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LEGISLATIVE SOLUTIONS FOR

THE RATING AGENCY DUOPOLY

HEARING

BEFORE THE

SUBCOMMITTEE ON 

CAPITAL MARKETS, INSURANCE AND 

GOVERNMENT SPONSORED ENTERPRISES

OF THE

COMMITTEE ON FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED NINTH CONGRESS

FIRST SESSION

JUNE 29, 2005

Printed for the use of the Committee on Financial Services

Serial No. 109–42

(

(II)

HOUSE COMMITTEE ON FINANCIAL SERVICES 

MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa 

RICHARD H. BAKER, Louisiana 

DEBORAH PRYCE, Ohio 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

ROBERT W. NEY, Ohio 

SUE W. KELLY, New York, Vice Chair 

RON PAUL, Texas 

PAUL E. GILLMOR, Ohio 

JIM RYUN, Kansas 

STEVEN C. LATOURETTE, Ohio 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

CHRISTOPHER SHAYS, Connecticut 

VITO FOSSELLA, New York 

GARY G. MILLER, California 

PATRICK J. TIBERI, Ohio 

MARK R. KENNEDY, Minnesota 

TOM FEENEY, Florida 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

GINNY BROWN-WAITE, Florida 

J. GRESHAM BARRETT, South Carolina 

KATHERINE HARRIS, Florida 

RICK RENZI, Arizona 

JIM GERLACH, Pennsylvania 

STEVAN PEARCE, New Mexico 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

MICHAEL G. FITZPATRICK, Pennsylvania 

GEOFF DAVIS, Kentucky 

PATRICK T. MCHENRY, North Carolina 

BARNEY FRANK, Massachusetts 

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

DARLENE HOOLEY, Oregon 

JULIA CARSON, Indiana 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

BARBARA LEE, California 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

HAROLD E. FORD, JR., Tennessee 

RUBE ́ N HINOJOSA, Texas 

JOSEPH CROWLEY, New York 

WM. LACY CLAY, Missouri 

STEVE ISRAEL, New York 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

JIM MATHESON, Utah 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

ARTUR DAVIS, Alabama 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

MELISSA L. BEAN, Illinois 

DEBBIE WASSERMAN SCHULTZ, Florida 

GWEN MOORE, Wisconsin, 

BERNARD SANDERS, Vermont

Robert U. Foster, III, Staff Director 

(III)

SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE AND GOVERNMENT SPONSORED

ENTERPRISES

RICHARD H. BAKER, Louisiana, Chairman

JIM RYUN, Kansas, Vice Chair 

CHRISTOPHER SHAYS, Connecticut 

PAUL E. GILLMOR, Ohio 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

FRANK D. LUCAS, Oklahoma 

DONALD A. MANZULLO, Illinois 

EDWARD R. ROYCE, California 

SUE W. KELLY, New York 

ROBERT W. NEY, Ohio 

VITO FOSSELLA, New York, 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

MARK R. KENNEDY, Minnesota 

PATRICK J. TIBERI, Ohio 

J. GRESHAM BARRETT, South Carolina 

GINNY BROWN-WAITE, Florida 

TOM FEENEY, Florida 

JIM GERLACH, Pennsylvania 

KATHERINE HARRIS, Florida 

JEB HENSARLING, Texas 

RICK RENZI, Arizona 

GEOFF DAVIS, Kentucky 

MICHAEL G. FITZPATRICK, Pennsylvania 

MICHAEL G. OXLEY, Ohio 

PAUL E. KANJORSKI, Pennsylvania 

GARY L. ACKERMAN, New York 

DARLENE HOOLEY, Oregon 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

HAROLD E. FORD, JR., Tennessee 

RUBE ́ N HINOJOSA, Texas 

JOSEPH CROWLEY, New York 

STEVE ISRAEL, New York 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

JIM MATHESON, Utah 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

ARTUR DAVIS, Alabama 

MELISSA L. BEAN, Illinois 

DEBBIE WASSERMAN SCHULTZ, Florida 

BARNEY FRANK, Massachusetts 

(V)

