

             8   the message, once again, the municipal market is different. 

             9   We -- our relationship and the information flow to the rating

            10   agencies, on an ongoing basis, we typically do in the form of

            11   a preliminary official statement in connection with a primary

            12   market offering of securities.  So for every program that we

            13   administer, and every time we sell bonds, we send the

            14   offering document to the rating agencies for their review.  

            15             And when we have a new program, we will go into a

            16   more extensive analysis of the credit, prepare presentations,

            17   sit down and have face-to-face with the rating agencies to

            18   explain to them what the underlying credit structure is, and

            19   the strength of the credit embedded in the legal documents. 

            20             There is another dynamic that's important to

            21   understand, and that is, we -- in connection with

            22   dissemination of information about the state of Florida,

            23   generally we do not discriminate among large institutional

            24   investors, retail, or the rating agencies.  Philosophically,

            25   what we want to do is, anything that is important information






             1   to the market, we want to disseminate that information

             2   simultaneously to everyone, and make that dissemination as

             3   broadly as possible, through press releases, postings to

             4   websites, and inclusion of that information in the offering

             5   documents that we are using. 

             6             Reg FD and the notion of confidential information

             7   just simply does not apply to the public sector.  There is no

             8   material nonpublic information.  So that whole notion that we

             9   are giving somehow some competitive advantage to the rating

            10   agencies, or they are receiving information that the market,

            11   more broadly, is not receiving, just simply doesn't apply in

            12   the context of municipal issuers. 

            13             MS. PETERSEN:  Excuse me, may I make a comment on

            14   that?

            15             MR. HARRIS:  Please. 

            16             MS. PETERSEN:  At Schwab, we have the largest

            17   single-state money market fund, and we also have the largest

            18   national money market fund, so our interest in public finance

            19   is rather significant.  And I think that the points that Ben

            20   has made are very good ones, but the disparity among the

            21   issuing community in public finance is great.  And

            22   consequently, when we on our side of the table need

            23   information, we generally have to rely on the rating

            24   agencies, because the rating agencies will tell an issuer,

            25   "In order for you to maintain your rating, there is a certain






             1   amount of information we need.  Here's the schedule in which

             2   we expect to get it."  

             3             Some of those issuers are diligent.  They're

             4   getting the information there.  And they figure, as long as

             5   I'm providing it to the rating agency, as they do in Florida,

             6   we'll post it on our website, we'll make it otherwise

             7   available.  But if you take a look at a small hospital, if

             8   you take a look at some special district financings and

             9   things, because of the budget constraints they have, they

            10   tend to deal exclusively with the rating agency, or, if it's

            11   insured, to deal exclusively with the bond insurer.  

            12             And consequently, that open line of communication

            13   and opportunity for us to get the same information is

            14   compromised.  That's another place where the rating agencies

            15   play an important role at helping to bridge the gap between

            16   what information we know is available and how it gets to us. 

            17             MR. HARRIS:  Now, given that many of those issuers

            18   are very, very small, is this a sensible arrangement of flow

            19   of information?  The alternative, of course, being that you

            20   and 150 others on the buy side would be asking for the same

            21   information, and asking for the same interviews, and

            22   essentially overwhelming people who, presumably, aren't

            23   entirely equipped to handle that kind of pressure.

            24             MS. PETERSEN:  Unfortunately, the numbers aren't

            25   quite that big, but they're already encountering that.  Some






             1   of them will tell you that it's bothersome to have five

             2   institutions call you with the same questions.  But the fact

             3   that the retail investor base, especially in public finance,

             4   has grown exponentially over the last several years, to the

             5   point, I think, that the number is something like 30 percent

             6   of all municipal securities are held by mom and pop, means

             7   that getting that information out there is even more

             8   important. 

             9             On the institutional side, I'm fortunate that I

            10   have some of the best and brightest analysts that,

            11   unfortunately, I've pilfered from S&P and Moody's and other

            12   places, but nonetheless, that we have the capacity to take

            13   that information, do something with it, that the average

            14   retail investor does not.  So since Schwab also has a

            15   significant amount of retail investors who buy individual

            16   securities, getting that information out there is important.

            17             And I think that the rating agencies stand in the

            18   best position to be able to disseminate some of that

            19   information, because unlike the corporate side of the

            20   business, the municipals do not have EDGAR, you do not have

            21   one central repository where there's an absolute requirement

            22   for filing certain information at a certain point in time. 

            23   The MSRB, I believe, is trying to develop that, but they

            24   haven't succeeded thus far.  So the rating agencies are the

            25   best proxy for getting that information. 






             1             MR. HARRIS:  Thank you.  

             2             MR. WATKINS:  I would echo what Stephanie says for

             3   the small and infrequent issuer, sort of the midlevel market,

             4   in terms of the role that the rating agencies play in

             5   connection with gathering the information.  They are an

             6   important repository of information, if you will, from a

             7   whole segment of the market. 

             8             Another important note to make sort of about

             9   information flow is, in the municipal market, under the

            10   current regulatory regime, there are annual filings that are

            11   required to be made with the NRMSIR system, which is an

            12   acronym for nationally recognized municipal securities

            13   information repository.  There are some difficulties with

            14   that system.  That rule has been in place since 1994, Rule

            15   15c2-12 

            16             The industry, in recognizing and acknowledging some

            17   of the deficiencies in the retrieval of the information from

            18   that system, is working in a collaborative, voluntary

            19   initiative that we call the MUNI counsel, to come up with

            20   some suggestions about how we might, as an industry

            21   voluntarily improve that flow of information to the

            22   investment community. 

            23             MR. HARRIS:  Thank you. 

            24             MS. PETERSEN:  The downside to the NRMSIRs, though,

            25   is the fact that you have to pay for the information, so a






             1   retail investor -- there are four NRMSIRs out there, and

             2   unless you pay for access to that information, it's not

             3   otherwise available. 

             4             MR. VAN ORMAN:  I've been thinking about your

             5   question as the conversation -- but to use an example of -- I

             6   would -- the analogy I would use is, say, our public

             7   documents are the topic sentence, and we provide more

             8   paragraphs to the rating agencies.  I think this is generally

             9   true.  

            10             For example, GMAC has a large wholesale and dealer

            11   loan exposure.  The ultimate results from that portfolio, you

            12   can see the size of it in our financial statements, you can

            13   see the charge-offs, you can see the reserving.  What we

            14   provide the rating agencies that we don't do in a public

            15   document, say, is, we will show them where the larger

            16   exposures are, case by case.  And I would use that as an

            17   example of the greater detail we provide them.  And we think

            18   that's one of the purposes they serve, is to absorb that for

            19   the public. 

            20             MR. HARRIS:  Thank you.  And we're going to explore

            21   that very shortly, but before we do that, I'd like to ask

            22   Paul, on behalf of the members of the Bond Market

            23   Association, how do you believe the information flow from the

            24   issuers through the credit rating agencies is of benefit to

            25   the market and to your members? 






             1             MR. SALTZMAN:  I think, consistent with the message

             2   that we're hearing, the rating agencies play a critical role,

             3   but the most important message point is that they are not the

             4   exclusive investment opinion, or the exclusive source of

             5   information.  If you look at ratings as simply a tool in the

             6   overall mix of information, I think that, then, sets the

             7   stage and the framework for everything else that we're

             8   talking about.  

             9             You know, the information flow from the issuer

            10   community, whether it be municipal or on the corporate side,

            11   is quite good.  Our members utilize ratings.  As I mentioned

            12   in my opening remarks, they're ubiquitous, from everything

            13   ranging from being ingrained into the regulatory framework,

            14   to being part of the pricing mechanism.  It would be a

            15   mistake for us to assume that ratings are guarantors of

            16   investment performance, or perfect predictors of credit

            17   performance.  They are an opinion. 

            18             Not to sort of get too far off the dime, but I

            19   guess there have been many remarks here talking about

            20   accountability, and how good the ratings are.  And I guess I

            21   have fundamental problem with that perspective, because, at

            22   the end of day, what you're talking about is holding people

            23   accountable for an opinion.  I don't think we should be

            24   thinking about ratings in the context of whether they are 100

            25   percent accurate all the time, or whether, in fact, they get






             1   it.  Because the reality of it is that the accountability

             2   goes to the investment community. 

             3             Look at the story as to how Fitch got started.  It

             4   got started because, ultimately, it produced added value

             5   information to the marketplace, where the investment

             6   community and the sell-side community basically said, "We

             7   want this."  So I think, from my members' perspective, we are

             8   very comfortable with the information flow. 

             9             To the particular point of FD, which, I guess, is

            10   underlying some of the discussions here, we continue to

            11   support the exclusion from FD.  And I think the correctness

            12   of that view is highlighted by what the world would look like

            13   if you didn't have that exemption.  You know, many of the

            14   corporate issuers go to rating agencies to seek out views in

            15   connection with proprietary transactions, and so forth.  If

            16   you didn't have that, you would either have a retraction in

            17   information to the marketplace, or volatility in the

            18   marketplace, because, effectively, the predictor of ratings

            19   would not be out there. 

            20             COMMISSIONER GOLDSHMID:  Just a quick follow-up

            21   question.  I take it the rating agencies create the material

            22   information they're given in this context.  That's

            23   confidential, as a matter of firm policy.  Ray, is that fair?

            24             MR. MCDANIEL:  Yes.  At Moody's, all of our staff

            25   adheres to a confidentiality policy.  We have written






             1   agreements about that.  And the only use of confidential

             2   information is in the application of it to the public rating

             3   that is distributed. 

             4             MR. MAYEWSKI:  I would echo Ray's comments on

             5   behalf of A.M. Best. 

             6             MR. HARRIS:  Barron, as you've noted, your

             7   application to be an NRSRO was not accepted, I guess.  The

             8   question is this, though Regulation FD offers you the same

             9   exemption offered to the NRSROs, have you found that your

            10   analysts are facing any resistance when they speak to the

            11   various firms that you occasionally do visit?  Understanding,

            12   of course, that with fewer analysts, and focusing more on the

            13   regulatory data, that you may not be out there as often.  But

            14   are you  finding that, though you have the privilege to speak

            15   on issues, or to ask to speak on issues that issuers

            16   otherwise might be reluctant to speak on, that you're being

            17   shut out where you suspect that other credit

            18   rating agencies that are NRSROs have privilege?

            19             MR. PUTNAM:  No, not really.  We have the same kind

            20   of -- in our company's rules about the use of

            21   confidentiality.  In fact, it's very restrictive.  Only

            22   staying with that particular analyst, and the review analyst

            23   that's dealing with it.  And we don't even keep it on a

            24   computer.  It's in a file, and it's destroyed after the

            25   rating period.  But I like -- I always worry about






             1   confidential information.  It concerns me a great deal.  I

             2   try and dissuade companies from giving it to us unless they -

             3   - unless it's very material in terms of their -- in the

             4   rating process.  If they feel that somehow this information

             5   might significantly affect, or be a major part of going into

             6   the rating.  I just don't want to know it, if, in fact, it's

             7   not clearly something that would affect their rating

             8   significantly. 

             9             COMMISSIONER GLASSMAN:  Could I follow up on that? 

            10   And this is really for all the rating agencies.  If you are

            11   getting information on a confidential basis that materially

            12   affects your rating, is that information that should be

            13   disclosed to the public in some way?

            14             MR. JOYNT:  Could I try to answer that?  Because I

            15   do think that this question about what we get in the way of

            16   what you could consider confidential is not so quantitative,

            17   I suppose.  A lot of the dialogue that we would have with

            18   companies, I believe, isn't collecting facts about the

            19   company, it's more understanding their systems, their risk

            20   management approach, their risk tolerances.  Things that are

            21   very debt oriented, not really equity oriented.  

            22             So while we may get projections from a company --

            23   and you could ask us the question about those projections,

            24   and should those be public -- the majority of the information

            25   that we get isn't of the factual type.  It's qualitative. 






             1   And so I don't see how one would make that public in that

             2   kind of way. 

             3             COMMISSIONER GLASSMAN:  What about in the

             4   management discussion and analysis section of the filings?

             5             MR. JOYNT:  Yes?

             6             COMMISSIONER GLASSMAN:  Is it appropriate for that?

             7             MY JOYNT:  Then my answer to that would be, it's

             8   how granular do we go in, versus what management can present. 

             9   So already in their management discussion, they would

            10   describe their views on risk tolerance, for example.  But if

            11   we go in and analyze an investment bank, then we'll be

            12   sitting down with people in fixed income, and equity trading

            13   areas, and talking about position limits by product area, and

            14   how much exposure they're willing to take, what's their

            15   tolerance, if they have a loss, do they then adjust interim

            16   period to the tolerance that they're allowed to take on an

            17   earnings tolerance?  There's so much more granular

            18   information that allows you to have a perspective, comparing

            19   one company versus another, that I'm not sure how they would

            20   be able to present all that just is that section. 

            21             MR. HARRIS:  I want to take a very quick survey of

            22   our rating agencies, and ask each one about the split of

            23   their services, between the public component that is revealed

            24   through their websites and their ratings, and so forth, and

            25   the subscriber services that they provide.  We'll turn to






             1   you, Steve.  Can you describe the subscriber services that

             2   you provide, and describe what the value added is there,

             3   relative to the public ratings that you provide at Fitch?

             4             MR. JOYNT:  Sure.  So the majority of our ratings -

             5   - of our revenues, 90 percent come from issuer fees, and

             6   around 10 percent come from subscription services.  And just

             7   a little background on Fitch.  When we first started, we put

             8   all our research -- we had no paid-for subscription services

             9   beginning in 1989.  For almost 10 years, all research we did

            10   was for free.  Then we merged with IBCA, and,

            11   subsequently, Duff & Phelps and Thomson BankWatch, where their

            12   business model was a subscriber-based fees model.  We had

            13   to accommodate what to do about that, we were presenting all

            14   our information for free. 

            15             Why did we do that?  We did that because we were

            16   following the model of an NRSRO rating, and we wanted to

            17   develop a global rating agency, and we needed the financial

            18   capability to do that, and that would require issuers paying

            19   fees.  So once we've made the transition, we've acquired the

            20   companies, we now charge subscribers for our services.  

            21             So what's the distinction?  Our ratings are public. 

            22   Our press releases are all public.  And our rating services

            23   are available for anyone to acquire.  And I would say that

            24   it's again a question of granularity.  So we put all our

            25   criteria pieces up on our web for free, all our general






             1   approaches to analysis.  Any press releases we make and

             2   public announcements that we make are designed to provide

             3   sufficient information to substantiate any rating we do, or

             4   any rating change we make. 

             5             Often in public finance, for example, we do presale

             6   reports that are put on the web.  And in structured finance

             7   areas, presale reports that are put on the web that are free,

             8   prior to the sale, for people to review the analysis and

             9   information.  So in the following of companies, and the

            10   surveillance -- the ongoing surveillance of securitizations,

            11   there are -- that's where we would be charging for detailed

            12   research reports that are acquired by investors, Schwab and

            13   others. 

            14             MR. HARRIS:  I would presume by the very fact that

            15   your clients pay for these subscription services, that they

            16   believe that there's substantial value added. 

            17             MR. JOYNT:  I think so, yes. 

            18             MR. HARRIS:  Mr. Harada?

            19             MR. HARADA:  Yes.  We don't differentiate the

            20   treatment between the subscriber and the public.  As far as

            21   the rating action on the conclusion, or there's some

            22   preemptive action that is -- we adopted a system of a rating

            23   monitor.  If the situation might change substantially, we

            24   give some signal, warning signal, to the market.  We call it

            25   a rating monitor.  






             1             And these kind of change of the rating, or the

             2   adoption of the rating -- introduction of the rating monitor

             3   or the other change, or a confirm of the rating.  And as far

             4   as these kind of rating action and fundamental contents of

             5   the rating, outcome is quite -- is provided to the public. 

             6   And as for the subscribers, we adopted so-called paid website

             7   system, with -- we provide to the subscribers some detailed

             8   information behind -- some background information behind our

             9   conclusions, or we give the summary information to the

            10   subscribers of the sectorial information.  

            11             That is, some detailed information or future

            12   structure of the -- such as one sector, or some of the

            13   changes, because we give the structure of change.  But as far

            14   as these kind of information, we're now providing through the

            15   so-called website page, subscription system.  

            16             But as far as the rating action concerned, or the

            17   outcomes of the rating, we provide identically to the public,

            18   without any subscription. 

            19             MR. HARRIS:  Thank you.  And Ray, can you describe

            20   briefly the value-added services that you believe your

            21   clients recognize when they subscribe to your services?

            22             MR. MCDANIEL:  Sure.  As far as our research

            23   service, and its place in the overall Moody's scheme, our

            24   revenue split is very similar to what Steve described for

            25   Fitch.  About 90 percent comes from issuers who pay fees for






             1   ratings, and about 10 percent comes from our research and

             2   data services.  

             3             The services that subscribers purchase from us

             4   include data and monitoring, first of all, financial

             5   statistics, collateral portfolio information, and structured

             6   finance, and research.  Our research includes, first of all,

             7   our press releases, which contain any rating changes and the

             8   rationale for rating changes, and those are made available

             9   publicly on our website.  

            10             And then we are selling the company research,

            11   transactional research, our company research.  We try to

            12   update at least once a year.  And what we call special

            13   comments.  And special comments may include industry

            14   analysis, geographic sectoral analysis, on a -- really taking

            15   on our credit perspectives from a larger perspective 

            16             We also make our analysts available to try and talk

            17   to the market, including our subscribers, and I believe they

            18   value that dialogue, as well. 

            19             MR. HARRIS:  Thank you.  And Larry, for A.M. Best?

            20             MR. HARADA:  I'd like to say that I share the

            21   revenue.  I'd like to explain that -- of the revenue.  About

            22   7 percent of the revenue comes from the subscribers.  And the

            23   rest, 93 percent from the issuers. 

            24             MR. HARRIS:  From issuers.  Thank you.  Larry, same

            25   question for Best?  What do the subscribers get?






             1             MR. MAYEWSKI:  A.M. Best has a long list of

             2   publications and products and services, in addition to

             3   ratings.  About 60 percent of our revenue comes from

             4   publications, data, subscriptions.  Publications in hard copy

             5   and CD version.  Data.  

             6             We take public data and have the largest database

             7   on insurance companies, so we're able to slice and dice, and

             8   do all kind of segment analysis, and peer analysis with the

             9   data.  So that's something that generally is very attractive

            10   to the marketplace.  Aggregates and averages and so on. 

            11             We also have subscriptions where we have a daily

            12   newswire, we have a weekly publication in hard copy, we have

            13   a monthly magazine.  And online access, also, to information

            14   and data.  And that's about 60 percent of our revenue.  40

            15   percent is in the rating arena, approximately. 

            16             MR. HARRIS:  Thank you.  And finally, Barron, is

            17   your model exclusively subscriber-based?

            18             MR. PUTNAM:  Well, I wouldn't say exclusively.  I

            19   would say about 90 percent, though, of our revenues are

            20   derived from selling subscription services.  And the data --

            21   we have an alert service, where we alert our clients,

            22   basically, to major changes in large bank ratings, country

            23   risks.  We also rate foreign banks.  And these larger

            24   institutions -- and this information is generally put on the

            25   web site.  On our web site. 






             1             We also -- almost all of our --

             2             MR. HARRIS:  When you say, "it put on the website,"

             3   is it protected by password?  Or it's generally accessible to

             4   everybody?

             5             MR. PUTNAM:  Accessible to everybody.  And

             6   sometimes not the whole release is put on the website.  And

             7   then we have all of our bank, S&L, credit union ratings, and

             8   a majority of the holding company ratings are in a service

             9   that goes out to libraries.  So it's really quite available. 

            10   And I think we have -- and most of the large libraries in the

            11   country subscribe to that service.  So it's available to the

            12   general public.  And that's something that we do provide on

            13   ratings of small companies, that the general public can use,

            14   particularly like going into one of these institutions, is

            15   making sure their deposits are secure --

            16             MR. HARRIS:  Did I cut you off?

            17             MR. PUTNAM:  No, go ahead. 

            18             MR. HARRIS:  I have another question directed to

            19   all of our rating agencies.  To what extent do subscribers

            20   obtain information on an earlier basis than, say, the public

            21   would, if at all?  Why don't we just go the other way around. 

            22   Barron, do your subscribers receive information that the

            23   public -- earlier than the public does?

            24             MR. PUTNAM:  Well, in fact, yes. 

            25             MR. HARRIS:  You mentioned something about an






             1   alert. 

             2             MR. PUTNAM:  Yes, that's true.  I want to -- I

             3   don't want to identify some of these, but we have one of the

             4   regulators here in Washington, one of the bank regulators. 

             5   We provide them with an early warning service for their

             6   institutions that they regulate.  That's not -- you know,

             7   that's just one of the things that they use. 

             8             But we also do this for the Federal Home Loan banks

             9   or their members, and things of that sort.  It's generally

            10   before what the public gets, because the book that goes to

            11   the libraries, even though it contains pretty much the same

            12   information, is the published book, and may come out three

            13   weeks later.  

            14             But we also provide to any of the institutions we

            15   rate, their rating.  And we will always discuss their rating

            16   with them, why we've rated them, and the whole thing.  And

            17   our -- one thing, though, that we have is that our data backs

            18   up the ratings.  We have the data that's used primarily in

            19   the rating process, alongside the rating and the date.  

            20             I feel it's very important when people rate

            21   institutions, that the user of that information knows the

            22   primary data that went into that rating.  And usually when

            23   you get down to it, it's the financials.  They're based on

            24   the company's financials, and it's usually quarterly

            25   financials that go into that. 






             1             Now, of course, you have releases that go out for

             2   other reasons.  You know, if a hurricane wipes out all the

             3   banks in Honduras or something, we'll put out a release on

             4   that. 

             5             MR. HARRIS:  And your buy-side clients who

             6   subscribe to these subscriber services, presumably, are

             7   getting similar things before it's publicly known.  Is that

             8   correct? 

             9             MR. PUTNAM:  Well, yes.  Our large clients, General

            10   Motors is one.  Not General Acceptance, but the accounting. 

            11   And they do receive the alerts.  If a company is going to

            12   fail -- if we feel a company is going to fail, we will put

            13   out an alert to them, telling them to secure their deposit. 

            14             MR. HARRIS:  Thank you.  Larry?

            15             MR. MAYEWSKI:  Yes.  Probably at Best we should

            16   distinguish between ratings and nonrating services.  In

            17   ratings, any rating or information that supports a rating

            18   action is provided simultaneously to our subscribers and the

            19   public.  Clearly, we do have subscription services that only

            20   subscribers purchase.  News products and things of that

            21   nature.  But as it relates to ratings, we endeavor, and our

            22   focus is making sure that that is presented to our

            23   subscribers and the marketplace simultaneously. 