C O N T E N T S 

Page 

Hearing held on: 

June 29, 2005 .................................................................................................... 1

Appendix: 

June 29, 2005 .................................................................................................... 41

WITNESSES 

WEDNESDAY, JUNE 29, 2005

Bolger, Rita M., Managing Director and Associate General Counsel, Standard 

and Poor’s ............................................................................................................. 15

Egan, Sean, Managing Director, Egan-Jones Ratings Co. ................................... 11

Kaitz, James A., President and CEO, Association for Financial Professionals .. 17

Partnoy, Frank, Professor of Law, University of San Diego School of Law ....... 7

Pollock, Alex J., Resident Fellow, American Enterprise Institute ...................... 13

Stroker, Nancy, Group Managing Director, Fitch Ratings ................................... 9

APPENDIX 

Prepared statements: 

Oxley, Hon. Michael G. .................................................................................... 42

Hinojosa, Hon. Ruben ....................................................................................... 44

Kanjorski, Hon. Paul E. ................................................................................... 45

Bolger, Rita M. .................................................................................................. 47

Egan, Sean ........................................................................................................ 64

Kaitz, James A. ................................................................................................. 72

Partnoy, Frank ................................................................................................. 83

Pollock, Alex J. ................................................................................................. 99

Stroker, Nancy .................................................................................................. 102

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Baker, Hon. Richard. H.: 

Letter from Investment Company Institute, June 29, 2005 ......................... 126

Kanjorski, Hon. Paul E.: 

Letter from Securities and Exchange Commission, June 6, 2005 ................ 127

The Bond Market Association, prepared statement ...................................... 131

(1)

LEGISLATIVE SOLUTIONS FOR 

THE RATING AGENCY DUOPOLY 

Wednesday, June 29, 2005

U.S. HOUSE OF REPRESENTATIVES, 

SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE

AND GOVERNMENT SPONSORED ENTERPRISES, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The subcommittee met, pursuant to call, at 10:05 a.m., in Room 

2128, Rayburn House Office Building, Hon. Richard H. Baker 

[chairman of the subcommittee] Presiding. 

Present: Representatives Baker, Shays, Kelly, Biggert, Kennedy, 

Tiberi, Brown-Waite, Feeney, Gerlach, Hensarling, Fitzpatrick, 

Kanjorski, Sherman, Hinojosa, Clay, Scott, and Wasserman 

Schultz. 

[10:05 a.m.] 

Chairman BAKER. I would like to call this meeting of the Capital 

Markets Subcommittee to order. I am advised that Mr. Kanjorski, 

the ranking member, is en route, and we are going to proceed and 

reserve the right for Mr. Kanjorski to give his opening statement 

should he not arrive at the conclusion of my own statement. 

Today, the subcommittee meets to discuss, for a change of pace—

we are not on GSEs today; we are going to be talking about GSDs. 

And what is that, you ask? It is a Government Sponsored Duopoly. 

Now I read over several witness’s testimony this morning and 

found myself almost immediately being corrected. 

I read the words ′′dual monopoly.′′ Then I read ′′partner monopoly.′′ Then I read ′′oligopoly.′′ I am not sure what kind of opoly we 

have got this morning, but it will be the subject of the committee’s 

discussions and determinations over the coming couple of hours. 

Since the early 20th century, credit rating agencies have been 

issuing ratings on the likelihood of issuers’ default on debt payments. As a result of the difficult corporate period we have come 

through and the fact that dominant rating agencies were not accurately predicting Enron and WorldCom’s financial condition, reforming the rating agency industry practice has been the subject of 

discussion over the last several years. 

The Subcommittee on Capital Markets has held a series of hearings on credit rating agencies. And most recently in April, Ms. 

Nazareth, director of the Division of Market Regulation, testified 

that to conduct oversight of the industry, the SEC needed more direct and explicit congressional authority to do so. 