            24             MR. HARRIS:  Simultaneously.  Ray?

            25             MR. MCDANIEL:  Yes.  Similarly to what Larry just






             1   described, our analysts are prohibited from talking about

             2   ratings or rating rationales until that information has been

             3   made available to the general public.  And I would also add

             4   that, just because of the nature of the rating process by a

             5   rating committee, the analyst, in fact, is not in a position

             6   to be able to discuss future ratings. 

             7             MR. HARRIS:  Steven?

             8             MR. JOYNT:  It would be identical in our case. 

             9   Ratings and watch lists, and any important action like that,

            10   supported by the key rating factors, would not be released --

            11   would be released simultaneously to the public, as well as to

            12   any subscribers. 

            13             MR. HARADA:  May I?

            14             MR. HARRIS:  I'm sorry. 

            15             MR. HARADA:  We share the same manners of the way

            16   Fitch and Moody's as far as the timing of the information.  

            17             MR. HARRIS:  Okay.  I'm sorry I passed over you

            18   there.  Okay.  So here's the difficult question.  Through Reg

            19   FD we've granted an exemption to the rating agencies,

            20   allowing issuers to share information with rating agencies

            21   that they're not required to share with others.  And the

            22   rating agencies, presumably, use that information, hopefully,

            23   to the public's benefit.  

            24             And we've been told that, in most cases, the

            25   alerts, the ratings, and other aggregated information is






             1   revealed only to the subscribers when it's revealed also

             2   simultaneously to the public, perhaps with some exception for

             3   LACE, but I suspect that that's probably a fair

             4   characterization, even there.  

             5             And yet, we know that there's additional

             6   information that is offered to the subscribers, for which the

             7   subscribers are certainly willing to pay.  And so the

             8   question is, how should we understand whether this is fair? 

             9   Is the information that's being offered to the subscribers

            10   that is derived from the prospectus that may be obtained

            11   through the Reg FD exemption, is that a special privilege

            12   that ought to be going out to the public as a whole?  Or is

            13   my characterization of the potential conflict here off base?

            14             And so why don't we first -- I'd like to ask all

            15   the issuers, but given it's a difficult question, we'll give

            16   them a moment to think about it, and we'll recognize the fog

            17   has undoubtedly now lifted on Steven Schwarcz, professor of

            18   law from Duke has now finally had a chance to greet us.  And

            19   lest you be embarrassed by being singled out here, you should

            20   know that a good six or seven other people walked in only

            21   shortly before you did, for the same reason.  So Steven, do

            22   we have a problem here with Reg FD, that opinions are being

            23   formed for which these firms are profiting, by perhaps

            24   selling the extended service, or something like that, that

            25   might somehow be related to Reg FD?  Should the Commission be






             1   concerned about this issue?

             2             MR. SCHWARCZ:  Well, I'd want to think about that,

             3   and look into it further before responding in any detail, but

             4   certainly, on its face, there might appear to be an issue

             5   that the subscribers would be favored over those who did not

             6   have the subscriptions, and they would get the information

             7   before the public did.  But I really would -- that's more of

             8   a visceral thought, and not really a firm opinion. 

             9             MR. HARRIS:  Okay.  Let's turn to our agencies now,

            10   and ask them why the SEC should not be concerned about this

            11   issue.  Mr. Harada, I suspect that, since you're not subject

            12   to Reg FD, that we can skip over you on this question, and

            13   ask Steve here, why should the agency not be concerned about

            14   the argument that I just provided?

            15             MR. JOYNT:  Well, I think the linkage that you're

            16   making is one that says the most important information that

            17   the subscriber is buying is somehow the confidential

            18   information that we receive from the company.  And I don't

            19   really think that's the case.  I think it's the depth and

            20   breadth of our analysis of a lot of the public information,

            21   as well, the comparative information on one company to

            22   another, one securitization to another, one city's finances

            23   to another.  

            24             So I don't make the same linkage that you make. 

            25   That we would have received, for example, in its most






             1   egregious form, next quarter's earnings, and somehow embody

             2   that into some thinking, if not disclose it confidentiality

             3   to subscribers.  That doesn't happen. 

             4             MR. HARRIS:  Ray?

             5             MR. MCDANIEL:  I would point out two things. 

             6   First, the research that we are publishing is -- does not

             7   contain information -- confidential information that we have

             8   collected from the issuer, similar to what Steve just

             9   described.  And in fact, we send our research reports to the

            10   issuers, to make sure that we are not disclosing inaccurate

            11   or confidential information improperly. 

            12             The second thing is, I think it's useful to also

            13   consider the public nature not only of our ratings, but of

            14   our other signals in the ratings process.  The outlooks, and

            15   in Moody's case, Watchlist, or from some of the other NRSROs,

            16   Credit Watch.  That is also a public process, and we handle

            17   changes in outlook and watch lists via press release and

            18   public dissemination, as well. 

            19             MR. HARRIS:  Larry?

            20             MR. MAYEWSKI:  Yes.  In spirit I would echo Steve

            21   and Ray's comments.  It really is a case of additional

            22   information, but not necessarily related to ratings, and

            23   anything we feel needs to be in the public domain that's

            24   maybe more depth about a company's operations, and things of

            25   that nature, that comes out of our analysis.  But nothing we






             1   believe that is relevant, per se, to the rating opinion.  All

             2   that information is released to the public. 

             3             MR. HARRIS:  Barron, did you want to add anything

             4   different?

             5             MR. PUTNAM:  Yes, I really do. 

             6             MR. HARRIS:  Please. 

             7             MR. PUTNAM:  I'm sorry, it's not really different. 

             8   I really agree with Fitch, but I need to make a point on

             9   this, that it's -- what we're releasing early is our

            10   interpretation of data that's already out there, okay?  A lot

            11   of the data that we use may be up on the FDIC website.  It

            12   could be that we're following an institution because it's

            13   been declining over time, and as soon as that data hits the

            14   FDIC website, we pull it off and run a rating on it.  

            15             And if it looks like that thing is going to fail or

            16   deteriorate or something, boom, an alert goes out to our

            17   clients.  And this is very important.  Some of these people

            18   are, let's say, card issuers.  You know, the largest card

            19   issuers.  Things like that.  And it's very, very important to

            20   them to get an early warning on the institution possibly

            21   failing.  But it's our interpretation of data only.  

            22             I particularly -- I could exist without this

            23   confidential information easily.  I really don't need to be

            24   included or exclude from it.  But again, it's our

            25   interpretation of information that we are releasing.  And the






             1   data is always out there for someone else to do it.  We just

             2   try and beat our competition to the punch. 

             3             COMMISSIONER GOLDSCHMID:  Larry, let me try one

             4   more spin on the information question.  This may be an

             5   unusual and law professor's kind of question, but assume I'm

             6   the CFO of a pharmaceutical company that's relatively small,

             7   and picking up David's example, we've got a new drug coming

             8   on line in a year that we now know is a blockbuster.  It's

             9   going to sell $4 billion, which, in pharmaceutical terms, is

            10   blockbuster level.  I've got a B rating.  I now tell you

            11   about this, and tell you I'm a triple A.  What do you do in

            12   changing my rating in terms of disclosure?

            13             MR. HARRIS:  Let me add to that just a little bit. 

            14   And we're going to ask the buy side the same question, which

            15   is, when the rating comes out that seems inconsistent with

            16   the underlying facts, what calls do you make to obtain color

            17   on what happened?  We can start with Stephanie. 

            18             MS. PETERSEN:  I wasn't exactly sure who you were

            19   asking the question of.  That kind of disparity in the

            20   published ratings will always prompt a phone call.  And

            21   therefore, if the information that's being conveyed, that

            22   leads to that kind of disparity is material nonpublic

            23   information, I don't want to know that, because I don't want

            24   to be in a position of having to, potentially, allegedly,

            25   make an insider trade.  Even in the debt market, that kind of






             1   allegation can stick. 

             2             COMMISSIONER GOLDSCHMID:  No, this is really a

             3   rating agency question, because by law, they can't convey to

             4   you the material information. 

             5             MS. PETERSEN:  Right.  And that's another reason --

             6             COMMISSIONER GOLDSCHMID:  And yet, they are going

             7   to be changing their rating, and they put out a statement. 

             8   And the question is, what do you say?  Maybe Ray, you're the

             9   right one to ask. 

            10             MR. MCDANIEL:  There are certainly cases where we

            11   raise and lower ratings, and the reason we do that is that we

            12   have incorporated important confidential information into the

            13   public rating.  And it is not fully explained in the press

            14   release.  And I know it frustrates the institutional buy-side

            15   community, but it's -- the way we operate right now, that's

            16   just the rules of the game. 

            17             MS. PETERSEN:  Well, if I could respond, as well. 

            18   I think that the key issue here is one of our ability to

            19   understand and appreciate the quality of the analysis that's

            20   being done by the various folks who work for the rating

            21   agencies.  And again, this goes back to that idea of

            22   competition.  Because we know that there is a certain amount

            23   of information and, hopefully, a better flow of information

            24   going back and forth when you have 700 or 800 analysts, as

            25   opposed to the fact that I only have seven on my taxable






             1   side, and I only have three on my public finance side. 

             2             So we are forever trying to evaluate the general

             3   quality of the analysis put forward.  So if, indeed , you

             4   develop a rapport with an analyst, or an expectation about

             5   the quality of the analysis, if their rating suddenly is

             6   significantly different than that published by another

             7   agency, we would take for granted that there must be

             8   additional information.  We would not try to pin down the

             9   analyst to tell us exactly what that information is, because

            10   we have to honor the confidentiality agreement. 

            11             MR. JOYNT:  If I could just offer a comment also. 

            12   All CFOs of drug companies think all their drugs are going to

            13   be blockbusters.  I've never met an auto company executive

            14   who didn't think he would sell more cars next quarter than

            15   the last quarter.  I don't think the ratings move that

            16   quickly.  They're not that sensitive.  There's a healthy

            17   degree of skepticism about whether that will be true about

            18   this drug company product.

            19             Also, the companies themselves have the ability to

            20   influence other factors, so if that's going to be a

            21   blockbuster drug, then it's likely they'll take those

            22   revenues -- extra revenues and earnings, buy another company,

            23   invest in another product.  So there's a stability about the

            24   ratings and the credit quality of a company, that's a lot

            25   more significant than the necessary stability about quarterly






             1   earnings variables and other things that might be related to

             2   what we're talking about. 

             3             MR. MCDANIEL:  I think this gets back to our

             4   probabilistic observation.  That these are interpreted as

             5   very strong point estimators, rather than a distribution.  So

             6   if one of the agencies -- and I'll give an alternative view. 

             7   If somebody were to downgrade one of them relative to the

             8   other rating agencies, saving money.  Not looking into it,

             9   but saying, "oh, I need to avoid that name.  I don't know

            10   why, but the rating agency is pessimistic about it.  If I

            11   invest less in it, even by not giving inside information, I

            12   may save my client money."  So it's not always just the

            13   upside bias.  It can also be a protective bias.  

            14             So again, the probability distribution idea as

            15   opposed to the point estimator is a way that a lot of us

            16   interpret it, and say, "the spread has gotten wider, there's

            17   more uncertainty around this thing," instead of everybody has

            18   got it as a triple A.  If everybody's got it as a triple A,

            19   the probabilistic range around that is very narrow. 

            20   Everybody has assigned a similar-like quality.  If it's split

            21   rated, the distribution is wider, and everybody's got a

            22   little bit more apprehension about how certain is that view

            23   on that company. 

            24             MR. HARRIS:  For the last few minutes, we've been

            25   talking about issues relating to Regulation FD.  And before I






             1   turn away from that, I'll recognize that I've been calling on

             2   people from the buy side, and the credit rating agencies and

             3   the issuers, but I have not, perhaps, given full opportunity

             4   to the other people -- the panelists at the table.  And I was

             5   wondering if anybody else wanted to contribute to this

             6   discussion at this point. 

             7             MR. VAN ORMAN:  Can I ask a question of your

             8   question?

             9             MR. HARRIS:  Please. 

            10             MR. VAN ORMAN:  Let's take my example.  Say, an in

            11   depth data we provide to an agency on our wholesale and

            12   dealer loans.  Let's use that example again.  That's

            13   information we wouldn't want a competitor to see, for obvious

            14   reasons.  To the extent that the rating agencies were not

            15   exempt from Regulation FD, is your question going to the

            16   point that then we could not reveal that information to the

            17   rating agencies without doing it in a public document, as

            18   well?

            19             MR. HARRIS:  That might be one implication,

            20   although I remind you that my role here is only to discover

            21   issues, and bring out opinions.  And I will be obtuse as to

            22   my own opinion. 

            23             MR. VAN ORMAN:  Given the setting I just

            24   established, my view of that is, one would have to think

            25   about providing that to a rating agency, because we wouldn't






             1   want that data public.  

             2             MR. HARRIS:  Right. 

             3             MR. VAN ORMAN:  And in that case, then there would

             4   be an issue with rating agency, how important that was to the

             5   rating.  And to the extent that it was very important, then

             6   we'd have to step back and make a decision in terms of

             7   revealing it in a public forum.  Maybe I'm picking an extreme

             8   case, but I think that would be --

             9             COMMISSIONER GOLDSCHMID:  Wearing my old general

            10   counsel's hat, or maybe practitioner or professor's hat, one,

            11   it may not be material information, so it's not an FD issue. 

            12   And you always can ask someone to hold things in

            13   confidentiality, even if it is material.  And then if they

            14   trade, then it's much more serious than FD.  Then it's an

            15   insider trading problem of criminal law, or triple penalties

            16   and all the rest that would attach. 

            17             MR. HARRIS:  Thanks for the point.  I certainly

            18   appreciate it. 

            19             MS. LANCELLOTA:  I have a question. 

            20             MR. HARRIS:  Yes, please. 

            21             MS. LANCELLOTA:  I don't remember the exact

            22   language of Reg FD, but I'd be curious to hear from the

            23   agencies, that when you receive nonpublic material

            24   information, do you use it just in your credit rating

            25   process, but you now are into so many lines of business, what






             1   do you have set up internally to protect that information

             2   from being used for other profitable endeavors?

             3             MR. MCDANIEL:  Well, from Moody's perspective, the

             4   only activity that we engage in other than ratings is

             5   publication of data and research.  And as I described before,

             6   that research would not include confidential information that

             7   we have received from an issuer. 

             8             MR. JOYNT:  Well, we are primarily a rating agency,

             9   and until recently were only a rating agency.  We started a

            10   very small risk management business, which I think you also

            11   have an acquisition -- and a similar parallel company, I

            12   guess, within the broad Moody's framework. 

            13             MR. MCDANIEL:  Within the Moody's corporation, yes.

            14             MR. JOYNT:  Yes, Moody's.  So maybe that was your

            15   broader question.  But in establishing this subsidiary,

            16   which, again, is very tiny, we have isolated the people from

            17   the ratings process entirely, from any of the information we

            18   gather in the ratings process.  So our approach, although we

            19   don't have to apply it much at this point is, there's a one-

            20   way street.  You know, our rating analysts can get any

            21   information from our risk management people in order to use,

            22   like we would any other service provider.  But they're not

            23   allowed to get any information from our rating analysts back

            24   the other way. 

            25             MR. MAYEWSKI:  I would just add from A.M. Best






             1   perspective, we have some very stringent code of conduct

             2   guidelines in place, a need to know loop when confidential

             3   information comes in.  It's the analysts, supervisor,

             4   possibly some members of the committee, obviously, that might

             5   be discussing a rating.  In terms of any information flow

             6   from, say, a rating division or to our other areas of the

             7   company, publications and other services, we have some very

             8   strict standards regarding information flow there.  It cannot

             9   move from one division to the other. 

            10             And obviously, if anybody breaks any of those

            11   guidelines or laws, policy is, there are obviously

            12   significant repercussions.  

            13             MR. HARADA:  R&I also includes a very severe,

            14   strict firewall between the information flow between --

            15   confidential information is strictly developed -- is set

            16   aside from the ordinary information.  And there is -- and

            17   also, as far as the personal level, there is a very strong --

            18   we have also introduced a very strict code of conduct.  If

            19   they were to disclose some confidential information, they

            20   would be very strictly punished.  That means, fired.  So we

            21   keep the -- very strictly the confidentiality of the

            22   information.  And also, that we -- of course, as non-public

            23   information is used, that's one of the factors of the -- to

            24   understand the credit quality as a whole of the issuers.  

            25             And for example, there's such a case of a new






             1   development or new product, but that kind of fact is

             2   construed -- is treated as one of the information to judge

             3   for the capability of the R&D process of that type issuer. 

             4   So that we didn't -- we haven't yet picked up some one

             5   particular information as when we decided the rating standard

             6   -- rating.  Thank you.

             7             MR. SCHWARCZ:  I just thought I'd ask for a

             8   clarification.  Some of the speakers indicated that the

             9   confidential information is not disclosed in the subscriber

            10   services.  Some indicated it's not used in the subscriber

            11   services.  And there is a distinction.  Of course, if it's

            12   not disclosed, it still could be used, and the consequences

            13   could come out in the recommendations.  And I'm just

            14   wondering whether -- I mean, I would be personally more

            15   comfortable if it were not used at all.  But is that what I'm

            16   hearing?  Or do some people actually use it?

            17             MR. HARRIS:  I think you've identified the exact

            18   issue, which is what happens when, either in the subscriber

            19   services or otherwise, information is produced that relies

            20   upon, but does not disclose the information.  Do we have a

            21   problem? Having raised the issues, and again reminding you

            22   that our job is to identify the issues, and we'll allow the

            23   Commission to judge them, let me turn away from private

            24   information now to public information. 

            25             MR. COLBY:  Could I ask --






             1             MR. HARRIS:  I'm sorry.  

             2             MR. COLBY:  I'm going someplace you're planning to

             3   go anyhow.  I was still unclear from the users of research

             4   what they get when they have a subscription that gives them

             5   access to a rating agency.  What do they get when they

             6   contact those people?  We've been talking about specifically

             7   private information.  I suppose there's also a question about

             8   a sense of given ratings have an impact on prices sometimes. 

             9   Any sort of sense of directional move on ratings?  I assume

            10   that you do get the ability, and I think Moody's said that

            11   there is ability to talk to the analysts, that comes from

            12   this subscription.  And if so, what do you get when you talk

            13   to the analysts?  What's the point of talking to them?

            14             MS. PETERSEN:  Well, generally speaking, most of

            15   the subscription services that we have -- one point that I

            16   wanted to make is, we can't lose sight of the fact that by

            17   giving someone an NRSRO status guarantees that they are going

            18   to have a subscriber base, because that status is built into

            19   a lot of the regulation.  And we then become captives of

            20   those agencies.  And I can tell you that the price

            21   competition among them doesn't exist.  If anything, they're

            22   all trying to end up charging us the same thing.  So there's

            23   a great deal of money at stake on the subscriber side for

            24   this. 

            25             What we generally get is access to their websites,






             1   which means that we get whatever is published.  Some of them

             2   have e-mail pushes.  If we identify a certain number of

             3   companies, or CUSIPs on the muni side, so that we get the

             4   information without necessarily having to log into their

             5   website.  We get access to all of their information. 

             6   Sometimes it's based on whether we're subscribing to a

             7   certain sector within their rating universe or not.  

             8             And then the access to the analysts.  Quite often,

             9   it's to get clarification on the issues presented in whatever

            10   they stated publicly.  It's nothing more than that.  There

            11   are -- I don't know anybody who can read one set of

            12   recommendations, and walk away saying, "I have absolutely no

            13   question whatsoever about the interpretation of this

            14   information."  So we're seeking clarification on certain

            15   points.  Because again, we do not want to be in possession of

            16   material non-public information at any point. 

            17             But if, indeed, the analyst on the rating agency

            18   side has received information that, unfortunately, the

            19   pharmaceutical company has just received a lawsuit naming it

            20   for whatever the biggest plaintiff's case could possibly be,

            21   they could put that in there in the form of their rating, but

            22   they wouldn't say anything about it in the recommendation.

            23             And so that's where we would have to rely on the

            24   fact that we know that they get a lot of ongoing information. 

            25   And sometimes if there's disparity like that, one of my






             1   analysts will go onto Lexis-Nexis and take a look to see if

             2   there's been a public filing of something.  It will prompt us

             3   to do additional research.  

             4             But it doesn't mean that we are calling, with the

             5   expectation that the analyst is going to say, "Well, just

             6   between you and I, this is really what's going on."  That

             7   kind of information is not disseminated. 

             8             MR. HARRIS:  Erwin, when your portfolio manager or

             9   analysts are talking to the credit rating agency managers and

            10   analysts, do you ever discuss values?  Do you expect that

            11   they discuss values?  Do they talk about the difference

            12   between what the credit rating would seem to indicate, and

            13   what the prices are indicating?

            14             MR. MCDANIEL:  That's more, I would call it, on the

            15   analytic side, where people take a look at these qualitative

            16   adjustments, these probabalistic statements.  And then take a

            17   look at how that jives with where the prices are, relative

            18   to, let's say, a triple A curve, or a single A curve.  That's

            19   sort of a meld between the analytic approach, so this is

            20   fairly priced, this is cheap, this is rich, relative to what

            21   the qualitative or probabilistic view is, how stable has this

            22   been, how much -- how long has it been centric to double A

            23   rating. 

            24             MR. HARRIS:  And are those discussions exclusively

            25   within your firm, or are those discussions that you're having






             1   when you make the phone calls that your subscription

             2   facilitates?

             3             MR. MCDANIEL:  It tends to be more methodological. 

             4   Like periodically people will check in and say, "Has there

             5   been any change, any different view on how you guys think

             6   about this rating?"  Particularly, you know, the whole group

             7   KMV was mentioned, which is a methodology that actually

             8   marries the two views almost, in a way.  It says, there's an

             9   influence here over the long term about where the ratings

            10   are, and then there's the prices.  

            11             And then there's some way to actually take a look

            12   at the both and say, "How stable has this been over time, and

            13   how does it manifest itself in terms of price.  I don't think

            14   it's one where we would call and say, "jeez, we got a decimal

            15   place off here or something, something must be up.  We'd

            16   better call the agent -- agency."  It's more like

            17   periodically we'd check in and say, "If there's any

            18   methodological advancements that we're unaware of, is there

            19   something going on that we should be incorporating?"

            20             But then I'd say we take those inputs, and it's

            21   back on our side, as was stated, to make the ultimate

            22   decision to buy or sell that asset, given where it is in the

            23   market. 