2

The SEC also announced last March a proposal to define nationally-recognized statistical rating organizations as firms generally 

accepted in the marketplace. 

Some critics have once again criticized the SEC for what they believe to be an anticompetitive definition. In 1997, a rule proposed 

to define the NRSROs; the SEC claimed that the most important 

factor was the firm be nationally recognized. 

That decision was not implemented in part because of a Department of Justice objection that the requirement, be nationally recognized, was an insurmountable barrier to entry of new market participants. Unfortunately, not much has changed since that proposal 

has failed. 

Today there are over 130 agencies, rating agencies. However, instead of allowing public companies’ investors to decide which one 

of those 130 to utilize, the SEC makes that determination. Now, 

after three decades of uncertainty, Mr. Fitzpatrick has introduced 

H.R. 2990, which would return this decision to the markets and the 

choice by consumers. 

Beyond the difference in retaining the SECs staff’s designation 

process, the SEC staff’s outline contained provisions similar to 

those in the Fitzpatrick bill. It suggests mandating reporting and 

recordkeeping requirements for registered firms, as well as giving 

inspection, examination, and enforcement authority to the SEC. 

In short, H.R. 2990 incorporates most of the SEC staff outline 

without the anticompetitive system that the designation process 

was to establish. I believe that competition is the essential component of a healthy capital market. 

Currently, there just isn’t competition in the rating industry. The 

SEC has chosen with specificity which agencies not only are acceptable, but which shall perform this singular duty. 

NRSROs are what they are because of a grant of privilege, not 

because they have earned it by competitive market choice. Competition has always proved to the benefit of investors and shareholders and consumers. Whether it is mutual funds, brokerage 

costs, insurance premiums, or whatever sector of the financial marketplace. 

Without competition in the ratings business, operating companies are frankly held hostage with S&P and Moody’s controlling approximately 80 percent of the market. The question is, do they control 80 percent of the market because they are really that good or 

because the SEC and the SEC staff has merely given them that opportunity? 

Compounding the problem is a lack of transparency regarding 

the ratings process and the operation of the firms. Additionally, the 

companies held hostage by their ratings avoid speaking out for fear 

of the consequences of the rating evaluation system. 

It is my hope that free enterprise, competitive principles will direct the committee’s decision in this arena. We should not seek to 

preserve a privilege. We should, however, fight to guarantee opportunity. Then the market will make the determination as to the 

winners and the losers. This is not and never has been the role of 

the Federal Government. 

Mr. Kanjorski. 

3

Mr. KANJORSKI. Mr. Chairman, we return this morning once 

again to explore the issue of regulating credit rating agencies. As 

I have noted during our past hearings, entities like Standard & 

Poor’s, Moody’s, and Fitch have long published their views on the 

credit worthiness of the issuers of debt securities, and the significance of these opinions has greatly expanded in recent years. 

Although rating agencies received some scrutiny after the recent 

surge of corporate scandals, we have not yet mandated any substantive changes in their practices. We have, however, since our 

last hearing, begun to consider potential legislative reforms in this 

area. 

A bill, H.R. 2990, has been introduced by my colleague from 

Pennsylvania. In addition, at my request, the experts of the Securities and Exchange Commission have put together a conceptual legislative outline for our consideration. 

While I agree with you, Mr. Chairman, that something needs to 

be done in this area of the securities marketplace to improve transparency and oversight, H.R. 2990, as introduced, is not the solution 

to this problem. It would eliminate the current nationally-recognized statistical rating organization framework that we have had 

in place for three decades. 

Instead of casting this accepted framework aside, we should 

build on the work of the Commission in these matters. H.R. 2990 

is also, as one witness will note in her testimony today, 

′′inconsistent with the overwhelming majority′′ of the commentators 

in the most recent Commission concept release. 

As I understand, less than 10 percent of the respondents to this 

concept release supported the elimination of the NRSRO framework. Additionally, we now have a classic quantity versus quality 

debate. H.R. 2990 focuses on increasing the quantity of raters. To 

protect investors, we should focus on the quality of ratings as the 

Commission’s conceptual legislative outline seeks to do. 

In my view, the problems encountered by investors before 

Enron’s downfall, WorldCom’s bankruptcy, and New York City’s 

debt crisis, among others, were related to the quality of ratings, not 

the quantity of raters. 

Nevertheless, Mr. Chairman, I understand the desire to increase 

competition in this field, and I am willing to explore these matters 

further. Additionally, in a statement prepared for today’s hearing, 

the Bond Market Association notes that the bill ′′could ultimately 

dilute the important role credit rating agencies play in capital markets.′′

Mr. Chairman, I ask unanimous consent to insert this statement 

into the record. 

Chairman BAKER. Without objection. 

Mr. KANJORSKI. Beyond quality issues, I am also concerned that 

H.R. 2990, could cause serious disruptions in the marketplace if enacted into law. Eliminating the recognition process and replacing 

it with a registration process could cause unintended consequences. 

The NRSRO concept, after all, has become embedded in many 

areas of the law. The term is used in about 8 Federal statutes, 47 

Federal rules, and more than 100 State laws. It is also used in 

laws related to communications, education, transportation, in addition to banking and security statutes. 

4

Moreover, changing the phrase could cause uncertainty and potential turmoil for any mutual fund that relies on a strategy of purchasing only those debt securities of investment grade as determined by an NRSRO. 

We must further be very sensitive to the First Amendment issues 

posed in these debates. The courts have previously ruled on matters such as the permissibility of registration requirements for publishers, which the NRSROs contend that they are. The courts have 

also ruled that we must be very precise in crafting statutes that 

impede upon the First Amendment. 

H.R. 2990 is vague, in its present construction, and needs work 

to withstand judicial scrutiny. Ultimately, we need to move deliberately in these matters. From my perspective, we need to focus on 

the prior work of the Securities and Exchange Commission. We 

should also put a great deal of weight on their conceptual legislative outline as a roadmap for our work in the months ahead. 

The outline seeks to establish an effective supervisory system to 

ensure that credit rating agencies operate in a transparent manner 

with adequate policies and procedures. To help us in these efforts, 

last week I called upon all interested parties to examine the roadmap of proposed reforms developed by the Commission’s experts at 

my request, and I request unanimous consent to insert this document into the record. 

Chairman BAKER. Without objection. 

Mr. KANJORSKI. Today I again call upon all parties to review this 

legislative outline and offer comments on it before the end of August. In the meantime, I hope that the Commission and the rating 

agencies will expedite their deliberations over a voluntary agreement to improve transparency in the coming months. The success 

of these negotiations and the effectiveness in enforcing any final 

voluntary accord will help to determine the need for a compulsory 

bill and the speed of legislative action. 

In conclusion, Mr. Chairman, this issue is one on which we 

should focus in the 109th Congress. I commend you for your leadership in these matters and hope that we can work together to identify an appropriate consensus in the months ahead. Thank you, Mr. 

Chairman. 

Chairman BAKER. I thank the gentleman. 

Mr. Shays, did you have a statement? 

Mr. SHAYS. No. 

Chairman BAKER. Mrs. Biggert. 

Mrs. BIGGERT. No. 

Mr. FITZGERALD. Thank you, Mr. Chairman. And I appreciate the 

comments of my colleague from Pennsylvania and his recognition 

that there is some requirement for reform. And I look forward to 

working with my colleague from Pennsylvania in that. 

As the chairman was, in his opening comments, identifying all of 

the different opolies that are referenced in your opening statements, whether it be monopoly or oligopoly or duopoly, clearly one 

of them applies. Probably duopoly is the best description, but what 

it means is that there is lack of competition. And lack of competition is not good for the individual investor or the consumer. 

As a Bucks County Commissioner, I remember the financial 

hardships that the people of the 8th Congressional District of 

5

Pennsylvania faced when Enron and WorldCom went bankruptcy. 