            24             MR. HARRIS:  The buy side, of course, always has

            25   ultimate responsibility for their purchase and sales






             1   decisions.  But help the Commission distinguish between a

             2   question of whether you're obtaining investigation analyses

             3   or investment advice, versus merely the subscription to a

             4   newspaper.  Would it be fair to characterize the subscriber

             5   relationship as producing information that is tailored

             6   specifically to your portfolio, or to your specific

             7   interests?

             8             MR. MCDANIEL:  No, it's one input among many.  And

             9   I'd echo the point that we actually subscribe to many of

            10   them, as a point of validation.  We're trying to determine

            11   whether there's consensus across a number of sources of

            12   information.  We then also maintain our own, that mimics, in

            13   a lot of ways, the process, albeit it's not in the level of

            14   depth that they're able to because of their manpower.  

            15             So in essence, we are trying to actually plumb the

            16   depths of a number of sources, get a validation, and then we

            17   would go on and make an investment decision internally. 

            18             COMMISSIONER GLASSMAN:  Can I just follow up with

            19   Stephanie on something she said?  If I understood you

            20   correctly, you said that you feel you have to subscribe to

            21   the NRSRO's subscription service.  So the implication is, you

            22   don't have to subscribe to the agencies that are not NRSROs. 

            23             MS. PETERSEN:  That's right. 

            24             COMMISSIONER GLASSMAN:  Why do you feel that way?

            25             MS. PETERSEN:  Because under Rule 2a-7, especially






             1   with all the money funds that we have, there are several

             2   parts within the rule that say that the quality and

             3   eligibility of that investment is dependent on us being able

             4   to demonstrate that the requisite NRSROs have rated it in a

             5   certain rating category.  And consequently, if something gets

             6   downgraded, there is a certain responsibility on our part to

             7   take action, simply because it no longer fulfills that

             8   eligibility criteria. 

             9             COMMISSIONER GLASSMAN:  Why can't you just rely on

            10   the rating?  Why do you have to have the subscription service

            11   to do that?

            12             MS. PETERSEN:  Well, for the most part, especially

            13   on the short-term side of the market as opposed to the long-

            14   term rating marketplace, there is very little variability in

            15   the short-term ratings.  And consequently, if you don't

            16   subscribe, and you don't understand and appreciate what kind

            17   of information the rating agencies are assessing, how they

            18   assess it, and that kind of thing, you are not going to be

            19   prepared for some of those ratings adjustments.  And the

            20   attendant reinvestment risk that can go along with having

            21   something go from tier one to tier two status can be very

            22   difficult to work through if you can't reasonably anticipate

            23   that. 

            24             So the subscription service gives us that kind of

            25   background information, so that we can make sure that we have






             1   the best possible information, so that we can try to

             2   anticipate which direction the ratings are likely to go. 

             3             MR. COLBY:  And how do you get that kind of

             4   insight?  I just don't understand.  Are you saying that the

             5   subscription helps you understand how the rating agency

             6   analysts think, and how they're going to respond to an

             7   external event?

             8             MS. PETERSEN:  Absolutely.  There are several ways

             9   that you do it.  Number one is, you read whatever more

            10   thoughtful and longer publication that gets produced, which

            11   usually comes out the first time a security or an entity is

            12   rated.  And then periodically, based on material information,

            13   such as when their annual reports get released.  Or on the

            14   public finance side, when the caffer is finally released.  

            15             Then, intermittently, depending upon what other

            16   information they're receiving, they may come out with

            17   something that says, "gee, it appears that this particular

            18   entity is experiencing some difficulty.  And therefore, we're

            19   going to place it on watch," which signals to us that the

            20   rating agency views that the trend that they're seeing is

            21   something that may result in a rating change. 

            22             And so all of that information is useful to us, to

            23   help anticipate what kind of investments we make, buy-sell

            24   decisions. 

            25             MR. COLBY:  But so far, everything you've said, I






             1   think, is public, right?

             2             MS. PETERSEN:  All the rating agency information is

             3   technically public.  I think it depends upon whether you

             4   subscribe.  Because S&P's information -- for instance, if you

             5   belong to Bloomberg, you might see an alert -- a headline

             6   that says, "S&P changes rating," but you won't get the

             7   rationale unless you're actually a subscriber.  So if you're

             8   just looking at ratings, you might get that public

             9   information, but the subscribers get the more in depth

            10   analysis, as well. 

            11             MR. HARRIS:  Our time is near the end, and I'd like

            12   to make sure that we take full advantage of an extraordinary

            13   panel in front of us to ask one final question.  Now, this

            14   question focuses on public information, and strictly

            15   speaking, it is not a question that is specific to the credit

            16   rating agency or the issues involved, but one that is of such

            17   close importance, that it really should be asked.  And that

            18   is this.  You may have heard it from me last time, if you

            19   listened.  It's the silver bullet question.  

            20             If they gave you a silver bullet that you could use

            21   to ask the SEC to mandate further disclosure from the issuers

            22   that would be of particular use to the buy side, and

            23   investors in general, how would you use that bullet?  What

            24   things should be better disclosed, that presently aren't

            25   being disclosed?  That information, presumably, could be






             1   processed through the credit rating agencies, or it could be

             2   processed by anybody else.  

             3             But given that we're talking about investment

             4   information, and we all recognize the incredible importance

             5   of the SEC's disclosure programs as providing the raw

             6   material that's processed by analysts of all types, whether

             7   they're in the credit rating agencies or elsewhere, what more

             8   should the SEC be doing in the public interest?  Anybody like

             9   to take that bullet?  For some people, it might not be a

            10   bullet.  It might be a mortar shell.  Would anybody like to

            11   take the opportunity to advise the Commission?

            12             MR. PUTNAM:  I would. 

            13             MR. HARRIS:  Please. 

            14             MR. PUTNAM:  This will probably shake it, but if

            15   you standardize some of your data that's coming into the SEC

            16   in a standardized form, very much like the Feds do, or the

            17   institutions that they regulate, this data could be utilized

            18   much more efficiently, and the whole rating process could

            19   change dramatically, and be much less costly.  

            20             MR. HARRIS:  I'm pleased to tell you that the SEC

            21   is aware of that issue, and we are discussing how to better

            22   tag data, and if the data were better tagged, then it could

            23   be recovered more easily.  And we're very sensitive to that. 

            24             MR. MCDANIEL:  Larry, from Moody's perspective, and

            25   I imagine this view is probably shared on the buy side, if we






             1   had to select one thing, it would probably be what we are

             2   calling triggers.  They include rating triggers, but can also

             3   include other conditional elements in financial agreements. 

             4   And it's our understanding that those are not currently

             5   disclosed publicly as comprehensively as they might be, and

             6   we think that that would probably be of benefit to the

             7   market. 

             8             MR. HARRIS:  Anybody else that would like to use

             9   their silver bullet?

            10             MR. PUTNAM:  I would add -- and this is only

            11   related to the question.  The question is, what further

            12   disclosure.  I think one of the major disclosure problems of

            13   the rating agencies is that of fraud, and information that's

            14   not accurate, given to the rating agencies, or omissions. 

            15   And obviously, to the extent that information is put into

            16   public financials and all, there are consequences.  But I'm

            17   just thinking, if there's any situation where information is

            18   given to the rating agencies that a rating is based on, but

            19   it's not given in any other way may be confidential

            20   information, and that information is misleading.  Are there

            21   any consequences to the issuer's officers providing that

            22   information, because there ought to be. 

            23             MR. HARRIS:  What about for structured products? 

            24   Should the SEC mandate more comprehensive disclosure of the

            25   characteristics of the underlying assets?






             1             MR. JOYNT:  I'm not very close to what's mandated

             2   today.  There's a lot of information available.  I'm not sure

             3   more depth on the information.  The question you've brought

             4   up is, I think, a very important and strong one.  There are

             5   some situations today in the asset-backed market, where the

             6   quality of the information being provided to everyone is

             7   being challenged and questioned.  In this morning's Journal,

             8   this case of NCFE is prominent in my mind.  

             9             And so I wonder there whether it's a question we've

            10   faced before about accountants, and the accountants and the

            11   company, and how they're working.  Or whether it just has to

            12   do with more granular information that isn't necessarily --

            13   that's presented in a way -- and I hadn't really thought

            14   about it in that way.  I'm not familiar with any situations

            15   where we feel like -- or I can't think of any, but I need to

            16   think about this more, whether there are situations where we

            17   feel like the information content from management was

            18   misleading or erroneous.  So we would not have a way to audit

            19   that, because, as you know, we don't do that. 

            20             MR. HARRIS:  Right.  Paul, would you like to ask

            21   anything?

            22             COMMISSIONER ATKINS:  Just on your last question, I

            23   think the Division of Corporation Finance is working 

            24   closely with the industry, with the Bond Market Association,

            25   to try and impose a more standardized disclosure framework






             1   into the asset-backed arena, and we're hopeful that that

             2   initiative will be published very shortly.  So I think the

             3   SEC is doing everything that it should be doing, to try to

             4   make sure the disclosure is fair, material, accurate, and

             5   standardized. 

             6             MR. HARRIS:  I've only been at the SEC for four and

             7   a half months, but I'm smart enough to know to close on a

             8   good statement for the SEC.  

             9             COMMISSIONER GOLDSCHMID:  Let me give you one more

            10   alert in answer to Steven's question.  There is a line of

            11   cases that say if an issuer uses an analyst as a conduit for

            12   misleading information, that certainly can be reached under

            13   our traditional antifraud doctrine. 

            14             MR. HARRIS:  Well, thank you very much.  We will

            15   resume at 1:30. 

            16             (Whereupon, at 12:26 p.m., a luncheon recess was

            17   taken.)

            18             MS. NAZARETH:  I think professor Schwarcz was the

            19   only person who didn't have the opportunity to make his

            20   opening statement because of the delays.  So before we begin

            21   our next session, I thought we'd give you the opportunity to

            22   make your opening statement.

            23             MR. SCHWARCZ:  Thank you.  Two minutes?  Two or

            24   three?

            25             MS. NAZARETH:  You can take three if you'd like. 






             1             MR. SCHWARCZ:  Three.  

             2             (Laughter.)

             3             MR. SCHWARCZ:  Ultimately, I believe that market

             4   forces, with a minimum of government action, will allow

             5   rating agencies to perform the job for which they're

             6   intended, and that economic efficiency alone should be the

             7   standard by which rating agencies should be judged.  

             8             Government regulation could potentially increase

             9   efficiency in two ways.  One, by improving rating agency

            10   performance.  And two, by limiting the negative consequences

            11   of rating agency actions.  Regulation could improve agency

            12   performance, I think, only by reducing overall costs, or

            13   improving ratings reliability. 

            14             Presently there's little reason to believe that

            15   rating agency fees, which are market driven, are excessive. 

            16   But of course, were a problem -- then a suggestion I'm going

            17   to make at the end about increasing competition, I think,

            18   could potentially reduce the costs.  

            19             Could regulation improve ratings reliability? 

            20   First of all, I think rating agencies are very concerned

            21   about this, because they are very careful of their good

            22   names.  Their reputation is really their credibility and

            23   their value.  Nonetheless, the economic downturn has reduced

            24   the perceived reliability of ratings by highlighting their

            25   relative stability.  And the stability, I think, is the key






             1   here.  

             2             Rating agencies should be careful to examine the

             3   reason for any downgrading, and especially sensitive to

             4   faults on investment-grade debt.  But to some extent,

             5   instability is inherent in the way ratings are presently

             6   interpreted.  Say, for example, you have a triple A bond. 

             7   That bond will retain its triple A rating years in the

             8   future, even though there may not be necessarily a

             9   reassessment at that time that the bond deserves to be triple

            10   A. 

            11             Now, there is downgrading, but the downgrading is

            12   more passive than sometimes active.  And one possibility

            13   might be to give ratings set life, and then prior to the

            14   expiration of the life, to do a complete analysis, and see

            15   whether the ratings should continue for another period. 

            16             There's also a problem with ratings -- a perceived

            17   problem with ratings reliability.  Rating agencies are

            18   conservative in downgrading, and this is because downgrading

            19   the bonds of an otherwise healthy company can become a self-

            20   fulfilling prophecy.  Nonetheless, a rating agency's failure

            21   to appropriately downgrade, like the failure in Enron, and

            22   more recently in National Century Financial Enterprises, can

            23   significantly impair rating agency credibility.  

            24             This suggests that rating agencies and government

            25   need to consider to whom rating agencies should have a






             1   primary responsibility.  To the issuers, who want stable

             2   ratings, or to the investors, the existing investors

             3   basically, who want to -- I'm sorry, to issuers and the

             4   existing investors, who want the stable rating, or to

             5   potential new investors, who basically want the most up-to-

             6   date information. 

             7             And this tension also highlights, I think, the

             8   dichotomy between rating agencies on the one hand, and market

             9   tests like credit spreads on the other hand.  Rating agencies

            10   are, and are intended to be, more conservatively stable. 

            11   Market-based test, such as credit spreads, are more

            12   sensitive.  However, they're also more prone to false

            13   negatives, and that could be problematic. 

            14             And in this context, one needs to realize that the

            15   function of rating agencies is really to reduce information

            16   asymmetry.  And I emphasize "reduce," because one cannot

            17   eliminate that.  There will always be problems with ratings,

            18   because rating agencies are not perfect and cannot be

            19   perfect. 

            20             Another problem is that ratings do not cover the

            21   risk of fraud.  Investors, no matter -- even though this is

            22   publicized, investors do not recognize this, and it whether

            23   or not be economically viable for rating agencies to act as

            24   guarantors of fraud.  

            25             It's unclear how further regulation could help the






             1   fraud problems, because companies are already required to

             2   produce accurate information, and fraudulent corporate

             3   officers can be fined and go to jail.  And as Commissioner

             4   Goldschmid pointed out this morning, even if the information

             5   is given to the rating agency, but not in the financials,

             6   there at least is a line of cases that suggests there can be

             7   penalties.  I think the solution here is to educate investors

             8   to the existence of the fraud exception to ratings, so

             9   investors themselves would become wary of possible fraud. 

            10             Another thought is, why are rating agencies

            11   different than accounting firms in the temptations that, for

            12   example, misled Arthur Andersen?  One reason is that rating

            13   agencies do not have disproportionately large concentrations

            14   of customer fees.  In fact, in looking at some of the

            15   statements made, I noticed, I think it was S&P that said that

            16   its largest concentration is 1 percent or under 1 percent. 

            17             But a second difference is that, unlike accounting

            18   firms, reserve account do not yet have internal conflicts of

            19   interest based on fees, such as combining both auditing and

            20   consulting businesses with the same entity.  And therefore,

            21   it may well be useful to examine whether regulation could

            22   restrict any such conflicts from developing. 

            23             Another potential problem is the potential to rate

            24   without request.  And I know we'll be discussing that this

            25   afternoon, so I won't mention that at the moment.  But the






             1   final negative is that rating agencies are conservatively

             2   biased against innovation, for a number of reasons. 

             3   Competition, I think, might be able to help that bias. 

             4   Certainly, increased government regulation would not help

             5   that bias, because government regulation never made anyone

             6   more liberal in doing things, only more conservative. 

             7             Now, the concern over competition exists, as

             8   everyone knows, because at present you only have three

             9   NRSROs.  And this at least suggests that government should

            10   consider balancing the need for a rigorous standard for

            11   rating agencies against the need to ensure competition.  

            12             My recommendation, which is in line with an

            13   earlier, but somewhat ignored, proposal by the antitrust

            14   division of the U.S. Department of Justice, is to award

            15   government designation -- NRSRO designation to foreign

            16   recognized rating agencies, and also to subsidiaries of high

            17   reputation U.S. firms active in evaluating business and

            18   securities of companies.  This risk could be further

            19   minimized by making any de novo applicant status provisional

            20   for some trial period. 

            21             In this way, the potential anticompetitive effect

            22   of NRSRO designation can be reduced without unintentionally

            23   creating a climate in which issuers of securities will shop

            24   around, to try to buy the highest rating.  We certainly want

            25   to avoid that perverse incentive.  Thank you. 






             1             MR. McCARTHY:  During this session we intend to

             2   explore the potential concerns regarding the role of credit

             3   rating agencies, particularly the potential for conflicts of

             4   interest in the credit rating business, and the potential for

             5   credit rating agencies to abuse their power in the

             6   marketplace.  

             7             The Commission staff is presently in the process of

             8   examining the role and function of rating agencies in the

             9   securities markets, and has focused a lot of attention on the

            10   various potential conflicts of interest.  Conflicts of

            11   interest in the equity research process have been the subject

            12   of much recent media attention, such as the pressure on

            13   equity analysts to maintain positive ratings on issuers, in

            14   order to gain lucrative investment banking fees for their

            15   firms. 

            16             One goal of this session is to discuss the extent

            17   to which conflicts such as those that have been alleged in

            18   the equity research process present themselves in the credit

            19   rating process.  And probably more importantly, to identify

            20   and discuss any potential conflicts that may be unique to the

            21   credit rating process. 

            22             Accordingly, we request your opinion as to whether

            23   potential conflicts of interest in the credit rating business

            24   influence the credit rating process.  And specifically, I

            25   have identified some potential conflicts.  And I'll just






             1   outline them now. 

             2             The first one is whether the fact that a credit

             3   rating agency is paid by an issuer it rates calls into

             4   question the objectivity of the ratings.  If so, what about

             5   agencies' practice of basing fees on the size of the debt

             6   issuance?  Does this practice increase the potential

             7   conflict, to the extent that the agencies could become

             8   dependent on a few large issuers for a disproportionate share

             9   of their revenue?

            10             Secondly, whether conflicts of interest are created

            11   when a credit rating agency provides consulting, or other

            12   advisory services to issuers it rates?

            13             And third, whether there are any other conflicts of

            14   interest in the credit rating business that influence the

            15   rating process.  

            16             I note that a couple of our rating agency

            17   participants here today, and at the previous hearing, do not

            18   charge issuers for ratings, and thus avoid certain influences

            19   of issuers.  We would be interested to know their views on

            20   whether similar conflicts of interest exist for these

            21   subscriber-based firms who could be subject to the influence

            22   of subscribers, particularly if the firm is experiencing

            23   economic pressures. 

            24             The NRSROs also maintain substantial power in the

            25   marketplace.  An NRSRO can directly impact an issuer's cost






             1   of issuing debt, and most issuers seek ratings from at least

             2   one NRSRO.  Accordingly, many commenters have stated that the

             3   potential exists for NRSROs to engage in abusive practices,

             4   such as improperly pressuring other issuers to pay for

             5   ratings.  

             6             In this regard, I would be interested to hear your

             7   comments on questions such as whether rating agencies rate

             8   issuers that have not requested a rating, and whether they do

             9   this as a means to generate business, whether these -- and

            10   they're often termed "unsolicited ratings" -- are less

            11   reliable than solicited ratings, and whether the use of

            12   unsolicited ratings should be restricted.  And secondly,

            13   whether rating agencies engage in any practices that are

            14   anticompetitive, or otherwise abusive.  

            15             To the extent that you believe that these conflicts

            16   of interest or abusive practices exist in the credit rating

            17   business, I welcome your comments on ways to prevent such

            18   conflicts, or ameliorate their consequences.  Okay.  So why

            19   don't we -- I'll frame the first conflict, and then open it

            20   up to the panel.  The first one, does the practice of issuers

            21   paying for ratings create a conflict of interest?  And if so,

            22   what effect does this have on ratings?  And also, the related

            23   topic, is this conflict exacerbated by frequent issuers of

            24   debt, because the rating agencies charge fees based on the

            25   size of the issuance?  And Ray, why don't I start with you,






             1   since I know you've talked a lot about this one. 

             2             MR. MCDANIEL:  Sure.  I'd be happy to give you the

             3   Moody's perspective on this.  I think, first of all, we would

             4   agree that there is a latent conflict of interest embedded in

             5   an issuer fee-paying model, and I think the burden, then, is

             6   on the rating agencies to demonstrate that they can manage

             7   those conflicts, and can produce high-quality opinions and

             8   maintain objectivity and independence.  

             9             I think we do that very well as an industry right

            10   now.  We have at Moody's a set of core principles that we

            11   follow, which we have talked about in our written materials,

            12   and those core principles deal with the independence of our

            13   ratings, the fact that we will not forbear to move a rating,

            14   regardless of the effect it may have on an issuer, the fact

            15   that ratings are not controlled by any commercial

            16   relationship that we may have with an issuer, the fact that

            17   we treat confidential information properly.  We act

            18   judiciously.  We operate by rating committee.  These are all

            19   important principles as far as mitigating some of these

            20   conflicts that come from having issuers pay us. 

            21             We also follow a set of more practical procedures

            22   that have to do with prohibiting our analysts from trading or

            23   owning securities of companies that they follow, except by

            24   way of diversified mutual funds.  We work to adhere to fixed

            25   fee schedules, and those are known by the applicants.  We






             1   work to manage any embedded conflicts of interest by having

             2   an open-door policy, as far as having analysts go in to

             3   managers if they see any concerns or problems.  And having a

             4   securities trading policy, confidentiality policies, conduct

             5   -- business conduct policies, all of which are designed to

             6   make sure that the independence and objectivity of our work

             7   is preserved.  

             8             And finally, we have the track record, and it's

             9   published.  There is predictive content to our ratings, and

            10   that track record is available for everyone in the market to

            11   review, and, in fact, for independent third parties to test. 

            12             MR. McCARTHY:  Steve, what are your general

            13   thoughts on the issuer payment conflict?

            14             MR. JOYNT:  Sure.  I have very comparable comments. 

            15   Without trying to repeat them all, maybe I'll try to do it

            16   more briefly.  I do think that culture is the most important

            17   thing, and so we've embedded in our culture at Fitch the same

            18   conservatism, in which we treat confidential information the

            19   same.  Important employee protection measures, in terms of

            20   their own behavior, including not owning securities in any

            21   companies that they're involved with.  And we're pretty

            22   strict.  And we've shared this information, actually, with

            23   the Commission.  

            24             And also the committee process, I think, is very

            25   important.  So it's a collegial process, a committee process. 






             1   There isn't a one-person rule, and I don't think one person

             2   could get away with undue influence in any particular rating

             3   situation, although they can have a lot of influence, and it

             4   needs to be protected against. 

             5             So I don't think we at all avoid the conflict issue

             6   with issuers paying.  I think we recognize it's there.  We've

             7   built into our process and our culture important protections

             8   against it.  And I also agree that I think -- it's not just a

             9   Fitch issue, but the industry issue is that we have a very

            10   good track record.  So there haven't been instances that have

            11   arisen of individual performance on the part of the analysts

            12   misusing information, or influencing ratings unduly, I don't

            13   believe.  So I think that's important. 

            14             MR. MAYEWSKI:  From Best's perspective, I would

            15   echo Steve and Ray's comments.  Very stringent polices,

            16   committee procedures, stock ownership issues, no analyst is

            17   allowed to own, in the rating division, any stock in an

            18   insurance company, outside of mutual funds.  Clearly, no one

            19   issuer's fee is a significant portion of the organization's

            20   total revenue.  

            21             And in the end, it all boils down to credibility,

            22   and the performance of a rating organization ultimately is

            23   what will be the judge as to whether they're going to remain

            24   in business and be credible.  So that is something we have to

            25   manage, and each and every day we do our best to manage that






             1   effectively. 

             2             MS. LANCELLOTA:  John, can I ask a question?  I'm

             3   just curious on the compensation structure for your analysts. 

             4   Whether it's based on the number of issuances rated, or is it

             5   just kind of an objective structure of some sort?

             6             MR. MAYEWSKI:  Compensation of analysts is not tied

             7   at all to any issues, size of issues.  Nothing to do with the

             8   rating fees.  It's not related at all to rating fees.  It's

             9   their performance, and the organization's performance.  

            10             MR. MCDANIEL:  That's true at Moody's, as well. 

            11             MR. JOYNT:  Also at Fitch -- and I think that's a

            12   really important of culture.  I should have mentioned it. 

            13   Thank you for bringing it up.  We look at the individual

            14   analyst's performance against all analysts in a judgmental

            15   way.  We focus the process of determining bonuses, which we -

            16   - and we have a bonus system -- is based on company

            17   performance, not on any department's performance.  We don't

            18   have any -- there's nothing written on a piece of paper that

            19   says, "your department and your share of pools" or anything

            20   like that.  And once people have surfaced recommendations on

            21   individual analysts, they're put together into a pool of all

            22   directors, and all managing directors, and looked at across

            23   the entire company. 

            24             And one further reflection I would have is that if

            25   you look at the compensation across our different departments






             1   -- and we do have different departments that are more or less

             2   profitable than other ones -- but the average analytical

             3   compensation does not have great variability.  There's not

             4   analysts in departments that are making a lot of money for

             5   the company, making $400,000, and other ones in public

             6   finance, which are very cautious on fees, making a far less

             7   amount.  It's just not -- and we're happy to share that

             8   information with the Commission. 

             9             MR. HARADA:  As far as conflict of interest, I

            10   think that there might be potentially some risks in conflict

            11   of interest in that such a rating fee comes from the issuer's

            12   expense.  But we have already introduced various devices with

            13   which we can avoid such kinds of conflicts of interest.  Most

            14   conflicts are quite similar to those of the Moody's and Fitch

            15   has been introduced.  

            16             But in addition to that, in the field of the

            17   education of the analysts, we reiterate very much -- very

            18   frequently that our ultimate goal is for the convenience --

            19   for the investors.  Our ultimate goal is not the issuers, but

            20   the investors.  The convenience of investors is our ultimate

            21   goal.  So that in order to keep such kind of ultimate goal,

            22   we pay attention -- make a very strong effort to the

            23   accountability.  And we always explain the whole rating

            24   process, so that if some -- what should I say -- explicitly,

            25   so that if there is some risks or there's some conflict of






             1   interest, an outsider can identify that such conflict of

             2   interest.  

             3             And also that we have also introduced a firewall

             4   between the promotion -- business promotion section and 

             5   analyst section.  We have -- there is no exchange of the

             6   information, and no exchange of the human resources, so that

             7   we have introduced such a very rather strict firewall between

             8   these two sections. 

             9             Thank you.

            10             MR. McCARTHY:  Does anyone else have any -- Barron?

            11             COMMISSIONER CAMPOS:  I have a question.  I'd like

            12   to direct it at the two individuals who spoke, Ray and the

            13   gentleman from --

            14             MR. JOYNT:  Steve. 

            15             COMMISSIONER CAMPOS:  Steve.  Sorry.  And my

            16   question is -- I guess it's two hypotheticals that I want you

            17   to think through.  One is, if we assume that we had a

            18   different environment, and we had more than three NRSROs, and

            19   we had five or ten, let's say, and if those particular --

            20   second hypothetical -- those particular agencies were

            21   dividing up the business, as it were, where we had,

            22   essentially, the individual issuers had a choice, and it

            23   wasn't always going to end up in two out of the three,

            24   essentially, in the regime we have now.  Would that situation

            25   -- and if we assume that that -- that now you have economic






             1   issues, you know, in terms of competition, okay?  

             2             Would your answer change, in terms of this

             3   insulation of conflicts, based on the procedures you have

             4   now?  Or do you think that, because there might be more

             5   pressure economically, maybe your business model is such that

             6   the ratings business needed other business, would there be a

             7   tension, and would there be some pressure on the integrity,

             8   and would there be -- would you be more susceptible, I guess,

             9   is the way to frame it, to the issuer desiring the

            10   maintenance of a good rating?

            11             MR. MCDANIEL:  I think, as a starting point in

            12   answering that question, we would have to consider whether

            13   having five or ten NRSROs would increase the stock of opinion

            14   -- credit opinions in the market by two or three times, or

            15   whether there would simply be the same number of opinions,

            16   but with issuers selecting from among a larger number of

            17   rating agencies.  I suspect that it would tend to be more the

            18   latter than the former, and that raises the question of, what

            19   will competition in the industry look like if that is the

            20   case. 

            21             The two forms of competition that -- well, there's

            22   three forms of competition that I can think of.  There

            23   certainly can be competition based on who provides the

            24   greatest accuracy over the body of opinions, over a long

            25   period of time.  There may also be competition on the basis






             1   of price, or competition on the basis of ratings, assigning

             2   the most favorable rating. 

             3             And in looking at that, I think the larger

             4   agencies, the agencies with significant reputational capital

             5   already in this market would certainly act to avoid

             6   competition on the basis of ratings inflation, and work to

             7   maintain quality in the industry.  I know that we would do so

             8   at Moody's.  But rather than having this raise a conflict of

             9   interest in terms of improperly interacting with the issuer

            10   community, I would say that the possibility of an unfavorable

            11   outcome for the quality of credit ratings overall would come

            12   from the possibility of a more compliant alternative being

            13   available to issuers.  I don't know if that would occur, but

            14   that would be the question I would ask. 

            15             COMMISSIONER GLASSMAN:  May I just follow up on

            16   that.  There were more rating agencies a few years ago.  I

            17   think the maximum was seven.  Was there any difference in

            18   that environment than there is now?

            19             MR. MCDANIEL:  Well, there was some academic

            20   research done that indicated that the more marginal players

            21   and the new entrants tended to rate more highly than the

            22   established players.  But again, whether that would occur in

            23   the scenario that Commissioner Campos posed in the future, I

            24   don't know. 

            25             MR. JOYNT:  I have many things I'd like to say on






             1   this issue, but I'll try to stay away from the competition

             2   aspects of it, and just stay on the conflicts aspects of it. 

             3   I don't need the hypothetical.  We lived that situation.  I

             4   was at Fitch, and there were seven rating agencies in 1989

             5   and 1990, and we had to try to build -- rebuild the

             6   reputation of Fitch.  It had not -- a weak reputation for the

             7   quality of its research.  So we brought in new analysts, we

             8   brought a new culture to the organization.  The things I

             9   described, we started embodying in the company at that point.

            10             We had to go out to the institutional investors and

            11   convince them that our ratings were accurate, and going to be

            12   accurate, and our research was deep and good and strong, and

            13   reflective of good credit quality work.  So it's not just a -

            14   - you just can't put the ratings out there.  People won't

            15   follow them just because they're ratings from an NRSRO.  They

            16   have to have great credibility. 

            17             We also knew we were doing that, and it was going

            18   to take a long time to convince people.  We weren't going to

            19   have a 20-year track record that the two larger ones might

            20   have of rating corporate bonds.  Although we thought we could

            21   establish a good track record over a five- or a ten-year

            22   period, which we feel like we have.  

            23             And it required a big investment.  So I think one -

            24   - without getting into the competitive aspects, one important

            25   thing would be to have a financial commitment to doing --






             1   that allows one to do quality work consistently, avoid the

             2   conflict issues, and the trial period that's been suggested,

             3   or limited entry based on the expertise in one particular

             4   area.  I think those would all be constructive ideas towards

             5   a time frame at which people could see how an organization

             6   acted regarding the conflict issues. 

             7             COMMISSIONER CAMPOS:  Let me push you a little bit

             8   more.  Is there a number of active credit agencies, let's

             9   say, that would have the national recognition category that

            10   the marketplace could sustain, before you have competition

            11   that endangers, or creates the conflicts that I'm posing?

            12             MR. JOYNT:  You could ask that of issuers and

            13   investors also, not just of the rating agencies, because

            14   issuers pay, and investors -- how many rating agency opinions

            15   can we actually work with and use.  Especially in the context

            16   of NRSRO and regulation.  So how they use those.  

            17             But the only answer I can give to you is, I think

            18   if you have credible management, and someone looks at the

            19   rating agency and says they have the proper procedures, and

            20   process, and experienced analysts, and some pretty basic

            21   fundamental things, then I'm confident that you could have

            22   many organizations that could manage the conflict issue.  But

            23   it would require, I believe, significant financial

            24   commitments.  

            25             So over time -- I mean, I don't think you would






             1   authorize, and people would follow a rating organization that

             2   had a very small staff, with limited financial capabilities,

             3   and got the benefit of some kind of recognition and

             4   regulation that they could misuse, I don't think. 

             5             COMMISSIONER CAMPOS:  So just to make sure, before

             6   Ray gives us his opinion about this, when you say, "financial

             7   commitment," you mean, have sufficient capital where they're

             8   not under distress, and have to, essentially, give in to

             9   creating higher ratings from issuers?  Is that what you mean? 

            10   Have a long-term financial capability, where they can

            11   withstand economic pressures?  Is that what you're getting

            12   at?

            13             MR. JOYNT:  That's what I mean.  I wouldn't

            14   describe it in the terms of capital, like a proscribed amount

            15   or a dollar amount of capital sitting in the firm, but the

            16   requirement to sustain the losses, and it may take to build

            17   up a reputable business.  When we built -- started building

            18   Fitch in 1989, it took us four and a half years before we

            19   made any money, and I think the total investment was over $40

            20   million.  

            21             So that was a pretty strong commitment,

            22   financially, to building our reputation sufficiently so we

            23   attracted enough investor interest.  We went two years --

            24   almost two years -- well, a little less than two years -- 18

            25   months before we, I think, received any issuer fees for our






             1   first securitization transaction, and yet we had hired many

             2   people, and were doing research and out visiting with

             3   investors.  So I can't prescribe the amount or the time

             4   frame. 

             5             COMMISSIONER CAMPOS:  I was just referring -- I'm

             6   not asking you to give me a business plan.  I just wanted to

             7   make sure that I understood how you were using that term, and

             8   that's the way I understood. 

             9             MR. MCDANIEL:  So just to finish up, from Moody's

            10   perspective, we certainly saw an environment in the late '80s

            11   and early '90s where there were more participants in the

            12   industry, and it's my view that industry performance was

            13   still quite good during that period.  So I don't think

            14   there's a magic number of three that is the right number.  I

            15   think that the questions relate more to, as you have asked,

            16   at what point do the benefits that come from the diversity of

            17   opinion in the marketplace get outweighed by other factors? 

            18   And I don't think I can give you a specific number on that. 

            19             COMMISSIONER CAMPOS:  Barron?

            20             MR. PUTNAM:  I meant to comment earlier.  I think

            21   you have to realize that there are niche players in this

            22   industry.  Obviously, -- like we have been rating banks for

            23   18 years, and we had been rating them before Moody's and

            24   Standard & Poors and, I believe, Fitch, although Thompson was

            25   before us in doing that.  






             1             And to think that maybe our ratings would be higher

             2   if we entered the industry to compete, I think, is very

             3   wrong, because I believe if you look at our ratings today --

             4   and we don't charge banks to rate them.  We sell services,

             5   but we don't charge banks to rate them -- that you'll find

             6   our ratings are more conservative.  They're, on the average,

             7   lower than you'll find with the NRSRO companies.  And I'd be

             8   glad to submit -- probably in the foreign area would be the

             9   best areas -- our foreign bank ratings to the SEC.  And they

            10   could actually make that comparison.  

            11             So I hope you don't conclude that, if new entrants

            12   coming into this industry will be competing by that.  We have

            13   -- our credibility is on the line, too.  I mean, we've been

            14   in existence a long time, and you can lose your whole

            15   business overnight if you're not credible.  It's gone. 

            16   Especially when you don't charge banks to rate them, you

            17   will. 

            18             MS. PETERSEN:  Excuse me.  If I could make a

            19   comment from the investors side.  I'd like to echo everything

            20   that was said about the fact that new entrants are not

            21   automatically blessed with an immediate triple A reputation. 

            22   It's something that has to be earned.  

            23             And as a matter of fact, when a new entrant comes

            24   on, even if the investment banker suggests to an issuer that,

            25   "Gee, I looked around, and it looks like we could go to






             1   market with Moody's and the new XYZ rating," the likelihood

             2   is that the market is not necessarily going to say, "okay. 

             3   It's got two ratings.  We feel better about that, and

             4   therefore, we're going to give you a better price on your

             5   securities."  Instead, they're going to say, "Well, it at

             6   least has a Moody's rating on it.  We know what that is.  

             7             And depending upon whether or not we agree or

             8   disagree with what that rating is, that's the price that

             9   we're going to set.  It's going to take several more

            10   opportunities for that new rating agency to prove itself

            11   before you can see a true rating differential.  

            12             And I think the biggest issue there is that the

            13   rating agencies would have to spend a great deal of time

            14   talking to the investment banking community, to get the

            15   bankers who talk to the issuers to say, "This is an entity

            16   that you need to do business with, and here's the reason why

            17   I'm putting you in front of them."

            18             I think the issue around specialization is

            19   something that's been missing ever since Fitch decided to buy 

            20   IBCA and Thomson BankWatch, because again, given that those

            21   entities had NRSRO status, and since, especially under Rule

            22   2a-7, as amended, you only need a second opinion in order to

            23   find eligibility under the rule for certain investments,

            24   taking away the NRSRO status from three or four different

            25   agencies means that we are now forced to align ourselves with






             1   opinions that might not necessarily, in our opinion, properly

             2   reflect the credit quality.  And we have to live by the buy

             3   and sell decisions that the regulations have promulgated on

             4   us, based on rating changes that happen.  Especially in the

             5   split-rated situations.  

             6             So I think that the issue presented is not one of,

             7   let's just open up the market to competition.  It's more a

             8   suggestion to the Commission that the requirements for NRSRO

             9   status be evaluated so that various players can be elevated

            10   to a position where those of us who have to rely on the

            11   regulation can look for an opportunity to maximize our

            12   investments by getting what we believe to be the best

            13   information and the best conclusions in the marketplace. 

            14             MR. McCARTHY:  Why don't we move on to the next

            15   conflict, since I think we've deviating a little from the

            16   conflict session.  It's probably something to talking about

            17   next hour.  The next conflict that I identified is the

            18   conflict of rating agencies marketing additional products to

            19   issuers, such as what's commonly called "rating assessment

            20   services," or other consulting services.  

            21             So the NRSROs all provide prerating assessment

            22   services, or valuation services for a fee, and typically

            23   these are that an issuer will provide a set of facts, for

            24   example, a hypothetical merger or acquisition, and present

            25   those facts to the rating agency, and then the rating agency






             1   would evaluate them, I think, under the same parameters that

             2   they would as if the hypothetical facts were real.  

             3             And then, would again state how they would or would

             4   not affect the rating of the issuer.  So I just want to --

             5   you know, obviously, this, in my mind, is a conflict of

             6   interest.  And why don't we start with the rating agencies,

             7   to see how they manage that.  And then I'll open it up to the

             8   rest of the panel.  So Steven, if you don't mind starting?

             9             MR. JOYNT:  Sure.  Where do I start on this one? 

            10   We have very limited rating assessment services.  We only

            11   actually introduced this service within the last nine months. 

            12   That was after many investment bankers and issuers came to us

            13   and said, "Why don't you have a service?  The other two do." 

            14             The reason we didn't have a service was because we

            15   always would be open to giving issuers feedback or investment

            16   bankers feedback regarding their rating.  So if they called

            17   up and said, "I'd like to come in and meet with your

            18   analysts, we have some hypotheticals, we're thinking about

            19   doing this.  How -- what would be the impact on the rating?,"

            20   we would do that.  It was part of our regular process, and

            21   it's part of the fee that the issuers pay. 

            22             So in some senses, bifurcating that into a separate

            23   service is just another way to get an additional issuer fee,

            24   a separate issuer fee.  So it would reflect more time and

            25   attention then.  So one could argue, paying a separate






             1   additional fee for this assessment service now says, "Oh, I

             2   want your analyst there on Tuesday at 9 o'clock, and I'd like

             3   an answer in a week."  And I actually think that's how those

             4   services have developed.  

             5             So I think that represents more of a conflict than

             6   the more open style.  I think it could be managed quite

             7   easily, so I don't -- I haven't seen anything out of that

             8   that would indicate that there are major conflicts coming out

             9   of the other side of that.  The two assessments that we've

            10   done -- one we've completed, and one we haven't -- offer no

            11   guarantees whatsoever.  So here's our views, but many things

            12   can change in the market, so they're so highly sort of open,

            13   and conditioned that I don't see them as representing major

            14   conflicts for our firm. 

            15             MR. McCARTHY:  Ray. 

            16             MR. MCDANIEL:  The rating assessment service that

            17   we run is also a very small part of our business, though a

            18   bit larger than what Steve just described.  It's about 1

            19   percent of our revenues in the last year.  The reason we

            20   offer it is because issuers value reaction to what-if

            21   scenarios to important, potentially, business-transforming

            22   activities that they may be undertaking.  It could be an

            23   acquisition.  It could be something having to do with an

            24   asset sale. 

            25             And on the other side, investors appreciate rating






             1   stability, and avoiding unnecessary rating reversals.  So to

             2   the extent that we are able to give an issuer feedback such

             3   that it knows what is likely to happen to its rating if it

             4   pursues a particular hypothetical situation, and the issuer

             5   is able, as a result, to make a decision about whether it

             6   wants to act or not act, it will not act, in many cases, in

             7   ways that cause an unexpected and material change in the

             8   rating.  

             9             But again, I think it's our view that that benefits

            10   both the issuer and the investor communities.  There are many

            11   conflicts around offering that service, though, and we have

            12   found that we have had to not offer it in a number of

            13   specific situations, because of those potential conflicts. 

            14   It could be that a company is interested in a takeover of

            15   another company that we rate, for example, and we do not want

            16   to have that situation where two rated issuers are being

            17   subjected to this kind of analysis.  

            18             And so really, the guidelines -- and we've written

            19   fairly extensive guidelines around this, and again, have

            20   submitted them to the Commission -- have been designed to

            21   enforce a prudential level of oversight from the senior

            22   management at Moody's, in deciding when we can accept these,

            23   and when we cannot.  And in the cases -- in any gray area

            24   case, we simply don't accept it, and we don't perform the

            25   service.  It's not a product development opportunity for us. 






             1   It's not going to be a significant part of our business. 

             2   Where we can do it, it is an accommodation to the

             3   marketplace. 

             4             MR. McCARTHY:  David, has Pfizer ever utilized

             5   these services?  And if so, why?  What do you see is the

             6   advantage to that?

             7             MR. SHEDLARZ:  Well, not taking a hypothetical

             8   situation to Moody's, we have used the services shortly

             9   before we're about to transact a particular business

            10   development initiative, to understand exactly how the

            11   reaction of the rating agencies is going to play out.  But

            12   not in terms of deciding whether we will or will not do a

            13   transaction, or how we'll do it.  And in many respects, we'll

            14   do the transaction, and we'll live with the consequences, but

            15   we want to know what the consequences are before they hit us

            16   right in the face.  But not in order to make a decision. 

            17             MR. McCARTHY:  And obviously, let's say you utilize

            18   the service, they say, hypothetically, it's not going to

            19   affect the rating at all.  And then you go through with your

            20   transaction, and, for whatever reasons, in the meantime it

            21   does.  I assume that would create tensions or conflict.  I

            22   assume you're not going to be happy if that happened, right?

            23             MR. SHEDLARZ:  Well, I wouldn't be real pleased if

            24   that happened, obviously, but if circumstances changed where

            25   that was warranted, then so be it.  I mean, obviously, you're






             1   playing into a fluid situation.  You're accepting the

             2   representation of the company at the time that the company is

             3   going through the nature of the transaction, but things

             4   change.  So if it was on the basis of factors that changed,

             5   or environmental conditions, or the nature of a particular

             6   transaction, that's something we'd have to live with. 

             7             I think in many respects, the company makes the

             8   rating, not the rating agency.  It's the performance of the

             9   company.  It's the expectation of the company.  And it's

            10   something we need to live with in terms of their assessment. 

            11             MR. MAYEWSKI:  John, just for the record, I'd like

            12   to just add that A.M. Best does not provide consulting or

            13   fee-based rating assessment services.  We do provide feedback

            14   as part of the normal rating process, but we don't have a

            15   rating assessment service in place. 

            16             COMMISSIONER GOLDSCHMID:  Consulting is perfectly

            17   understandable, as I see it, but let me tell you another

            18   story about a different industry, called accounting.  Twenty

            19   years ago, 70 percent of large firm revenues came from

            20   auditing.  The latest figures show it under 30 percent. 

            21   Congress obviously was concerned enough about that to

            22   prohibit nine categories recently in Sarbanes-Oxley.  To

            23   avoid what happened in accounting, is there a reason for any

            24   public intervention, given the relatively low level of

            25   reserves from consulting? 






             1        MR. MCDANIEL:  From Moody's perspective, as I mentioned,

             2   it is not a material part of our business.  And so as a

             3   business issue, that would not, I think, be over troubling. 

             4             COMMISSIONER GOLDSCHMID:  Would it inhibit you from

             5   going much further?

             6             MR. MCDANIEL:  Well, I think we do a very good job

             7   of inhibiting ourselves from going much further, but that

             8   will ultimately, I imagine, be your determination. 

             9             MR. McCARTHY:  Well, I mean, assume, as Steven

            10   said, before they set up these formal businesses, I assume

            11   there was an informal process where you could contact the

            12   analyst and say, "Hey, we're thinking about doing XYZ, what

            13   would be your views on that?"  So is it so much that you saw

            14   a business opportunity, and have decided to go down that

            15   road?  Or is there something?  That's why I asked Pfizer. 

            16   Maybe GMAC can comment.  Is there something more valuable to

            17   the formal process than, say, what existed previously?  Is

            18   there something that you think it's very important?