And it is, for many of us, extremely disturbing that the two largest 

nationally recognized statistical rating organizations, Moody’s and 

S&P, rated Enron and WorldCom at investment grade just prior to 

their filing of bankruptcies. 

Essentially, Moody’s and S&P told the market that Enron and 

WorldCom were safe investments. Credit rating agencies claim that 

they are not in the business of detecting fraud, but they are most 

certainly in the business of impacting the bottom line of companies 

and also municipalities, school districts. 

The better the credit rating, the lower the interest rate the borrower must pay to expand its operations, construct a road, or build 

a school. The credit ratings industry is dominated by Moody’s and 

S&P. Together, as you heard, they have over 80 percent of the market share. 

In three previous hearings, this subcommittee has received testimony that the lack of competition in the credit rating industry has 

lowered the quality of ratings, has inflated prices, stifled innovation, and allowed conflicts of interest to go unchecked. This duopoly 

cannot continue to be preserved by an artificial barrier to entry 

and anticompetitive industry practices. 

Last week I introduced the Credit Rating Agency Relief Act, H.R. 

2990, that would inject greater competition, transparency, and accountability in the credit rating agency industry through marketbased reform. My legislation would eliminate the SEC staff’s anticompetitive designation process and prohibit anticompetitive industry practices by mandating reporting and record keeping requirements for registered firms as well as giving inspection, examination, and enforcement authority to the SEC. 

By eliminating the SECs staff’s opaque designation process, the 

bill incorporates most of the SEC staff’s outline of a regulatory 

framework. A minority of commentators have claimed that any registration of this industry amounts to a violation of First Amendment privileges. My bill does not infringe upon those privileges. 

H.R. 2990 neither bans nor restrict their First Amendment rights 

in any manner. The Government has an undeniable interest in registering rating agencies giving the credit rating industry’s substantial impact and effects on the market. My legislation regulates the 

credit ratings industry through disclosure. This is the least restrictive means of any regulation. 

Currently, all five SEC-approved agencies already voluntarily 

register under the Investment Advisors Act of 1940, and many of 

the complaints seem hypocritical. By encouraging competition in 

the industry, prices and anticompetitive practices will be reduced. 

Credit ratings quality will improve, and firms will innovate. 

H.R. 2990 addresses the basic problems of the credit ratings industry and protects our robust marketplace and, thus, more importantly, the individual investors. 

I look forward to discussing my proposal with the distinguished 

panel here today as a solution in the credit rating industry. 

Chairman Baker, I thank you for your leadership on this issue, 

this vital issue, and I yield back the balance of my time. 

Chairman BAKER. I thank the gentleman. Mr. Hinojosa. 

6

Mr. HINOJOSA. Chairman Baker and Ranking Member Kanjorski, 

I want to express my sincere appreciation for you holding this 

fourth in a series of hearings on credit rating agencies. 

Chairman Baker, I want to thank you for doggedly pursuing the 

reform of the definition and oversight of the agencies. This hearing 

is of particular interest to me as a Member of the Texas delegation. 

The Enron bankruptcy and the harm it caused to its employees, 

the small businesses, the community, and the overall perception of 

public trust in corporations and the national recognized statistical 

rating agencies was enormous. 

So this hearing is timely and needed, despite the number of 

years that have passed since the Enron bankruptcy. 

Ranking Member Kanjorski, I commend you for working with the 

Securities and Exchange Commission to arrive at legislative language. Hopefully, it will not only increase competition among the 

credit rating agencies and make the system more transparent, but 

also ensure that the legislation does not violate the nationally recognized statistical rating organizations’ First Amendment rights to 

free speech. 

I also believe that your actions have encouraged the Securities 

and Exchange Commission to begin working with these nationallyrecognized statistical rating organizations on a voluntary framework to establish an SEC oversight regime. In essence, this could 

result in something resembling a best practices for the NRSROs. 