            19             MR. VAN ORMAN:  From a process point of view, I

            20   don't think it's been dramatically different.  I think it's

            21   one of a number of occasions where the company has wanted to

            22   have a contemporary rating out in the marketplace at the same

            23   time it's announcing a transaction.  And so it's more of a

            24   timing issue in terms of assuring that the marketplace is in

            25   the best position to assess the merits of a particular






             1   transaction, especially when you're making a very large,

             2   significant transaction, and it's going to impact the nature

             3   of the company.  

             4             So I think it's more of a timing issue.  I don't

             5   think the substance of what transpires in terms of the review

             6   and the setting of the rating has changed dramatically.  But

             7   the timing is important.  The quality of information

             8   available to investors on the basis of having announced, or

             9   taken, some action is something that the investment community

            10   is looking for. 

            11             MR. VAN ORMAN:  I would just agree with what David

            12   said.  I'd just be repeating. 

            13             MR. SALTZMAN:  I would just like to, maybe in

            14   response to Commissioner Goldschmid, even question the

            15   analogy, because it very well may be that the current

            16   environment is such that the rating agencies don't derive a

            17   substantial portion of their revenue.  But I think implicit

            18   in your question was, maybe five years from now, it will. 

            19   And I think the question is, so what?  Because the nature of

            20   the service that the rating agencies are providing to the

            21   marketplace is completely different than the nature of the

            22   service that an accounting firm provides with respect to an

            23   audit.  

            24             In an audit environment, you have a single opinion

            25   with respect to a company's financial statements, that the






             1   investment community is basically forced to rely on.  And in

             2   a rating agency environment, you have multiple rating

             3   agencies.  Even in an oligopolistic environment, there still

             4   is competition, and I guess we'll get to that in a second. 

             5   So there are built-in market-based incentives to sort of

             6   prevent the conflicts from surfacing, even if the rating

             7   agencies were perhaps unduly influenced by a disproportionate

             8   revenue stream. 

             9             COMMISSIONER GOLDSCHMID:  Paul, right now there are

            10   three, and two of them are needed for most ratings, as I

            11   understand it.  And so there's an awful lot of power here. 

            12   And reputational constraints, which are very powerful and

            13   real, were there for the accounting firms too.  There is a

            14   problem here.  If these began to be perverted in any serious

            15   way, this is an immense, immense market, and we've got to be

            16   very careful.  I'm not saying intervention is wise, or

            17   necessary, but I am enormously concerned that the quality of

            18   the ratings remain high. 

            19             MR. SCHWARCZ:  I want to agree with my former

            20   corporations professor. 

            21             COMMISSIONER GOLDSCHMID:  There's a conflict.  

            22             (laughter.)

            23             MR. SCHWARCZ:  You know, one of the concerns that

            24   I've had -- and I mentioned this in my statement -- is that

            25   although there aren't any material conflicts now, rating






             1   agencies, after all, are business.  And if it turns out in

             2   the future that other fee-based business becomes material,

             3   then there will be conflicts as to how they basically divide

             4   their business.  The reputational capital of rating agencies

             5   right now is important, because ratings are the way that

             6   rating agencies make money.  But if, in the future,

             7   consulting is also a way that rating agencies make a lot of

             8   money, then that does diminish the potential reputational

             9   capital.  

            10             And it seems to me that there is an easy fix.  The

            11   rating agencies are saying, on the one hand, the consulting

            12   is not going to be a material part of their business.  You

            13   know, the SEC is saying, "We're concerned that consulting may

            14   become a material part of your business."  Why can't there

            15   simply be an agreement, whether by regulation or otherwise,

            16   that, in fact, consulting will not be a material part of your

            17   business?

            18             MR. McCARTHY:  Are you ready to agree, Ray?

            19             MR. MCDANIEL:  I think I can agree that consulting

            20   will not be a material part of our business. 

            21             MR. JOYNT:  The most complex issue of what me mean

            22   by "materiality."

            23             MR. McCARTHY:  And by "consulting."  We're assuming

            24   just consulting about rating activities, but there's a

            25   broader --






             1             MR. JOYNT:  Activities other than rating.  There's

             2   a broader base of consulting.  Risk management services that

             3   we talked about before, and there's a large development on

             4   the part of, if not Moody's rating company, technically,

             5   although the broader Moody's corporation in terms of advisory

             6   and consulting services.  We certainly wouldn't want to, at

             7   Fitch Ratings, preclude ourselves from becoming involved in

             8   consulting and advisory services.  Especially those near,

             9   that we have capabilities in.  So I wouldn't quickly concede

            10   the point to you, although I'm open to it. 

            11             MR. MCDANIEL:  And I would just like to add,

            12   because Steve has raised the consulting services, that occurs

            13   through Moody's KMV, which is part of Moody's corporation. 

            14   In my answers, I am looking at the rating agency.  And I

            15   think we would anticipate keeping -- we have, and will

            16   anticipate keeping a clear division and set of firewalls

            17   between the KMV business and the Moody's Investor Service

            18   rating agency business. 

            19             MR. COLBY:  Could I ask, and maybe start with you

            20   Steve, in the asset-backed securitization business, there's

            21   an awful lot of involvement, I've heard over the years,

            22   between the rating agencies and the issuer in structuring the

            23   pools.  And yet there's also sometimes a fee that's based on

            24   the size of the offering.  Is there a conflict there?  An

            25   involvement is helping to structure the offering, but also a






             1   pay that's dependent on how well the offering goes, in a

             2   sense?

             3             MR. JOYNT:  Not really, actually.  If there's any

             4   fee based on the size, it would be reflective of the amount

             5   of effort that goes into the deal, or the amount of work. 

             6   It's not -- we can get confused on this issue.  Historically,

             7   or traditionally, rating agencies have charged corporate

             8   based on the size of issues, two basis points, or two and a

             9   half, and that also ended up reflecting the size of Ford and

            10   GM, and the complexity of analyzing them, versus the size of

            11   an industrial company that was small, did $100 million issue

            12   and got charged $10,000.  

            13             And so in the securitization market, I'd say it's

            14   similar to that.  There's no success fee, performance fee,

            15   big deal, get more money kind of approach.  Our largest fees

            16   are in commercial mortgage securitization.  And that's --

            17   they're typically very large transactions, but the reason we

            18   have a very large fee.  So $700,000 or $390,000 would be

            19   because we have many properties to go -- it's like rating

            20   seven deals or ten deals.  So that's the reason for the fee. 

            21   It's not based on some kind of success.  I don't see a

            22   conflict with that.  No.  I don't know if Ray does. 

            23             MR. MCDANIEL:  No, I would agree with Steve. 

            24             MS. PETERSEN:  Can I make an observation with

            25   regard to this line of questioning?  I think the one thing






             1   that we need to keep in mind is, a good investment banker is

             2   going to have a really good idea of what the ramifications

             3   will be of certain transactions.  And that's the reason why

             4   companies usually employ them at what are probably considered

             5   very high fees, for the purpose of making sure that the

             6   transaction is completed in an orderly fashion, their

             7   accessibility to the market is there.  So the idea that the

             8   conflict is going to arise because they formalize that

             9   process by actually going to the rating agency and asking for

            10   their confirmation of it, I think, is something that maybe

            11   should happen for some transactions, but I don't know how

            12   that could necessarily create an inherent conflict. 

            13             But having said that, if the rating agencies were

            14   to get themselves wound up in a lot of these transactions,

            15   and be found to sell their ratings because they're involved

            16   in that, they will sustain a hardship in the marketplace,

            17   because we will pick up on that.  We will start pricing

            18   differently, because they will no longer have the reputation

            19   for being objective and forthright.  And if that happens,

            20   it's -- in my mind, it's almost analogous to Arthur Andersen,

            21   where an entire firm of, what was it, 80,000 people came

            22   crashing down because there was a select group of folks who

            23   were found to be operating outside of what people considered

            24   to be appropriate under the circumstances.  

            25             So if you found that the situation at Moody's, S&P,






             1   or any of the other rating agencies was severely compromised

             2   because a group within that organization was working to,

             3   potentially, create problems in the market, I would suspect

             4   that the end result would be that Moody's might have to go

             5   out of business, or Fitch, or S&P, or any of the other rating

             6   agencies. 

             7             MR. MAYEWSKI:  I should add that I've done -- as in

             8   independent observer, I've done dozens, perhaps more than

             9   dozens, of deals, structured finance securitization deals

            10   where I worked closely with the rating agencies, and I've

            11   never noticed any conflict of interest whatsoever. 

            12             MR. VAN ORMAN:  Just listening to the flow of the

            13   conversation, one thing I'd point out is, while the issuers

            14   pay the fees -- and I speak -- since I've been at General

            15   Motors, the rating's gone down, it's gone up, it's  gone down

            16   again.  So I've seen a lot of fluctuations in ratings, and

            17   I've never detected that the fee we paid had anything to do

            18   with the rating itself.  

            19             I would say, I think what we should consider -- I

            20   think, at the end of the day, what General Motors is paying

            21   for is the reputation of the rating agency.  And in the long

            22   term, if the rating agency doesn't do its job to the investor

            23   base, it's going to have a problem, and then we won't want to

            24   pay them.  So I think there's that inherent check and balance

            25   on the system. 






             1             MR. SCHWARCZ:  On the reputational side, let me add

             2   one thing, which is sort of similar to the last conversation. 

             3   To the extent that there's been an emphasis on how important

             4   reputation is to the rating, and that is true, but there is

             5   an area on the margin where that may not be true, and that's

             6   in privately placed structured finance deals, where,

             7   basically, the information is -- you know, no one else can

             8   assess it.  And in that case, the rating -- an investment-

             9   grade rating of an NRSRO is something that's necessary for,

            10   let's say, insurance companies to invest in those securities. 

            11   And insurance companies don't necessarily care how valuable

            12   that rating is, as long as it's investment-grade by an NRSRO,

            13   because that allows that rating to comply with the NAIC,

            14   National Association of Insurance Commissioner requirements. 

            15   And they only have to keep that investment as a basket asset.

            16             So there is this little narrow sliver of area where

            17   one wants to be very cautious.  I think that will become more

            18   significant when we talk about competition later, because

            19   there may later come an argument that, well, you can open up

            20   NRSRO ratings to many different entities, and the marketplace

            21   will basically price them out if they're not good.  But

            22   that's not 100 percent so, because you still will have this

            23   area of privately placed structured finance securities, and

            24   it's relatively a little sliver, but in absolute dollars,

            25   it's a very large amount, where even poor NRSRO ratings are






             1   highly valued. 

             2             COMMISSIONER CAMPOS:  John, I have a technical

             3   question for you and Annette and Bob.  Under our factors, in

             4   terms of giving the NRSRO designation, do we have as one of

             5   the factors a determination of independence by the agency? 

             6   And if we do, doesn't that allow us to get into these issues

             7   if we felt that the designation was at issue?  Mike, do you

             8   want to do this?  Give you a chance to talk?

             9             MR. MACCHIAROLI:  We've always looked at the

            10   entity.  In making a determination, we've always looked at

            11   all the conflicts of interest that we could.  That was one of

            12   the first things we looked at.  We looked to see what their

            13   procedures were for preventing any conflicts of interest.  We

            14   made sure that they were independent of any -- for example,

            15   Standard & Poors is obviously owned by a public company, but

            16   we had to make sure that they had built-in protections, to

            17   protect them from any kind of influence.  And we had to make

            18   sure that they won't allow an investment banking firm, for

            19   example, to own a rating agency.  So obviously, very serious. 

            20   So we've looked at all those kinds of questions, and that's

            21   one of the factors in the criteria.

            22             COMMISSIONER CAMPOS:  So to follow up on

            23   Commissioner Goldschmid's issue, if a development occurred

            24   where a significant portion of revenues were outside of the

            25   exact, specific ratings effort, then we have the authority to






             1   revisit the NRSRO designation, correct?

             2             MR. MACCHIAROLI:  I would think so. 

             3             MR. McCARTHY:  All right.  So why don't we move to

             4   the last conflict of interest that I dreamed up.  A lot of

             5   commenters have alleged that the practice of conducting what

             6   everyone terms are unsolicited ratings, but that's not a

             7   defined term -- I know that what I consider unsolicited is

             8   not what some of the rating agencies consider unsolicited --

             9   but for the most part, where an issuer doesn't ask for -- at

            10   the outset, for a rating, a lot of commenters have alleged

            11   that this practice whereby they will then send a bill to the

            12   issuer, and there's kind of this -- the issuers feel that

            13   there's a pressure to pay.  

            14             Whereas if they don't pay, it may affect their

            15   rating.  That this unsolicited rating pressure is a conflict

            16   of interest.  And I'd just like to throw it out there to the

            17   panel.  How prevalent they think it is, how significant it

            18   is, and what, potentially, the Commission could do to address

            19   the issues related to unsolicited ratings.  And again, I

            20   apologize, but let me start with Ray and Steve, and then open

            21   it to the panel.  So Ray, why don't you start. 

            22             MR. MCDANIEL:  Sure.  From our perspective, I think

            23   the conceptual value of unsolicited ratings is that they

            24   allow for rating agencies to provide comprehensive coverage. 

            25   That may be valuable for new entrants.  It's certainly






             1   valuable even for established rating agencies in markets that

             2   have not traditionally operated with ratings in place.  And

             3   that was much more true, say, a decade or so ago in the

             4   European market.  

             5             We engaged in unsolicited ratings for a number of

             6   years, and despite the conceptual benefit I would articulate,

             7   I can also tell you that, as a practical matter, we received

             8   almost uniform condemnation from anyone who decided to voice

             9   an opinion on that.  And that includes market participants,

            10   and even some governments around the world.  

            11             And so we have, essentially, abandoned the

            12   practice.  We, as a matter of fact, as part of this overall

            13   process, just ran a check, and in terms of the last rating

            14   that we have assigned to a first-time rating, where the

            15   issuer did not participate, that was a couple of years ago,

            16   in fact, in 2000, and we have not done it since then. 

            17             MR. JOYNT:  The only area in which we -- we call

            18   them Fitch-initiated ratings for unsolicited ratings -- and

            19   the only area in which we've initiated ratings has been in

            20   corporates.  Corporations.  The reason we've initiated

            21   ratings there is to expand our coverage to better serve

            22   investors.  When we go out and see investors, they say, "So

            23   you rate one drug company, that's nice, but what's your

            24   opinion on the other five drug companies?"  And we say, "Oh,

            25   we don't have coverage of them."  So, "in order to be really






             1   valuable to us, we need to know your opinion on all drug

             2   companies."  And so we have initiated coverage in different

             3   industry sectors. 

             4             And corporates because we can get the information. 

             5   We believe there is sufficient public information to have a

             6   reasoned opinion.  So we don't think our opinion is

             7   particularly conservative or liberal, and if we don't feel

             8   like it's accurate, then we wouldn't -- even though we'd

             9   initiated the process of research, we wouldn't release the

            10   rating if we didn't feel like we could release an accurate

            11   rating.  

            12             In securitization markets, it's  harder to find the

            13   information to initiate ratings on your own.  In the public

            14   finance market, it's harder to find information to start the

            15   rating on your own.  So it's pretty much limited to the

            16   corporate market.  Once we -- a corollary question to that,

            17   though, would be, once we've started a rating on a company,

            18   if the company decided not to pay us any more, would we

            19   withdraw the rating?  How do we get out of the assignment? 

            20   Or on a securitization, how do we get out of the rating

            21   that's there?  

            22             And so I think that's a harder question and a

            23   little bit different one.  Once we've initiated the rating,

            24   it's our practice to try to maintain that rating, in the

            25   interest of investors and coverage, but all the time, we






             1   can't necessarily do that.  For U.S. public companies, often

             2   we can, but sometimes the information that was available to

             3   us from the issuer -- in other words, unpaid, may not

             4   continue to be available to us.  So that's difficult --

             5   problematic.  And I don't know how Moody's would handle that

             6   if General Motors decided to no longer cooperate with Moody's

             7   and pay.  Whether they would drop the coverage, or if they

             8   would have to issue an unsolicited rating. 

             9             Also, one final point would be that we don't send

            10   bills.  So we initiate the coverage, and we continue to work

            11   with the company and encourage them to meet with us, and we

            12   encourage them to see the value in our rating, and then start

            13   paying us.  We've offered them our fee schedule.  But we

            14   don't just send them a bill.  We don't initiate coverage and

            15   say, "Here's the bill."  We've never -- we do not send them a

            16   bill until they agree to have a fee paying relationship with

            17   us. 

            18             MR. MAYEWSKI:  And I would just add that Best does

            19   not issue unsolicited securities ratings. 

            20             MR. HARADA:  And as far as our big concern, that we

            21   don't have any conflicting interest in terms of the

            22   unsolicited ratings, because, in principle, we do not conduct

            23   unsolicited ratings.  We -- normally we conduct solicited

            24   ratings, but there are very few exceptions.  That is, if the

            25   demand from the investors is very strong, that occasion we






             1   conduct an unsolicited basis rating.  

             2             That example is that in Japan, there is a very

             3   particular condition.  It's a reflection of a very particular

             4   condition in Japan, but we rate -- there are three examples

             5   of the unsolicited rating. 

             6             One is the insurance -- life insurance company,

             7   because most of the life insurance companies in Japan is a

             8   mutual company, so that they do not issue any papers in the

             9   market.  But the investors have many strong interests. 

            10   Investors or policy holders have a very strong demand for

            11   that rating, so that particularly in this situation, this

            12   very strong demand, we rate most of the rating agencies --

            13   insurance agencies -- companies -- with -- unsolicited basis. 

            14             And the second example is regional government. 

            15   Some particular condition in Japan, that the regional

            16   government has a very -- expressed a very strong reservation

            17   against the rating, but the investor -- strong -- demand of

            18   the investor for that rating is very strong, so that we

            19   conduct on an unsolicited basis. 

            20             And the third one is falling sovereign ratings. 

            21   It's also very strong demand from the investors.  So that the

            22   -- but the manners of the rating is -- of the unsolicited

            23   rating -- is quite -- almost similar to that of the solicited

            24   ratings, that we make the interview with the management

            25   staff, even it is unsolicited rating.  






             1             But, of course, we do not have the -- we do not

             2   establish some confidential clause with the management staff

             3   so that they will not disclose that non-public, confidential

             4   information, so that there might be some slight difference

             5   between -- in that sense, slight difference between the

             6   unsolicited rating and solicited rating, so that we indicate

             7   that, in case of unsolicited rating, we indicate some letter,

             8   that is OB.  We add OB in that rating, which indicates -- it

             9   expresses that this rating is based upon the unsolicited

            10   basis.  

            11             So that in these manners, we very -- although we

            12   conduct it in some limited manners, unsolicited ratings, but

            13   the way of the rating is almost similar to that, and the

            14   number of unsolicited ratings is very much limited, so that

            15   as far as -- our only concern that there is no risk of

            16   conflicting interests in terms of the unsolicited rating. 

            17             MR. PUTNAM:  I need to point out here to the

            18   Commissioners that all our ratings are unsolicited.  So if

            19   you decide to do away with them, we're out of business.  But

            20   don't think so much about me, but about small investors,

            21   okay?  Because we've done this for 18 years, and we've issued

            22   over a million of them.  But it's very helpful to small banks

            23   wanting access to the capital markets, and this is something

            24   we've recently been doing.  And these -- it's -- there is no

            25   course of conflict, because we don't charge on the other






             1   side.  But I just want you to know that we do issue

             2   unsolicited ratings, and a lot of them. 

             3             MR. SCHWARCZ:  Let me respond to that by saying

             4   that there's -- there really is a major distinction between

             5   unsolicited ratings in public deals and in private deals.  In

             6   public deals, one could say that unsolicited ratings is a

             7   public good, because investors have a right to know, and most

             8   of the information is out there.  All you lose is the

             9   confidential information.  

            10             In private deals -- and that's where rating

            11   agencies in the past have -- that's the area, and the only

            12   area, in which rating agencies have been criticized in the

            13   past for issuing unsolicited ratings.  And the problem there

            14   is that there is insufficient information, because it is a

            15   private deal, because it depends oftentimes on the structure

            16   of the deal, or on the nature of the deal itself. 

            17             Now, in that case, I know on pages 16 through 18 of

            18   my University of Illinois Law Review article, there's a

            19   lengthy discussion of this, that the one rating agency that

            20   did this, Moody's, has basically been convinced by the

            21   market, as Ray said, to change this.  They now -- well,

            22   they've stopped, basically, issuing unsolicited private

            23   ratings.  And even before that -- in the years before that,

            24   they were finally convinced by the market to basically, as

            25   the gentleman from Japan says, to designate in the rating






             1   itself that it is an unsolicited rating.  So at least market

             2   forces, to that extent, took care of it. 

             3             MR. MCDANIEL:  I would just add that we were

             4   criticized for both our public and our private ratings. 

             5             COMMISSIONER ATKINS:  I just wanted to throw one

             6   thing into this discussion regarding unsolicited ratings. 

             7   And it's sort of following in your footsteps there.  There is

             8   a thing called the First Amendment.  And if you are out

             9   there, and you want to put your opinion out, regarding a

            10   security, I don't see how anyone can really question that.  

            11             COMMISSIONER GOLDSCHMID:  I had an even -- well,

            12   the First Amendment is large, but an even larger one that

            13   we've touched on -- but before we break, I thought maybe we

            14   ought to pin down -- this is a break for coffee -- how good

            15   are the ratings, from the standpoint of the issuers and the

            16   investors taking an initial one, and then over time?  I'd

            17   really like to hear how good you think they are.  Using Paul

            18   Saltzman's definition of risk, and knowing that these are not

            19   precise numbers that you can write in stone. 

            20             MR. MCDANIEL:  You mean, the unsolicited ratings?

            21             COMMISSIONER GOLDSCHMID:  No, generally. 

            22             MR. MCDANIEL:  Generally? 

            23             COMMISSIONER GOLDSCHMID:  But here I want to focus

            24   on the issuers, and on investors, the institutional

            25   investors. 






             1             MS. PETERSEN:  Okay.  I'll take a stab at this one. 

             2   As I mentioned in my opening remarks, one of the things that

             3   helps us create more value for the investors on whose behalf

             4   we're investing billions of dollars is our ability to

             5   anticipate what the rating changes will be.  So it's

             6   incumbent upon us to try to get, as best we can, knowledge of

             7   how the various rating agencies and the analysts within those

             8   agencies do their business.  

             9             And we do distinguish.  There are certain segments

            10   of the business where we prefer to see a Moody's rating, or

            11   we prefer to see an S&P rating, that kind of thing.  And we

            12   vote with our dollars.  So consequently, I'd have to say that

            13   we have come to understand what the trends are.  

            14             What's been problematic of late, almost since -- I

            15   guess post Enron anyway, is that there seems to be a cliff. 