Additionally, the SEC has proposed a rule that would codify the 

definition of an NRSRO. Some of our Members of Congress and the 

SEC have suggested that legislation might be needed to give the 

SEC the oversight authority to increase its regulations of the 

NRSROs. 

I understand that my colleague across the aisle, Congressman 

Fitzpatrick, has introduced legislation to address the current oversight of the NRSROs, and this panel of witnesses is heavily weighted with those in support of that legislation, with the exception of 

Standard and Poor’s. 

Mr. Chairman, I would like to hear from a more balanced panel 

in the future. Chairman Baker and Ranking Member Kanjorski, I 

believe that Congress should give the SEC, the NRSROs additional 

time to work on a voluntary framework and to develop and introduce any legislation needed to oversee the NRSROs and provide 

the SEC whatever statutory authority it needs to regulate them. 

Having said that, Mr. Chairman, I yield back the remainder of 

my time. 

[The prepared statement of Hon. Ruben Hinojosa can be found 

on page 44 in the appendix.] 

Chairman BAKER. Thank the gentleman. Ms. Brown-Waite, did 

you have a statement? 

Ms. GINNY BROWN-WAITE. No, I do not have an opening statement. I just look forward to hearing the witnesses that we have 

today. 

Chairman BAKER. I thank the gentlelady. Mr. Hensarling? 

Mr. HENSARLING. No. 

Chairman BAKER. Mrs. Kelly. 

Mrs. KELLY. Yes, I do, Mr. Chairman. 

Chairman BAKER. Please proceed. 

7

Mrs. KELLY. First I want to thank you, Chairman Baker and Mr. 

Fitzpatrick, to your commitment to ensuring openness and competition within the debt rating industry. I want to thank all of the witnesses for being here today. 

I share the committee’s view that it is important that debt rating 

firms provide the best possible analysis at the lowest possible price. 

I believe that encouraging more firms to enter this industry is critical, and I am glad the SEC is working within the industry. 

The nationally recognized statistical rating organizations and the 

SEC have entered into a process for ensuring that high standards 

and open competition are met within the industry without disrupting the bond markets or imposing unneeded regulation. 

These talks are continuing, and I hope that Chairman Cox, when 

confirmed, will be able to complete this process and present the 

committee with a finished product. I have serious concerns however, that any abrupt change to the ratings market could adversely 

impact the bond markets, confuse investors, and increase the size 

and scope of Government regulation. 

As the BMA noted, as currently—and I am quoting, ′′as currently 

drafted, H.R. 2990 could ultimately dilute the important role credit 

rating agencies play in the capital markets.′′ Debt ratings are, as 

the courts have observed, journalistic products protected by the 

First Amendment. Mandatory regulation regimes on financial 

speech, however well intentioned, harm the very freedom to make 

qualitative judgments that make the debt rating process valuable. 

The ability to speak freely and honestly about a debt product 

without Government sanction needs to be protected by this committee. And I will closely examine all proposals for regulation of 

debt ratings agencies with that in mind. Thank you very much, Mr. 

Chairman. 

Chairman BAKER. I thank the gentlelady. Any member, other 

member have an opening statement? If not, at this time, I would 

proceed to our panel of witnesses, and I would like to state the general rules by which the committee functions, that all of your official 

statements will be made part of the committee’s record. 

We would request that, to the best of your ability, that you proceed with a 5-minute clock in mind to enable members to have the 

opportunity to ask questions in the course of the hearing this 

morning. 

And we will proceed from left to right, first with Mr. Frank 

Partnoy, professor of law, University of San Diego School of Law. 

Please proceed at your leisure, sir. 

STATEMENT OF FRANK PARTNOY, PROFESSOR OF LAW, 

UNIVERSITY OF SAN DIEGO SCHOOL OF LAW 

Mr. PARTNOY. Thank you, Chairman Baker and Ranking Member 

Kanjorski and members of the committee. I am a law professor at 

the University of San Diego, where I have spent much of the past 

8 years studying the credit rating industry and credit ratings. 