            16   That some of the rating agencies are not using some of the

            17   tools at their disposal, such as Outlook and Watch, to give

            18   us a better indication of what the general direction would be

            19   on a rating.  And instead, you can just wake up one morning,

            20   and discover that the rating got downgraded.  And

            21   potentially, more so then you would have otherwise thought.  

            22             So I think that we have the capacity to understand

            23   and appreciate the quality of the ratings.  And they're

            24   generally pretty good.  But having said that, some are better

            25   than others. 






             1             MR. KAITZ:  I would just say that was the subject

             2   of one of the questions that we asked our 700 respondents,

             3   and our members are both issuers of debt, as well as

             4   investors.  And in both cases, it came back about 65 percent

             5   thought they were accurate on each side.  So depending on

             6   your perspective, 65 percent is a good grade, or 65 percent

             7   is a bad grade.  

             8             COMMISSIONER GOLDSCHMID:  My children would say

             9   good, but I --

            10             MR. KAITZ:  Yes, well, I have a son in college, and

            11   that's not acceptable from him to me, but that came back on

            12   the debt, as well as on the investor side. 

            13             MR. WATKINS:  On the municipal side, I think, by

            14   and large, the rating agencies get it right.  And I would

            15   have to say, if there is a bias, the bias is on the

            16   conservative side, rather than being more aggressive.  And

            17   don't get me wrong, I've had my disagreements with the rating

            18   agencies, and in many cases, think sometimes they don't get

            19   it.  But it always has erred on the side of caution, as

            20   opposed to being completely sold by the story that we're

            21   telling. 

            22             On the other side, on the surveillance side, with

            23   respect to the timeliness and the accuracy, and their real

            24   ability to penetrate and have insights into what's really

            25   going on in our business is not quite as good.  And






             1   reiterating what Stephanie said, using some of the sort of

             2   interim stats, an anecdotal story is with respect to the

             3   timeliness of information.  

             4             We were put on a change in Outlook, which is the

             5   lowest grade of change that there can be.  That came in

             6   December, post 9/11, and it was a general concern about the

             7   economy.  Well, by the time we'd gotten to December, a

             8   consensus had coalesced about what the economic outlook was

             9   going to be, and it wasn't going to be as catastrophic as was

            10   being predicted.  And in the interim, we had had a special

            11   legislative session, and made adjustments to our budget

            12   through expenditure reductions, to balance our budget.  So I

            13   don't think it was nearly as contemporaneous as it could have

            14   been.  That would have been warranted in October.  By the

            15   time we got to December, in my judgment, it was stale, and

            16   not a good predictor of things coming in the future.  But by

            17   and large, I think they do a very good job. 

            18             MR. KAITZ:  On the timeliness question, it came in

            19   at 40 percent. 

            20             MR. SHEDLARZ:  I think one of the things we have to

            21   be cautious about is, judging any company, including the

            22   rating agencies, in an unprecedented environment.  And I

            23   think we're learning now, we could all do a better job of

            24   assessing an investment decision, by bringing a whole host of

            25   reference points to bear.  If we're looking to the rating






             1   agencies to be the primary vehicle through which we make

             2   investment decisions, and not bring to bear the richness of

             3   market information, which moves quickly, in unprecedented

             4   environments, I think we're all making a mistake. 

             5             I also think we're establishing probably a standard

             6   for a whole host of institutions, including the rating

             7   agencies, which is not possible to meet.  So I think we have

             8   to be very cautious in terms of -- especially during times of

             9   turmoil, unprecedented dislocations, and assuming the we're

            10   going to get the penultimate answer from just about anybody. 

            11   I think what this has taught all of us that make investments,

            12   and rely on the agencies in terms of issuers, is one of the

            13   things very early on in the discussions today.  

            14             This is a reference point.  It has to be brought to

            15   bear with the richness of primary, and other analyses.  The

            16   investment decision is yours.  Don't make the investment

            17   purely on the basis of rating agency information.  I think

            18   that would be remiss in terms of all of us who have to make

            19   investments on an ongoing basis.  And I don't think any of us

            20   do it on that basis. 

            21             I guess I could point to a whole host of

            22   constituencies who didn't pick the trend, who didn't pick up

            23   on what was happening in terms of a number of key

            24   institutions in this unprecedented time.  And so does it

            25   point to an opportunity in terms of improving upon the






             1   predictive nature of the models that we're using?  The answer

             2   is, absolutely yes.  I think Moody's and others are taking a

             3   look at expanding their capabilities in exactly that area, in

             4   order to respond to these dynamics. 

             5             But I'd be cautious about setting a standard in an

             6   unprecedented environment, which is probably not achievable. 

             7   And yes, I think we can say, in retrospect, given what

             8   recently happened, timeliness and accuracy could have been a

             9   lot better from a whole host of constituents who were

            10   involved in trying to assess the situation. 

            11             I'd just like to add one component to this

            12   discussion, and that's price.  Because at the end of the day,

            13   you can define "good" in one way as how much of a predictor

            14   is the rating of default.  And I think you're going to get

            15   statistics --and perhaps the rating agency folks can support

            16   me here -- that are in the high 90s, okay?  A very good

            17   grade, by anyone's account.  

            18             And I think when you interview buy-side

            19   professionals, and other investment professionals, they're

            20   looking at "good" in a different fashion.  They're looking at

            21   "good" relative to, hey, this double A should have traded

            22   here, this single A should have been traded there.  And

            23   volatility in credit spreads, which have occurred over recent

            24   months, have a lot more to do with the accuracy of ratings. 

            25   And I think that has got to be factored into the mix. 






             1             And I would echo what David said earlier.  There's

             2   a lot of information out there, and ratings are simply one

             3   part of it.  So when you're judging the performance of rating

             4   agencies, I would just encourage the Commission to be very

             5   creative and broad-minded about what the benchmark is. 

             6             MR. SALTZMAN:  This actually keys into the conflict

             7   I had identified in the statement, which is a different

             8   conflict, and that is -- and I'm not sure it's even

             9   technically a conflict, but there's a question, to whom

            10   should rating agencies have a responsibility?  Who is,

            11   essentially, their client?  Is it the issuers and the

            12   existing investors, who basically want stability in ratings? 

            13   Or is it the potential investors, who would like to be up to

            14   speed in terms of what's changing?  And the risk you have is

            15   that you're never perfect.  

            16             If you say your client, effectively, is the

            17   potential investors, and you prematurely downgrade a

            18   company's bonds, a false negative, so to speak, well, those

            19   potential investors would be warned there may be a problem,

            20   but you're going to basically kill the company, or create a

            21   self-fulfilling prophecy, whereby the company whose bonds

            22   were downgraded now finds it harder to get credit, and its

            23   financial condition may actually go down as a result, whereas

            24   it didn't deserve to go down.  Things like credit spreads

            25   basically are much more likely to give you false negatives. 






             1   And therefore, I think part of the stability of the ratings

             2   is really keyed into this issue, to whom should rating

             3   agencies look in terms of making a judgmental decision as to

             4   whether or not to downgrade?  

             5             MR. COLBY:  We've been waiting a while for somebody

             6   to say something positive about the SEC, but since no one is

             7   doing it, we'll have to break without it.  If we could be

             8   back in 15 minutes, which would be 3:20.  If anyone wants to

             9   know where to find sodas, if you ask one of the staff,

            10   they'll show you the key to the map. 

            11             (A brief recess was taken.)

            12             MR. COLBY:  When I closed down the discussion from

            13   the last item I cut off one person who wanted to address it. 

            14   Jerry, do you want to say a few words on this before we move

            15   on?

            16             MR. VAN ORMAN:  In terms of the question on the --

            17   how are the ratings, I saw an opening to get into the short-

            18   term ratings, which is the gist of my written remarks, so I'm

            19   going to take it.

            20             In terms of long-term ratings, I think overall my

            21   experience has been the agencies, on balance, do a good job

            22   at evaluating long-term credit trends without getting hung up

            23   on the emotions of day-to-day changes in credit spreads and

            24   the like.  I think they have a very good balance that way. 

            25   And certainly my experience, in the four agencies we deal






             1   with in North America, is that they treat their jobs in a

             2   professional way and are very conscientious.

             3             Having said that -- that applies to long-term

             4   ratings -- an area of concern I've had for 10 years now is

             5   the short-term rating scale.  And I think the focus of the

             6   rating agencies -- and again, this is a personal opinion --

             7   is strictly -- is for the most part on the long-term rating. 

             8   They are evaluating a corporation with respect to its long-

             9   term rating.  And then from that comes a short-term rating. 

            10   And I think that's too automatic, because it's essentially

            11   based upon correlations that have evolved over the last 10 to

            12   20 years, and the evolution of the short-term rating scale

            13   has not had as many nuances as the long-term scale.  I

            14   remember 20 years ago there weren't pluses and minuses, for

            15   the most part, and now -- well, you can look at a scale.

            16             But the short-term rating scales have never really

            17   changed.  And I think the agencies have been remiss in not

            18   evaluating that situation more.  Because certainly in those

            19   20 years, the commercial paper market has become very

            20   important to this country, both as an asset to my money

            21   market funds -- and essentially people viewing money market

            22   funds as money, so the quality of that asset is very

            23   important -- but also in terms of a corporation funding

            24   itself.  I think not enough attention has been paid to the

            25   evolution of the short-term credit tiers, and it's to the






             1   point now -- and this is somewhat exacerbated by Rule 2a-7

             2   having said that, I think the goals of Rule 2a-7 are very

             3   important, and I understand why it exists -- because of the

             4   importance of money funds and money.  

             5             But Rule 2a-7 is based upon short-term credit

             6   ratings -- tier one, tier two.  And those in turn are based

             7   upon long-term ratings that correlate back to those.  And I

             8   don't think enough thought has been given to that by the

             9   agencies, or perhaps the SEC, in terms of knowing what a tier

            10   one and tier two rating is.  And we've gotten to the

            11   situation where an A- credit is a tier two credit almost

            12   automatically, and there's a credit click between tier one

            13   and tier two.  And I know from personal experience it is

            14   easier for an A- company to issue five-year debt than it is

            15   to issue 30-day commercial paper.  

            16             I've always thought that absurd.  And I'd like to

            17   point it out.  And in Detroit, I've been on this for 10

            18   years; I'm down to talking to the family dog about it.  

            19             (Laughter.)

            20             MR. VAN ORMAN:  He's 11, and he's never heard

            21   anything but this.

            22             (Laughter.)

            23             MR. HARRIS:  Does anyone want to take up this

            24   topic?  Anyone want to add anything?  

            25             I've barked up the wrong tree.






             1             (Laughter.)

             2             MR. HARRIS:  Jerry?

             3             MR. COLBY:  I would say I imagine if you offer the

             4   same rates on the 30-day stuff that you offer on the five-

             5   year stuff, you'll have no trouble selling it.  

             6             MR. VAN ORMAN:  Well, actually, if you look at

             7   relative spreads it requires -- the money at 30 days is not

             8   available for most any spread.  And it's not only the cost of

             9   the money, it's the availability as well.  It's an unusual

            10   situation, and it's not good for the economy and the capital

            11   markets.

            12             MR. COLBY:  Well, moving to the last topic, which

            13   really is not the last topic at all because we've been

            14   talking about it all day long in fits and snatches.  And

            15   that's the question of competition between NRSROs, regulatory

            16   treatment, and barriers to entry.  This is something that

            17   from a regulatory standpoint started in 1975, when the

            18   Commission first used the term nationally, "NRSRO."  Only a

            19   few people actually know what that means.  It means nationally

            20   recognized statistical rating organization.  It's a badge of

            21   honor in deciding what the haircut should be under the net

            22   capital rule, and it has incrementally expanded under

            23   Commission regulation to things like registration forms and 

            24   Rule 2a-7.  It's statutory in places, it's in the '34 Act.  And

            25   it's spreading around the world; at the earlier session the






             1   person from the British financial services agency said that

             2   it's being incorporated in the Basel II capital requirements.

             3             And so it becomes extremely important who gets

             4   treatment under this and how it's treated.  The Commission

             5   hasn't ignored the fact that there's this issue; we've been

             6   struggling with it for years and years.  Ten years ago there

             7   was serious consideration about whether we should seek more

             8   regulatory authority from Congress to oversee rating

             9   agencies.  That never went forward.  In 1994 we put out a

            10   concept release that raised many of the questions we're

            11   talking about today.  A few years after that, we proposed

            12   some amendments for a process for deciding about NRSROs that

            13   has never actually been adopted.  And along with this process

            14   goes that question of how do we recognize them and what goes

            15   with recognition, what sort of regulation, if any, is needed?

            16             So I'd like to start off by saying that we're going

            17   to stop when we finish discussing this or 4:45, whichever

            18   comes first.  So if people are tired of it, we may go

            19   quickly.

            20             The other thing, I think in the last session when

            21   we talked about this topic, I think the consensus was that

            22   this is something like Churchill's comment about democracy, 

            23   'the worst system except for all the rest'.  And so when we

            24   talk about this I think it's very important not just to point

            25   out the faults, but we need to talk about what could be done






             1   better -- what are the avenues for improvement.  

             2             I'd like to start off first by throwing open the

             3   question of where there are barriers of access, to what

             4   extent do they arise from the existence of largely well-

             5   recognized players in the market already?  To what extent

             6   does it arise from the regulatory use of the rating, and to

             7   what extent from a lack of desire for more sources of

             8   guidance in this area?  So I'm going to start -- I want to

             9   start by asking Larry, you've been operating as a rating

            10   agency for a very long time and only recently asked for

            11   recognition.  Could you talk about how you developed your

            12   position and how you view these issues?

            13             MR. MAYEWSKI:  Well, A.M. Best I guess goes back to

            14   1999, is when we started to actually expand our ratings into

            15   the securities area.  In fact, all of the analysis that we do

            16   in the underlying insurance companies incorporates holding

            17   company issues and in effect, this was just a very extension,

            18   and in effect we were doing all of the work but not assigning

            19   the ratings.  

            20             But as more and more insurance companies were

            21   issuing securities and we were not in the business, they

            22   asked us, you know, would you consider rating our securities? 

            23   And so we started to think about it, thought it was very much

            24   a logical extension of what we were doing, and decided to do

            25   that.  






             1             Clearly, the lack of an NRSRO designation has had

             2   some impact.  I would probably not say at this time -- or I'd

             3   probably say that it's not as much the net capital rule and

             4   some of the other imbedded guidelines, although those are

             5   issues.  But

             6   overall, issuers look at it as a Good Housekeeping seal of

             7   approval.  And to the extent that you obtain it, you're

             8   viewed as having the capabilities to do that.  So from a

             9   competitive standpoint, it's put us at a bit of a competitive

            10   disadvantage, although, with that said, we still right now

            11   rate about 115 issuers of the 400 or so that are active in

            12   the marketplace.  So we've had a pretty good inroad over the

            13   last couple of years in that area.  

            14             But over the years in speaking in every panel with

            15   other rating agencies, they'll always take the chance or the

            16   opportunity to point out that they're an NRSRO in competition

            17   with A.M. Best in terms of the insurance focus that we have. 

            18   But obviously, it is a barrier to entry, to a certain extent. 

            19   We've tried to work hard to overcome that, but there are

            20   still companies that, obviously, would like to see us with an

            21   NRSRO designation before they'll do business with us. 

            22             MR. COLBY:  Mr. Harada? 

            23             MR. HARADA:  Thank you very much.  As far as R&I is

            24   concerned, although the definition or criteria of the NRSRO

            25   is so clearly defined, we are well-fortified as an NRSRO in






             1   terms of the competition of the capital structure and quality

             2   of the ratings and human resources and conflict of interest

             3   point of view.  

             4             And also, from the point of view of the national

             5   recognition, we are also -- we recognize, we think that R&I

             6   is well nationally recognized, because most of the major

             7   investment bank had already sent -- written some supporting

             8   letter to us for our application of the NRSRO.  So that in

             9   this sense, we are well-qualified in NRSRO.  But we haven't

            10   yet been recognized as an NRSRO.  This is why -- the reason

            11   why such a postponement might be the ambiguity or vagueness

            12   of the procedure.  And especially the process of the no-

            13   action process, the very much -- has not yet been clearly

            14   defined.  And there is no clear time limit for that

            15   procedure.  

            16             And also, that -- of course, the definition is

            17   still a little vague, so that there is some room for, what

            18   shall I say, the postponement of such a procedure.  

            19             And so that -- but in that sense, we are well-

            20   qualified as an NRSRO, but especially in the -- there is a --

            21   NRSRO is composed of the two factors.  One is national

            22   recognition.  The second part is statistical rating agency. 

            23   It means that quality -- good quality of the rating, their

            24   rating.  

            25             But the first definition -- the first -- that is,






             1   national -- recognition should be less -- what should I say -

             2   - stressed.  It should be less important, because this -- in

             3   NRSRO program, the national recognition is a kind of a

             4   problem of the so-called chicken and the egg.  If we are

             5   recognized as a national -- as an NRSRO, we will improve the

             6   situation of the national recognition.  But if it is not the

             7   case, then it's very difficult to be -- to recognize as a

             8   national -- NRSRO.  But we do -- we had been very --

             9   continuing that very effort to be recognized by the major

            10   investment bank and financial institution, investment

            11   management company, so that we have -- in my understanding,

            12   and in our judgment, that we have well recognized as an

            13   NRSRO.  

            14             MR. COLBY:  Thank you.  Jack, what are the

            15   barriers to a building a business as a rating agency, not an

            16   NRSRO?  That's obviously a regulatory label.  But what are

            17   the barriers?  And from where do they arise?

            18             MR. MALVEY:  Let me answer the question.  I also

            19   want to quickly add, on the overall concept here, number one,

            20   I think we need to sharpen the definition of this concept,

            21   for sure.  Most of us in the industry don't even know what

            22   this means.  Two, the acronym is acronistic here.  What is a

            23   statistical rating organization?  Are there nonstatistical

            24   rating organizations?  It's a qualitative art.  Statistical? 

            25   It's -- appropriate acronym.  As far as -- if I were going to






             1   BIS, I would say break it into GRA, Global Rating Agency,

             2   Local Rating Agency, to simplify the concept. 

             3             The third thing is, for sure, open it up.  There's

             4   folks here knocking at the door who want to be rating

             5   agencies.  Let them come.  And then let the markets decide

             6   who they want to listen to here.  So what are the barriers,

             7   in answer to your question?  They do have to, as you heard

             8   from Steve earlier, they need to define or provide a

             9   constituency out there.  They have to have investors who are

            10   willing to listen to what they have to say.  That's one for

            11   sure.  Ultimately that's the test.  Are investors going to

            12   pay attention?  If XYZ Corporation comes in and says, "We're

            13   a rating agency," and it's rating symbol is B minus, who

            14   cares if you never heard of them?  So they have to go out and

            15   market. I think -- the number one. 

            16             Number two, they have to develop a track record

            17   through time.  It's not an overnight process.  Again, we

            18   heard from Fitch.  Others in the industry can well attest,

            19   it's a multiyear process, really, for institutional investors

            20   and the marketplace to become familiar with your

            21   organization. 

            22             I'll stop there.  I think those are the two largest

            23   barriers to entry.  Maybe the first one, getting back, is,

            24   maybe it's the fact that some of these entities can't get

            25   this official designation.  That is a significant barrier. 






             1             MR. COLBY:  I want to not let this be dominated by

             2   the people seeking the rating activities, to hear from some

             3   of the other folks first.  

             4             MR. SALTZMAN:  I guess I'll chime in from the

             5   perspective of the Bond Market Association.  Our view is that

             6   there certainly can be more transparency brought to the

             7   process, and that the regulatory definition of the criteria

             8   should not be a barrier to entry.  I should really say, it

             9   should not be an unreasonable barrier to entry, because every

            10   criterion -- each and every criterion, at some level, will be

            11   a barrier to entry for somebody, even if the criteria are

            12   minimal in terms of the infrastructure and number of

            13   employees, et cetera. 

            14             The one point that we've raised is this sort of

            15   catch 22 associated with the national recognition criteria. 

            16   And picking up on some of the things that Jack said, it seems

            17   to me that one can achieve a minimal level of recognition,

            18   perhaps through a seasoning requirement, you have to be in

            19   business for a certain minimal period of time, you have to

            20   issue a certain number of ratings, without necessarily

            21   imposing the end game result, because in many respects, if

            22   someone is willing to put forth the capital and the

            23   infrastructure, and willing to do what it takes to get

            24   involved in getting regulators comfortable, even if it

            25   doesn't have that national recognition, it should be afforded






             1   the opportunity. 

             2             MR. COLBY:  Amy, do you want to talk about this?

             3             MS. LANCELLOTA:  Well, as far as barriers of entry,

             4   no, not really.  I don't have any comments there, except that

             5   I do think the national recognition attribute people have

             6   called the chicken and egg, or whatever situation, is an

             7   important one, and I do think that if there's any thought of

             8   relaxing the requisite criteria for becoming designated an

             9   NRSRO, that really calls for increased regulation, or at

            10   least oversight by the SEC.  

            11             We don't have a view about the number, or whether

            12   there should be greater competition.  Competition is always

            13   good.  But I do think, though, that it would be helpful, too,

            14   maybe to designate specialized NRSROs.  I think Thomson

            15   BankWatch was designated just with respect to rating

            16   financial institutions, and that may be one way to bring in

            17   additional agencies into the NRSRO designation.  And I think

            18   that would be helpful.  But I do think if there's any thought

            19   of trying to lower the barriers, or make it easier for new

            20   agencies to come in, that the SEC needs to increase its

            21   oversight. 

            22             MR. COLBY:  That itself poses a set of questions. 

            23   We may need to come back to that topic.  Steve, do you want

            24   to go, and then Barron?

            25             MR. JOYNT:  Either way.  Barron, do you want to go






             1   first?

             2             MR. SCHWARCZ:  A few thoughts.  The NRSRO

             3   designation, although it's unique to the U.S., in that -- so

             4   many terms -- a concept similar to NRSRO exists in virtually

             5   all of the major money center nations of the world.  My

             6   University of Illinois Law Review article, I think --

             7             MR. COLBY:  Is that for sale?

             8             MR. SCHWARCZ:  Absolutely.  No, it goes -- I think

             9   it was every country, at least, that has the data on it.  And

            10   it works the same way it works here.  The fact that something

            11   is so widespread doesn't necessarily mean it's good, but it

            12   certainly is some indirect evidence of its merit. 

            13             In terms of the alternatives to NRSRO, there are

            14   some nations, I believe India is one, that has substantive

            15   regulation of the rating agencies, but I'm not sure that's --

            16   there are no major money center nations that do that, and I'm

            17   not sure that that sort of -- regulation is necessary, or

            18   even appropriate, under the philosophy of the securities

            19   laws. 

            20             In terms of the anticompetitive effect, I mentioned

            21   in my statement that, yes, there clearly is an

            22   anticompetitive effect, and I think it needs to be remedied

            23   in some way, but you have to make sure that if you remedy it,

            24   you don't open up the process to so many NRSROs that you

            25   basically encourage ratings shopping.  That would be a very






             1   unintended and perverse result. 

             2             And so I would disagree with those who say, "open

             3   it up and let the markets decide."  I'm not sure that is the

             4   right answer.  And as I mentioned earlier, the markets

             5   themselves may try to get an NRSRO rating simply because it

             6   has value, but say it translates into an NAIC rating.  So you

             7   want to be rather cautious about that. 

             8             MR. COLBY:  Barron?

             9             MR. PUTNAM:  I'm glad I let Steve go before me. 

            10   NAIC is a very good client of mine, and it so happens,

            11   though, they'll only use Moody's and Standard & Poors and

            12   Fitch where they're issuing ratings, and then use us for the

            13   rest of the financial institutions that they don't rate. 

            14   Because we're the only game in town other than that.  

            15             I think, to answer your questions on the barriers

            16   to entry, I've listed some in terms of my comments earlier. 

            17   But I think one that was alluded to earlier, and maybe once

            18   or twice, is, there's a very, very serious barrier -- and I

            19   know the SEC is aware of this.  I don't know if they know the

            20   extent, but it's in all the -- almost all the bylaws of large

            21   corporations, it's in state laws, municipalities, that they

            22   must use ratings of NRSRO companies.  

            23             And to compete with Moody's and Standard & Poors,

            24   you must -- they have tremendous name recognition, and you're

            25   a new kid on the block, and you're coming in and competing






             1   with them, that's tough.  But when you go in and they say,

             2   "Well, we can't use you, but gee, we like your service and

             3   everything," and they have to change their law to do that, so

             4   that they can use your service.  And we've done this.  We've

             5   actually -- a lot of states use us, a lot of municipalities

             6   use us.  But that's a tough barrier to overcome.  It's a

             7   struggle, and we spend a lot of time and effort trying to

             8   compete.  We're not on a level playing field.  And it's a

             9   tough -- it's tough to compete with the majors.  And again,

            10   we're a niche player in terms of financial institutions.  But

            11   we've been able to stay alive for 18 years, and we've watched

            12   Thomson BankWatch go down, which was our major competitor. 

            13   And that is a very serious barrier.  And I've alluded to

            14   others, and you're aware of those. 

            15             MR. JOYNT:  Thomson BankWatch didn't go down, by

            16   the way.  They rose up with us. 

            17             (Laughter.)

            18             MR. PUTNAM:  Several of their analysts are knocking

            19   on my door. 

            20             MR. SALTZMAN:  Bob, I would just add that in some

            21   respects, I think we're not actually focusing on the real

            22   issue, which is, why is it the case that these substantive

            23   rules embrace an NRSRO acronym and designation.  Right now,

            24   the NRSRO designation grew up because of its use in the

            25   capital Reg M bylaws, et cetera.  And as to that point, I






             1   think no one has mentioned the fact that ratings continue to

             2   be a very, very useful and accurate proxy for inclusion in

             3   substantive regulations.  You know, whether it's drawing the

             4   lines in the capital rules and so forth.  

             5             So it seems to me -- let's not throw the baby out

             6   with the bath water here.  If there are problems with the

             7   NRSRO designation process, don't get rid of that proxy, which

             8   is very useful in substantive regulation, but bring some more

             9   transparency and process to the designation process.  For

            10   example, Barron -- and you can understand -- why is it that

            11   you're not an NRSRO?  Are those reasonable.  

            12             Perhaps including an appeals process in that, to

            13   allow you to go to some higher authority, to question whether

            14   or not you've reached that level of designation.  But let's

            15   not go back to a situation where we completely get rid of the

            16   NRSRO designation process, because I think, at that point, it

            17   will truly have investor protection, and market regulatory

            18   implications that I don't think anyone wants. 

            19             MR. COLBY:  What do others think about Paul's idea? 

            20   It's very tempting when you look at this designation process,

            21   to say that this process is just so difficult, why don't we

            22   dump the use of ratings.  What do others think about that? 

            23   Of course, you'd have to figure out what to replace it with,

            24   but other views on this?  Or the use of ratings in regulatory

            25   provisions?






             1             MS. LANCELLOTA:  Bob, I personally would not scrap

             2   the NRSRO designation, I think it plays a crucial role in

             3   Rule 2a-7, and for that purpose, I think it's been important,

             4   and it's done its job.  I would not suggest, though -- the

             5   SEC has gone down this road -- relying on the rating agencies

             6   for regulatory purposes beyond the assessment of credit risk. 

             7   So I think it's important to limit their role in substantive

             8   SEC regulations to an assessment of credit risk.  And there,

             9   I think they play a very valuable role.  And Rule 2a-7, I

            10   don't think -- it would just not be as successful as it is

            11   today, without the use of NRSROs, and of course, Rule 2a-7

            12   doesn't say your analysis stops with just looking at the

            13   ratings.  Mutual funds have to go beyond, and make their own

            14   independent, minimal credit risk determinations, but the

            15   rating agencies provide an invaluable service. 

            16             MR. SCHWARCZ:  I agree completely with what you

            17   said, and I would say that I looked at this issue

            18   extensively, and I looked at nations around the world, what

            19   they did, and this seems to be the way that everyone has come

            20   up, and a very logical way.  If you're going to -- first of

            21   all, if you're going to use some sort of private ordering

            22   process as part of ratings, rating agencies make sense. 

            23   Rating agencies look at -- only look at credit risk.  

            24             They don't look at investment advisability, because

            25   they say nothing about the rater, you know, the suitability






             1   for investment.  So I mean, yes, I agree, it should only be

             2   used for the credit risk, and I think that is how it's only

             3   used in all the regulations I know of.  

             4             So I would -- the only thing I would say is -- and

             5   I agree with Paul -- that if I were not an NRSRO, I would be

             6   very frustrated, because I wouldn't be entirely sure what

             7   criteria I could look to, to try to improve myself to get

             8   there.  And it would be very helpful to increase the

             9   transparency of the process, just as it would be helpful for

            10   the legitimacy of ratings, for the agencies themselves to

            11   increase the transparency of their ratings process.  And so I

            12   think that would be a very desirable thing. 

            13             MR. COLBY:  Do others want to talk about the use of

            14   ratings in the regulatory process?  Should I take this as

            15   agreement that it's valuable?  Or is everyone just tired

            16   today?  All right.  Then there seems to be a focus, then, on

            17   how do we go about choosing an NRSRO.  And it has a number of

            18   criteria, but one of the leading ones is this -- as Mr.

            19   Harada spoke of -- national recognition.  And the thinking

            20   behind national recognition was actually sort of intended,

            21   I'm told -- I wasn't around at the time -- to be a market

            22   decision, as opposed to making it a regulatory decision. 

            23   Look and see, for people that are out and are being used, has

            24   the market decided that they add enough value, and that their

            25   ratings are good enough, that are useful enough that the






             1   regulators can them use them for a similar purpose.  There

             2   have been a lot of thoughts expressed about that, and it's a

             3   very judgmental approach, which has a transparency problem.  

             4             Anyone else that hasn't talked about this want to

             5   speak about the use of national recognition?

             6             MR. SULLIVAN:  I just want to point out one thing,

             7   that I believe -- and I could be wrong, but at the time that

             8   the NRSRO designation came about, there weren't that many

             9   regulatory sections that really depended on them, so that you

            10   probably could make a national reputation without being an

            11   NRSRO.  Now there are so many aspects of securities law that

            12   rely upon the NRSRO, that, in effect, you've created the

            13   monopoly on the market. 

            14             I'd make the following observation.  I don't think

            15   that one wants to scrap the national recognition as one of

            16   the criteria, because I think that it has a useful purpose. 

            17   And again, as to the staff, I think they do rigorously apply

            18   a lot of other criteria to ensure that there's a quality

            19   threshold of entrance.  I think the problem becomes that,

            20   under the current structure, the national recognition becomes

            21   the seemingly most important determinant, the seemingly most

            22   important criteria.  And that, I think, is where the

            23   frustration comes.  So back to Paul's observation, and your

            24   observation about the '97 proposal for a process, that's

            25   where we should probably be focusing our efforts and our






             1   attention, because it's the lack of a specific process, it's

             2   the lack of timelines and the like, where I think a lot of

             3   the frustration comes about. 

             4             And the last observation I would make is, as we

             5   discussed new applicants and the like, I think that there is

             6   a sense that "new" means inexperienced.  And I think that

             7   many of the people around the table would say that a new

             8   applicant doesn't necessarily have to be an inexperienced

             9   rating agency in terms of what its business line is, whether

            10   it's a niche business line, or in a broader context. 

            11             MR. COLBY:  On that topic, Mr. Kaitz, your survey

            12   looked at other sources of information besides NRSROs.  What

            13   did you ascertain about what people were using for

            14   information, and who was there, and what they were

            15   contributing?

            16             MR. KAITZ:  Actually, almost 83 percent of the

            17   people that responded to our survey, in addition to using the

            18   rating agency, used other organizations, including A.M. Best,

            19   Dunn & Bradstreet.  And surprisingly, because all of our

            20   members are corporate finance professionals, none of -- a

            21   number of them use their own proprietary research, as well. 

            22   Again, most of our members are investors, as well as debt

            23   issuers.  So it was a very high percentage.  But again, they

            24   saw lots of value in the rating agencies, but a huge majority

            25   used other sources.  






             1             COMMISSIONER ATKINS:  I have a question, to follow

             2   up on Mr. Malvey's discussion there.  Is there any merit to a

             3   two-tier type of thing, like minor leagues and major leagues,

             4   and then have people graduate up through the steps?  And

             5   then, obviously, change other regulations that are

             6   bootstrapped on this NRSRO concept.  But I don't know if

             7   anyone had any thoughts on that to follow up on this point. 

             8             MR. MALVEY:  Let me respond.  To be determined, to

             9   be thought about.  I'm not sure that sort of an apprentice

            10   rating agency would have much ability in the marketplace.  I

            11   don't know exactly the test that the Commission goes through

            12   to examine nationally recognized.  But there are certainly

            13   many ways you could -- looking at it objectively, if you look

            14   at the amount of assets out there in the market, and if

            15   you've had some threshold level whereby you had institutional

            16   investors certify a certain level, is it 5 percent, is it 10

            17   percent of the market, and write a letter, almost like a

            18   politician filing and saying that we have enough signatures

            19   here to file for candidacy in a particular jurisdiction. 

            20   Can't you do that?  Get $50 billion?  Is it $100 billion?  Or

            21   do you already do that?  All you have to do is get -- to say

            22   yes, and you're in. 

            23             (Laughter.)

            24             MR. COLBY:  The Justice Department, I think,

            25   Steven, you and maybe others suggested some sort of a






             1   provisional registration. 

             2             MR. SCHWARCZ:  Right.  They basically say -- they

             3   suggested that the designation be given to -- and I'm sort of

             4   taking my own summary of it, with my changes, but it's in the

             5   article.  Foreign recognized rating agencies, and also

             6   subsidiaries of high-reputation U.S. firms, active in

             7   evaluating the business and securities of companies.  And

             8   then they suggested -- and I think it makes a lot of sense --

             9   that there be a provisional time period, perhaps a year, to

            10   make sure that it works out okay. 

            11             MR. COLBY:  Anyone have any reaction to this?

            12             MR. JOYNT:  I'm patiently waiting to speak, but

            13   I'll wait until you're ready to go for rating agencies. 

            14             MR. COLBY:  Are you speaking about this topic?

            15             MR. JOYNT:  Yes. 

            16             MR. COLBY:  Okay, go ahead. 

            17             MR. JOYNT:  Maybe I'll give you some background on

            18   the development of big rating agencies and little minor

            19   league, or major league kind of approach.  If you go back to

            20   1989 when there were six or seven rating agencies, there

            21   really was two tiers.  There was Moody's and Standard &

            22   Poors, the two large dominant ones.  And for smaller rating

            23   agencies, two of which were only recognized in a limited way,

            24   IBCA and Thomson BankWatch, and then Duff & Phelps and Fitch

            25   were broadly recognized.  






             1             So you have a test case for what we're thinking

             2   about here for the future, and how it might unfold.  So I

             3   would point out, or maybe ask the rhetorical question, which

             4   we asked ourselves in 1989.  If you have two very dominant

             5   rating agencies that do competent ratings, which we think

             6   everyone agrees that the ratings -- do a good job of rating

             7   risk.  Why does anyone need any of the rating agencies?  Why

             8   is anyone going to pick Fitch?

             9             And it turned out that people found tremendous

            10   value in another rating agency.  Not an NRSRO, necessarily,

            11   for regulations and rules, although it could be helpful for

            12   that.  But instead, for -- at the time, if we go back, rating

            13   agencies -- the two larger ones were accused of being black

            14   boxes, and people wanted more transparency from the rating

            15   agencies.  There was a lot of turnover at the rating agencies

            16   of analysts.  People were looking for more experienced

            17   analysts to talk to on the investor side.  And the issuer

            18   side, as well.  At least there were newspaper articles

            19   written about this at the time. 

            20             Securitization was beginning.  And investors and

            21   issuers wanted new model developments, new thinking to be

            22   happening faster and quicker, and more resources for that. 

            23   And all of those are -- and also surveillance information. 

            24   Also they wanted more surveillance information, more

            25   research.  So at the time, the ratings were the key. 






             1   Ratings.  And the research wasn't as readily available, or

             2   widespread, or there wasn't as much of it.  Especially

             3   original research.  

             4             So Fitch actually stepped in with that in mind. 

             5   How can we compete on that basis?  And I would argue that

             6   those were the advantages that Fitch brought.  And in the

             7   first four or five years, Fitch was almost always added as

             8   third rating agency, never in replacement of one of the other

             9   two larger ones.  So I do see -- we are pro competition, and

            10   I do see a role for other rating agencies.  Thomson BankWatch

            11   was used for bank ratings, as it was mentioned.  And maybe in

            12   a limited way.  So I do see more usefulness.  I do think you

            13   need to set standards and guide them, and think about them,

            14   but there is a useful purpose. 

            15             We decided at Fitch to move on from that, because

            16   we wanted to compete at the other level, as a global rating

            17   agency.  And the reason for that is, in addition to our

            18   business interests of expanding and growing, is that

            19   investors and issuers wanted another choice.  They wanted a

            20   choice actually of two ratings out of any three, not two

            21   ratings out of any two.  And what you would describe as the

            22   big three.  

            23             So the result of our mergers with Duff & Phelps,

            24   where they had stronger corporate and insurance expertise

            25   than Fitch had, IBCA, which had an international network and






             1   a strong banking practice, and Thomson BankWatch, which,

             2   interestingly, we didn't go acquire -- it was being sold by

             3   Thomson Financial, a major player with significant resources,

             4   deciding they didn't want to compete in the business.  It was

             5   very difficult to compete as a small, niche rating agency

             6   against the two larger rating agencies.  So we bought them,

             7   and they merged and joined with us. 

             8             So we weren't buying NRSROs, either.  We were

             9   buying experienced analysts and the capability to compete on

            10   a global scale.  So I think we're now operating on that

            11   level.  We do see some competitive issues out there in that

            12   way, and I think they're important for this group I've

            13   mentioned to think about.  Because if you think you're

            14   opening competition by naming some new rating agencies for

            15   niche areas, or for international securities, then they will

            16   only be named in a limited way.  Their effectiveness in the

            17   marketplace will be used in a limited way.  And they won't be

            18   broad-based rating agencies, readily accepted quickly.  

            19             And also, there's a large development outside of

            20   these regulations we're talking about.  The largest new class

            21   of investors in the last two years has been CEOs,

            22   collateralized debt pools created.  Hundreds of billions have

            23   been created within the last 18 months.  And those aren't

            24   regulated, other than by the ratings they get from,

            25   predominantly, the two large rating agencies.  






             1             And in those instances, they don't acknowledge

             2   ratings of all NRSRO.  They only acknowledge ratings of the

             3   other rating agencies.  So for instance, both Moody's and

             4   Standard & Poors require that they buy securities, 80 percent

             5   of their portfolio must be rated only by Moody's or Standard

             6   & Poors.  So there isn't an open -- they're not allowed to

             7   choose the Fitch Ratings because we're an NRSRO.  They're

             8   proscribed not to.  If they use Fitch as a rating, then they

             9   receive penalties in the analysis done by the two larger

            10   organizations.  So that is a large investor pool.  

            11             And actually, they've had great effect on our

            12   market share, and we've built over 10 years' great expertise

            13   in commercial mortgage securitization.  In the first quarter

            14   of this year, our market share went from 60 percent, about

            15   equal to the other two larger players, to 19 percent within

            16   one quarter.  So it has actually, since, rebounded, because

            17   the CEOs have not raised as much new money.  

            18             Actually, on the high-yield side, they've performed

            19   poorly, so they're not raising much new money.  And

            20   traditional buyers, like insurance companies, that do use

            21   NRSRO regulations, and are familiar with using Fitch, have

            22   started requesting and using Fitch again.  So actually, our

            23   market share has moved back up.  But still, there's an -- I

            24   believe there's an artificial impediment in the external

            25   nonregulated market usage of rating agencies.  






             1             Now, I will tell you -- and I'm almost finished --

             2   that that slips over to this group, because, in fact, money

             3   market funds also -- 35 percent of prime money market funds

             4   have ratings, and the expectation -- from Standard & Poors

             5   and Moody's, and the expectation there is that they use their

             6   ratings, not our ratings either, in doing their analysis of

             7   those money market funds.  

             8             And in fact, one of the money market funds that's

             9   here has a very large holding in a structured investment

            10   vehicle, which has that same kind of requirement.  We've met

            11   with the vehicle, and it has ratings from Moody's and S&P, as

            12   required to use their ratings.  And so by transfer, all the

            13   way through the process, what you think is choice, freedom of

            14   choice by designating any NRSRO, including, today, Moody's,

            15   S&P, and Fitch, and maybe if you'll designate further ones,

            16   they will not be able to be used by the market power that's

            17   happening outside of your regulations.  

            18             But we've suggested that you think about that

            19   issue, look into it.  I think there is a remedy I would

            20   offer, which is, if you're designated NRSRO, then you should

            21   expect them to not operate in anticompetitive ways, because

            22   we think they are doing that, for competitive reasons, not

            23   for analytical reasons.  So there is some merit for an

            24   analytical argument.  But I'd ask the economists whether 80

            25   percent is a requirement for a random selection.  I think






             1   it's much lower than that.  

             2             And also, you could force NRSROs to accept the

             3   ratings of other NRSROs, given that you've vetted them.  And

             4   if there's a limited acceptance of the NRSRO for bank

             5   analysis only, then obviously you think they're capable.  The

             6   market must think they're capable.  And the net result of

             7   that would only be to give freedom of choice to all the

             8   investors.  So every investor I've met, and investment banker

             9   on this topic, would like to be able to choose us.  They

            10   might not choose us.  

            11             And in fact, I would argue they would probably

            12   continue to move through Moody's and S&P a lot, because they

            13   have very strong name recognition, and good reputations.  But

            14   I certainly would like to be freely chosen, and so I think

            15   there's something you can do about it, and you should

            16   consider that.  Thank you.  

            17             MR. MCDANIEL:  I'll just respond to a couple of

            18   comments from Steve, partly in agreement and partly in

            19   disagreement.  But I guess I should start by saying that

            20   Moody's absolutely believes its competitive practices are

            21   fair and proper.  I think a number of Steve's early comments

            22   I would agree with.  We are pro competition, and we are,

            23   being pro competition, really pro diversity of opinion. 

            24   That's really, in our view, what's critical.  It's not the

            25   number of rating agencies, but it's the number of credible






             1   opinions that are available in the marketplace.  

             2             And I think, because of that orientation or

             3   framework, is perhaps where Steve and I part ways a bit,

             4   because I think the assertion that all NRSRO ratings should

             5   be treated similarly assumes that the opinions should be

             6   treated as fungible, and that assumes that the opinions are,

             7   in fact, fungible.  And we very strongly believe they are

             8   not.  We have quite a bit of statistical information that

             9   indicates they are not.  

            10             And we think that, when the market is using the

            11   Moody's rating, it should have a Moody's independent

            12   assessment of that rating.  I would also add, just as a

            13   technical matter, that we do not require 80 percent Moody's

            14   rated assets in the -- there are other ways have assets

            15   contributed into -- other than having Moody's ratings.  

            16             MR. COLBY:  Anyone else want to discuss this topic? 

            17   Two things arose in my mind.  One is the question of -- if I

            18   understood you, Steve, you said that maybe this should be a

            19   topic addressed by regulation, that would go with being an

            20   NRSRO.  Steve earlier said that you didn't think

            21   adding regulation to the NRSRO process was valuable.  

            22             The legal situation we're in now is that NRSRO is

            23   not a statutory category.  And our authority over it arises

            24   from some limited authority, based on recognition, which

            25   we've never truly exercised very much, and the fact that






             1   NRSROs to date have consented to be registered as investment

             2   advisors, and yet much of the investment advisor regulation

             3   is inapposite to what they do. 

             4             And so my question is, do any participants think

             5   that there should be some additional form of oversight or

             6   regulation of NRSROs as they are now?  If we should design a

             7   means to speed and extend the recognition process?  Whether

             8   there would need to be greater oversight in some way, shape,

             9   or form? 

            10             MR. SCHWARCZ:  I will briefly respond.  The

            11   concerns that Steve raises, I don't think, have anything to

            12   do with the NRSRO designation.  And in fact, the more -- I

            13   mean, they're completely independent of it, because in fact,

            14   the more NRSROs there are, then marginally, the less

            15   concerned -- the less the concern would be.  The concerns

            16   that Steve raises have to do with antitrust law, and in fact,

            17   if Moody's or Standard & Poors are violating the antitrust

            18   law, then that's something that they should be punished for

            19   if that's happening.  But they say it's not happening, and so

            20   that's an issues that has nothing to do with this hearing, I

            21   think.  

            22             MS. LANCELLOTA:  Well, I can't read it in my

            23   article, because I haven't written an article.  The -- has

            24   weighed in on this issue, starting in 1994, when you issued

            25   the -- and in 1998 when you issued the specific proposal.  






             1             MR. COLBY:  The trade association equivalent to an

             2   article. 

             3             MS. LANCELLOTA:  That's right.  And we do think

             4   that, given the significant role they play in the

             5   marketplace, and the significant reliance, that there should

             6   be greater oversight.  And I think it can be done fairly

             7   easily.  I know you stretch resources, but there needs to be

             8   some more oversight than I think what's currently being done. 