I, before teaching, worked on the derivatives desks at Morgan 

Stanley and CS First Boston, where my group structured debt instruments that received ratings from S&P and Moody’s. First, let 

me say that I agree with Chairman Baker and Chairman Oxley 

that this legislation marks an excellent starting point for debate. 

8

I commend Congressman Fitzpatrick for introducing this legislation. 

I also agree with much of what Ranking Member Kanjorski has 

said here today, and in the recent past; there should be bipartisan 

support for credit rating reform. The primary split in opinion is between those with a vested interest in preserving the status quo, 

namely S&P and Moody’s, and virtually everyone else. So with respect, I actually think this panel is quite balanced. 

I want to discuss very briefly some background I hope will be 

useful to this committee. I have found in my research that credit 

rating agencies pose a troubling paradox. On one hand, credit ratings are enormously valuable and important. A downgrade can kill 

a company and issuers pay big money for ratings. Moody’s alone 

had gross profits of more than a billion dollars last year. And its 

shares are worth almost as much as General Motors and Ford. 

On the other hand, there is overwhelming evidence that ratings 

are of scant informational value, particularly since the mid 1970s, 

the informational value of ratings has plummeted. You do not need 

to read academic studies to know this; just recall Orange County, 

Enron, WorldCom and most recently, General Motors and Ford. 

The Agency’s response that ratings are correlated with actual default is misplaced because ratings can both correlated with defaults 

and have no informational value. All of you and I could publish ratings that were correlated with default experience simply by reading 

the newspaper. 

In my writings I have argued that this paradox, high market 

value, low informational value, is best explained by regulation. As 

Chairman Baker has stated, namely the rules that depend on ratings by nationally recognized statistical ratings organizations. It 

started in 1975, and during the next 3 decades, numerous regulators, especially the Commission, established rules that depended 

on NRSRO ratings. Put simply, NRSRO ratings now are important 

because the rules say they are. 

NRSRO ratings are valuable as keys to unlock the benefits or 

avoid the costs of various regulatory schemes. Yet for more than 30 

years, no one has bothered to say conclusively what the term 

NRSRO means. Not even George Orwell could have imagined such 

a state. 

Given that the Commission has designated just five NRSROs for 

regulatory purposes, it is not surprising that the industry is so concentrated. If regulators required that the Washington Wizards play 

just five basketball players, and one of the approved players was 

me, even I would get a lot of playing time. And if I played, you can 

be sure the others would score most of the points, even if they 

weren’t very good. 

The Commission’s proposals would not correct these fundamental 

flaws. Defining NRSRO is too little too late, and the commission is 

not an office of central planning; nor should it be. It generally does 

not designate which companies can issue securities to the public, 

and it certainly does not do so based on ambiguous standards such 

as whether ratings are ′′generally accepted.′′

Instead, the Commission requires companies to disclose material 

facts and then permits market participants to make decisions 

based on those facts. That is the role the Commission should play 

9

with respect to NRSROs. Congressman Fitzpatrick’s bill is a major 

step in the direction of resolving the paradox I just described. 

It permits the 130-plus non-NRSRO agencies to compete with 

current NRSROs. Perhaps most importantly, it encourages new 

rating agencies, which could use market-based measures in assessing companies. In my academic work, I have stressed that marketbased measures are the best alternatives to current NRSRO ratings. 

We have already heard, and some will argue, that opening the 

market to competition will be disruptive and/or lead to rate shopping. But based on my experience and available evidence, I think 

the opposite is true. 

When markets such as credit ratings are opened to competition, 

they become more stable, indeed, because current ratings by S&P 

and Moody’s distort the markets; they create incentives for dysfunctional regulatory arbitrized transactions, which this legislation 

would reduce. 

My further understanding is that NRSROs would be subject to 

liability for Federal securities fraud and/or State law causes of actions just like other gatekeeper firms. S&P and Moody’s claim their 

ratings are merely opinions and there is the free speech argument 

that has already been mentioned today, which is a clever one; it 

has been accepted by some courts. 