             9   While they may not be investment advisors in the traditional

            10   sense, they are providing investment advice and receiving

            11   compensation for it.  The SEC does have broad inspection

            12   authority of their books and records under the Advisors Act. 

            13   I think it's appropriate to continue to somewhat regulate

            14   them under the Advisors Act, but putting aside the specific

            15   regulatory structure, I do think that your inspection staff

            16   can get out a little bit more, and do a more vigorous

            17   examination of whether they continue to meet the criteria. 

            18             You were talking earlier about the national

            19   recognition attribute, and how difficult that is, because it

            20   is subjective.  But one way to test it may be to solicit

            21   public comments on a periodic basis, as to whether or not the

            22   market really does see them as issuing credible, reliable

            23   rating agencies.  And I said earlier in my opening remarks,

            24   it's my understanding that the FCC does something like this,

            25   where they have a broadcast license renewal process, where






             1   they do go and solicit public comment from those that are

             2   actually the end users of the product.  

             3             And finally, they said this morning, I think the

             4   NRSROs should be accountable for their ratings.  I just don't

             5   under how they can be exempt from expert liability, given the

             6   minimal level of regulations imposed on them, and the

             7   significant role that they do play in the marketplace, and

             8   the significant reliance on them.  I just don't really

             9   understand how -- I don't understand, I guess, the rational

            10   for the exemption.  

            11             MR. MCDANIEL:  From Moody's perspective, in terms

            12   of expert liability standards, what we're dealing with is

            13   probabilistic assessment -- these are not -- ratings are not

            14   performance guarantees.  And obviously, ratings will perform

            15   in a binary manner.  And in fact, they will either pay or

            16   they will not.  But nobody knows that today.  And so what we

            17   are doing is putting ratings into -- using ratings -- credit

            18   -- risk factors.  It may be helpful to think of it the way an

            19   insurance company might put 25-year-olds with 40-year-olds

            20   for risk factors in actuarial.  But you have the risk

            21   process, and the 25-year-olds are going to die.  Some 40-

            22   year-olds are going to live. 

            23             MR. COLBY:  Hopefully. 

            24             MR. MCDANIEL:  On the whole, there would be more

            25   mortality among the 40-year-olds than the 25-year-olds.  So






             1   therein is the risk.  And so what we have are opinions about

             2   the future with degrees of uncertainty to those opinions. 

             3   And we are also, I would add, publishing those opinions.  And

             4   there is very strong history as to how opinion publishers are

             5   treated. 

             6             MR. COLBY:  Paul, did you want to respond?

             7             MS. LANCELLOTA:  Can I respond real fast?  I don't

             8   think anyone expects the rating agencies to be correct 100

             9   percent of the time.  That would be impossible.  But you're

            10   rendering a professional opinion.  You're exercising

            11   professional judgment.  And given the reliance on it, I think

            12   you should be willing to stand behind it.  I mean, there are

            13   other opinions that appear in registration statements, and

            14   the process is -- or the law is that you get their consent,

            15   the issuer gets the expert's consent, and the expert is

            16   liable to investors for negligently misleading opinions.  

            17             So there are opinions that are included in

            18   registration statements.  They're not statements of 100

            19   percent accuracy, or no one's holding them up to that

            20   standard.  That would be an impossible standard.  But it

            21   seems to me that the rating agencies should be willing to

            22   stand behind your professional -- your exercise of

            23   professional judgment, and your rendering of the opinions

            24   that you render. 

            25             MR. MCDANIEL:  As far as following professional






             1   standards and procedures, I think that that is a fair

             2   expectation from the marketplace.  

             3             MR. COLBY:  Paul?

             4             MR. SALTZMAN:  Yes.  Just to sort of throw the Bond

             5   Market Association into the picture here, I think part of the

             6   problem is that any regulatory framework that involves the

             7   federal government into the assessment of subjective rating

             8   quality is a real serious problem, on multiple levels.  To

             9   have the office of compliance and examination, or the NASDR,

            10   or whomever else one would appoint as the inspectors, go in

            11   and second-guess the opinions of rating agencies, obviously,

            12   with all the benefit of hindsight, is truly problematic on

            13   multiple levels.  That is not to say, however, that the

            14   Securities and Exchange Commission couldn't perform more of

            15   an ongoing monitoring role, once the NRSRO designation

            16   process, or if the NRSRO designation process becomes a little

            17   bit more objective and transparent.  

            18             Perhaps, you suggested, certifications whereby the

            19   rating agencies can, on an ongoing basis, certify to their

            20   compliance with the procedural aspect of the NRSRO

            21   designation process.  But to the point of accountability, I

            22   guess, again, I would remind everyone that the opinions

            23   expressed by the rating agencies are just simply not

            24   recommendations, in the traditional sense that securities

            25   analysts or other opinion makers provide.  They're one tool,






             1   they're one factor.  You've heard from multiple sources.  

             2             In a wholesale market, there are many different

             3   aspects of the information spectrum, and ratings are simply

             4   one aspect of it.  So the accountability point, I think, is

             5   sort of nice to talk about, but rating agencies are not

             6   guarantors of performance, any more than mutual funds are. 

             7             MR. COLBY:  With the Commissioner's lead, let's

             8   just say that you all are now Commissioners.  You take a pay

             9   cut, and you get attacked in the press.  It gets worse.  And

            10   you're beginning to think that there is a rating agency out

            11   there that's an NRSRO, whose ratings are inflated, and

            12   they're being used in a variety of contexts to satisfy

            13   regulatory requirements.  Now what do you do?  What's the

            14   approach?

            15             MS. PETERSEN:  Actually, I think that this goes

            16   back to an issue that's been floated previously, which is,

            17   since we don't know exactly what it takes to become an NRSRO,

            18   and I don't think that the average investor knows what that

            19   designating really means, other than the fact that if you

            20   confer it on someone, then it must really mean something,

            21   because you're the SEC, and you're supposed to be protecting

            22   investors, and therefore, NRSRO must mean something.  

            23             So at the end of the day, what is it that it's

            24   supposed to do, and are you "in a position" to be able to

            25   walk into a rating agency, and determine whether or not the






             1   quality of the analysis that is being placed on the ratings

             2   in the marketplace is good, bad, or indifferent?  You can go

             3   in, and you can ask them, "What are your processes? What kind

             4   of people do you have on staff?  How often do you issue

             5   ratings?"  

             6             But I don't know that a lot of that objective

             7   criteria is necessarily going to spell the difference between

             8   whether or not the ratings that the agency is generating are

             9   good, bad, or indifferent.  And that's the reason why I have

            10   mentioned the issue of competition.  Because from an

            11   investor's point of view, especially if we are going to be

            12   held to some regulatory standards, it would be helpful for us

            13   if we could choose to go out and use the ratings generated by

            14   folks whose opinions we value.  And that's not to say that we

            15   don't value a lot of the opinions that are being expressed by

            16   the three agencies now.  

            17             But if indeed there are other people out there who

            18   have established a reputation for themselves in something

            19   that we feel would be beneficial in our overall process, we'd

            20   like to have the opportunity to be able to say we are meeting

            21   our regulatory requirements by having the requisite NRSRO. 

            22   It just so happens that maybe in one case, it's Moody's and

            23   LACE, or in another case it's A.M. Best and Fitch.  So that's

            24   the issue.  What is the NRSRO's status?  Why should we be

            25   held to a standard that we're not absolutely certain that






             1   you're giving us?

             2             MR. COLBY:  I don't want to foreclose any other

             3   Commissioner from speaking, but it sounds like you're really

             4   taking issue with the use of NRSRO in a regulatory context. 

             5   Because it sounds like what you're saying -- and maybe I'm

             6   misunderstanding -- is that we should have more people to

             7   choose from, so that we can find a way of compliance with

             8   Rule 2a-7 that accords better with our view of what the real

             9   credit risks are. 

            10             MS. PETERSEN:  Well, it just opens up the

            11   opportunity for us to remain in compliance, without

            12   necessarily being perceived as trying to cook the books, or

            13   to go rating shopping.  At the end of the day, the issue

            14   becomes, did you make a reasonable investment decision?  What

            15   did you do, as a result of change in circumstances, to

            16   protect the investor?  

            17             And therefore, if we feel that some entity that's

            18   relatively new -- or let's say, a law firm who decided they

            19   want to go out on their own, and perhaps the skill and

            20   expertise that they take out into the marketplace to

            21   establish their own partnership is something that you want to

            22   continue participating in, but now you're being told that you

            23   can't use that expertise any longer, because it's newsletter

            24   part of Baker & McKenzie.  They've gone off to the Adams &

            25   Jones partnership.  






             1             And that's pretty much what you're imposing upon us

             2   with this NRSRO status.  It's that we don't have,

             3   necessarily, the ability to use LACE or A.M. Best to reach

             4   the regulatory requirement that's being imposed on us, even

             5   though, perhaps, those entities have the expertise to bring

             6   to bear on that sector of the market that would be beneficial

             7   to us and to our investors.  

             8             MS. NAZARETH:  Where would you draw the line?  How

             9   would you determine, if you were a Commissioner, from a

            10   regulatory standpoint that the buy side was not out,

            11   basically, shopping for ratings that they wanted, as opposed

            12   to ensuring that they were credible ratings?

            13             MS. PETERSEN:  Well, I'd have to throw that back

            14   and ask, is the criterion that you use for an NRSRO

            15   designation one that clearly identifies and appreciates the

            16   relative skill set -- the absolute skill set among the

            17   analysts in the agencies that have achieved that status?

            18             MS. NAZARETH:  I think what's happened, and it goes

            19   back to what Paul said, is that I'm not sure you would want

            20   government employees making those determinations, and so what

            21   it does is this very, obviously, imperfect proxy for that,

            22   and this is the chicken and egg problem -- what does the

            23   marketplace think?  

            24             COMMISSIONER GOLDSCHMID:  You're saying that, as

            25   part of the marketplace, if she had more choice, she could






             1   think more.  That that would give her the ability to select

             2   the good ones, in a way that right now she's trapped in. 

             3             MR. COLBY:  But you used good ones for regulatory

             4   purposes.  Because she's always free to use these people for

             5   analysis. 

             6             COMMISSIONER GOLDSCHMID:  But she's saying she's

             7   trapped into it, if I understand you, because the NRSRO

             8   designation is just too powerful a designation for all kinds

             9   of regulatory reasons.  

            10             MS. PETERSEN:  And it's even more problematic for

            11   us on the public finance side than it is on the corporate

            12   side, because on the corporate side, there has been,

            13   historically, an understanding that market access is going to

            14   be more real if you have two ratings.  And therefore, most of

            15   the issues out there tend to have two ratings.  On the public

            16   finance side, however, it's not unusual, in many

            17   circumstances, to only have one rating.  

            18             And when Rule 2a-7 says that you have to comply

            19   with this regulatory mandate that says you need to have most

            20   of your portfolio in tier one rated securities, yet a lot of

            21   the issuers, and your ability to remain invested means that

            22   you're going to end up with a lot of securities that only

            23   have one rating on it.  I'm kind of backed into a corner. 

            24   And what Jerry said earlier about this cliff.  Their access

            25   to -- short-term marketplace is being, potentially, stymied






             1   by the fact that they're the only ones doing it.  

             2             I can't -- even if I disagreed, let's say I think

             3   that Moody's had too high a rating on that security.  The

             4   only way I can vote now is by not buying.  And therefore,

             5   you're not giving me the opportunity to say, "Well, I don't

             6   think that it's quite tier one, I think it's a tier two

             7   security, and therefore, I'm going to go with the lesser of a

             8   million dollars or 1 percent for issuer under Rule 2a-7."  

             9             So it's one of those situations where it's well

            10   intentioned, because Rule 2a-7 is trying to make sure that a

            11   dollar in is a dollar out.  But it has this unintended

            12   consequence of saying that we who do have true liability, in

            13   the event that we blow it, and we -- that we, even though we

            14   have that requirement, are still forced to look to only three

            15   agencies currently to get that kind of information.  

            16             And the thing that I would throw out, too, we don't

            17   have any of our money funds rated by Moody's or S&P.  But if

            18   an entity were to get one of those money fund ratings, I

            19   think that a perception -- and this is my personal opinion --

            20   as an investor, if I placed my money into something that had

            21   a specific designation, it's got a triple A money fund rating

            22   from Moody's, I'm expecting that the people at Moody's really

            23   know what they're doing, and have the capacity to let me know

            24   if there's something wrong, because I'm expecting that, if I

            25   put something in a triple A, that's really good, because I,






             1   the investor, know that triple A is really good.  And I don't

             2   know that there are double A-rated money funds.  I don't know

             3   if there would be a single A-rated money fund.  

             4             So I think as far as what the investor expects,

             5   based on what the Commission has established as the gold

             6   standard, with the three NRSROs, is really important, and

             7   just something that needs to be considered when thinking

             8   about either increasing or decreasing regulation, or however

             9   you choose to handle it. 

            10             MR. COLBY:  In true Commissioner form, she took a

            11   question and revealed its complexity.  Neal, I think, is

            12   next. 

            13             MR. SULLIVAN:  I think if I were the Commissioner,

            14   I'd say to the staff, you've brought this issue to me, and

            15   you've asked me to take some sort of action.  Yet there are

            16   no underlying criteria against which I can judge a retraction

            17   of the status.  And I would be -- I would ask you, are you

            18   asking me to refer this, because there has been some

            19   violation of a securities law?  Are you asking me that

            20   there's been some sort of qualitative or quantitative erosion

            21   or concern that you think has risen to the point where I can

            22   take that designation away, yet you don't have any objective

            23   criteria against which I can measure that, and then support

            24   my decision.  So I think, as a Commissioner, I would say to

            25   the staff, "Would you please promulgate -- would you please






             1   propose some criteria against which I can measure the

             2   performance of these designated rating agencies, so I can, if

             3   these issues arise, take action.  But in the absence of that

             4   criteria, in the absence of that process, I'd be hesitant to

             5   do so. 

             6             MR. COLBY:  So you're saying that, unless you have

             7   objective criteria, there will not be a way to take an

             8   outlier that's inflating the rating criteria out of the

             9   NRSRO?

            10             MR. SULLIVAN:  I'm hesitant to use words like "any"

            11   ever, but I think it is more problematic, yes, and I think

            12   that the entire process is strengthened when you take various

            13   criteria, both objective and subjective, and publish that,

            14   and utilize it, and apply it to different applicants, and to

            15   different existing NRSROs in the marketplace.  And I think it

            16   would strengthen the Commission's hand, rather than weaken

            17   it. 

            18             MR. COLBY:  Jack?

            19             MR. MALVEY:  I just wanted to point out the very

            20   good news that there really are criteria, and we can measure

            21   the efficacy of the rating agencies through time.  In the

            22   asset management industry, over the last three decades, has a

            23   very large and healthy consulting industry, which does

            24   measure the performance of assets managers.  There are all

            25   sorts of statistical techniques which are regularly applied. 






             1   And the rating agencies themselves -- and some of the date is

             2   submitted here -- measure things like what is the default

             3   rate on various rating categories.  That data goes back

             4   decades.  We can look and see.  As an illustration today, we

             5   can fit credit quality term structure vis-a-vis ratings, to

             6   see who is the most accurate, who is the market closest to in

             7   terms of ratings.  And I'll throw out the notion -- it should

             8   not be the notion that an agency which has the highest

             9   ratings possibly would be suspect, and off the mark.  You

            10   should also be careful, an agency could also ingratiate

            11   itself to some entities on the buy side, by saying, "We have

            12   the lowest ratings."  And you can check that, so we can look

            13   at those things today.  So it's not a problem, really, to

            14   create a test to evaluate this. 

            15             MR. SALTZMAN:   Very quickly, I would embrace that

            16   concept that Jack identified, but more in the nature of

            17   disclosure.  It would seem to me entirely appropriate that,

            18   perhaps as part of the NRSRO designation prepaid

            19   subscriptions, to standardize and to require some sort of

            20   performance-based disclosure.  But I think when you move

            21   beyond the mere disclosures to some form of merit regulation,

            22   that some form of subjective judgment about inflation or

            23   deflation of a particular rating, that's where I think you

            24   get into a slippery slope of not only First Amendment issues,

            25   but all sorts of other problems. 






             1             MR. COLBY:  Let me see if I understand what you're

             2   saying.  It would be all right to tell a rating agency that

             3   was always two grades higher than everyone else that they had

             4   to disclose that, but we shouldn't pull -- or stop those

             5   ratings from being used for regulatory purposes?

             6             MR. SALTZMAN:  That's correct.  Because ultimately,

             7   I would -- this is a market where ratings, for the most part,

             8   are not the exclusive tool.  And the fact of the matter is

             9   that that marketplace itself, whether through credit spreads,

            10   whether through reputation, will effectively put that rating

            11   agency out of business.  So as long as you have -- and I

            12   wouldn't -- I would even argue perhaps to, as a precondition,

            13   regularized disclosure.  You know, standardized, regularized

            14   disclosure, so that, on an ongoing basis, the market can

            15   assess the quality and the performance other rating agencies,

            16   but not to have substantive invasive regulation where someone

            17   is making the judgment as to what's good or bad. 

            18             COMMISSIONER GOLDSCHMID:  Well, there's one more

            19   possibility I just want to throw in, which is to look not at

            20   the merits.  No one wants someone sitting over your shoulder

            21   on merits.  But what about judging professional conduct

            22   or all of the rating agencies explain how they've built in

            23   various checks and safeguards?  Is there any reason why we

            24   shouldn't look to see whether they're serious about that, in

            25   terms of practice?






             1             MR. MCDANIEL:  From the Moody's perspective, I

             2   don't think we would have a problem with that.  In fact, I

             3   think it would be beneficial to the industry, because to the

             4   extent that our practices are as good as we believe they are

             5   -- and that's confirmed by the Commission -- that's, I think,

             6   going to help our reputation. 

             7             MR. COLBY:  I would just add that, as a practical

             8   matter, that is one of the areas that the Commission staff

             9   looks at.  So that exists today, as is, yet it is not a

            10   published or noticed criterion. 

            11             COMMISSIONER GOLDSCHMID:  I think we could do more

            12   in the way of publication, and some have argued we ought to

            13   be doing more -- although our resources are limited. 

            14             MR. COLBY:  Any other Commissioners want to speak? 

            15             MR. SCHWARCZ:  Michael already said what I was

            16   going to say, so I don't want to repeat it.  But just a few

            17   brief thoughts.  And that is, in answer to the, I guess,

            18   Stephanie's concern.  Of course, if you designate more

            19   NRSROs, then you at least try to ameliorate your problem. 

            20   I'm not sure I would agree with Paul that -- you made a

            21   statement, you said that the market would take care of a

            22   rating agency that is not doing its job.  If you take that to

            23   its logical limit, you should designate any rating agency

            24   that wanted to be an NRSRO.  And I'm not sure you would mean

            25   that.  And I'm not sure that would have a good impact. 






             1             So I think you still need to be a little cautious. 

             2   And so what I would suggest is, just as I had -- or really,

             3   the Department of Justice had proposed, taking rating

             4   agencies and putting them initially on a provisional NRSRO

             5   status.  One could, in answer to the question you originally

             6   raised, Bob, about what happens if the SEC suspects the

             7   ratings are much too high?  One could go to the rating agency

             8   and say, "Look, we're going to put you on a provisional

             9   downgrade status."  Sort of like a credit watch, so to speak,

            10   what rating agencies now do with bonds.  And that would

            11   certainly get their attention, and make them -- give them a

            12   very strong incentive to try to remedy any problematic

            13   actions without really -- without sort of forcing them right

            14   over the cliff.  

            15             But to do that, I also agree with Paul that you

            16   really -- it would really help politically for you to have

            17   more transparent standards as to how you designate an NRSRO. 

            18   Because let's assume that S&P was thought to be issuing too

            19   high ratings, it would be very hard politically to say,

            20   "We're going to take you off of NRSRO status," without having

            21   -- or even put you on a provisional downgrade, without having

            22   criteria. 

            23             COMMISSIONER GLASSMAN:  What would be the basis for

            24   our deciding that somebody's ratings are too high, or too low,

            25   or just right?  Unless we had the time period, especially for






             1   the long ratings, the 15 years or so to determine whether

             2   they actually are correct, how can we make that decision at

             3   the Commission?

             4             MR. SCHWARCZ:  Well, I think there are two answers

             5   to that.  One, in terms of the -- the best way to do that is

             6   rating stability, I would argue.  See a rating, once

             7   designated, you know, how long that rating really keeps up,

             8   and whether the defaults of investment-grade debt issues. 

             9   You know, as everyone agrees, there to be defaults, and the

            10   analogy to the insurance categories makes a lot of sense. 

            11   But I think if one rating agency, one NRSRO had a history of

            12   defaults that was much higher than the history of the others,

            13   and if the stability of their ratings was much weaker than

            14   those of the others, that would be a highly bad factor. 

            15             Now, of course, as you've correctly stated, that's

            16   something that you wouldn't know until substantial time had

            17   gone by, unless there are really some pretty lousy ratings. 

            18   And therefore, the concept is, well, what happens if you

            19   provisionally say we're going to give, I guess, R&I a

            20   provisional rating, and a year goes by, and there are no

            21   defaults, and then two years later you find out there are

            22   many -- there are really problems.  Well, that's where the

            23   concept of putting them back onto a provisional footing would

            24   come into play.  So you can sort of downgrade the agency, as

            25   well. 






             1             But the other thing, of course, you can do during

             2   the year period, is, you can perhaps see how they're

             3   performing their business, seeing there are no conflicts. 

             4   I'm not -- I'm probably not the best person to say as to how

             5   you would go about it, but I imagine there's at least a

             6   people process of going about it, like Commissioner

             7   Goldschmid said, and you look at the standards of conduct. 

             8             COMMISSIONER GLASSMAN:  Yes.  The latter kind of

             9   inspection is something that we do, and that's not difficult

            10   in context.  But what you're suggesting in terms of our

            11   flagging high ratings and low ratings, without history, seems

            12   more difficult. 

            13             MR. SCHWARCZ:  Well, that hypothetical, of course,

            14   was not one I had raised.  I was only responding to it.  I

            15   would go more to the rating stability and the defaults of

            16   investment-grade. 

            17             MR. COLBY:  At this point we're coming close to the

            18   end of our time.  Are there any people that wanted to add

            19   comments that they're just waiting to make?  

            20             Well, in that case, I thank you very much for

            21   coming in.  We ended on time and under budget.  And we very

            22   much appreciate the assistance you've provided us. 

            23             (Whereupon, at 4:45 p.m., the hearing was

            24   concluded.)

            25                             * * * * *