But credit ratings are not really just opinions any more than 

fairness opinions of investment banks, audit opinions of accounting 

firms, legal opinions of attorneys, buy-sell ratings of security analysts, or even the certification of financial statements by CEOs and 

CFOs are mere opinions. 

So, in sum, I commend Congressman Fitzpatrick for introducing 

this legislation. I believe that this panel does represent all of the 

interests except perhaps one interest that is not here today, the 

millions of individual investors whose mutual funds and pension 

funds are in fixed-income investments and whose faith in S&P and 

Moody’s has been shattered by events of recent years. 

Those people have much more to gain from this legislation than 

S&P and Moody’s have to lose. I thank you, and they will thank 

you. 

[The prepared statement of Frank Partnoy can be found on page 

83 in the appendix.] 

Chairman BAKER. I thank the gentleman for his statement. 

Our next witness is Ms. Nancy Stroker, group managing director, 

Fitch Ratings. Welcome. 

STATEMENT OF NANCY STROKER, GROUP MANAGING 

DIRECTOR, FITCH RATINGS 

Ms. STROKER. Good morning, Chairman Baker, Ranking Member 

Kanjorski, and members of the committee. My name is Nancy 

Stroker, and I am a group managing director at Fitch Ratings, responsible for overseeing the North American corporate financial institutions and public finance ratings. 

I would like to thank you for offering Fitch the opportunity to 

testify today and to share with you our views on the recently proposed Credit Rating Agency Duopoly Act and SEC staff outline on 

10

oversight of credit rating agencies that was delivered earlier this 

month. 

We commend Representative Fitzpatrick and the committee for 

recognizing the importance of fostering competition in the ratings 

industry. We hope you will find our views constructive. 

Fitch firmly believes in the power of competition, and we fully 

support the objectives of the Fitzpatrick bill, providing greater competition and transparency in the credit rating industry. 

While we have concerns about whether the Act as currently proposed will provide either greater competition or transparency, we 

believe that the Act and the debate surrounding it will serve as a 

constructive first step in fostering competition in the credit rating 

industry, a point made by both Representatives Oxley and Baker 

at the introduction of the bill. 

In terms of addressing the issues before this committee, we 

would like to make the following three points. First, any recognition or registration system should be a transparent process based 

on objective standards related to the demonstrated reliability of 

ratings that are uniformly applied. 

Second, any oversight regime should be designed to avoid unnecessary burdens and interference in the decision-making process of 

rating agencies. As the SEC staff has noted, any legislation in this 

area must make clear that the decision-making process of rating 

agencies and the content of the ratings assigned should be beyond 

the scope of regulation. 

And finally, we will state the obvious, but investors will benefit 

from increased competition. I would like to take this opportunity to 

elaborate on these three key points. Regardless of whether or not 

the NRSRO system remains intact or a system of registration is 

adopted, there needs to be clear and objective standards to assess 

the reliability of an agency’s ratings. 

Indicators of reliability, including a proven track record, should 

be the key because the public interest will not be served if the ratings of potentially dozens of agencies without such a proven record 

are used in safety and soundness regulations. 

In terms of oversight, given the importance of unbiased credit 

ratings in the financial markets, we believe oversight and enforcement authority in matters such as conflict of interest and integrity 

are vitally important. Furthermore, we believe that the examination and oversight of rating agencies should be principally focused 

on objective measures of the ongoing reliability of a rating organization’s rating, such as default and transition studies. 

Within this framework, any regulatory or legislative approach 

should provide a narrowly tailored oversight scheme specifically developed for rating agencies. We do not believe that the existing regulatory schemes under the Exchange Act or under the Investment 

Advisers Act are a plausible fit, as agencies are very unique. 

And finally, in terms of the increased competition and how investors will benefit, while the NRSRO system is often cited as a barrier to entry for new rating organizations, we believe that the debate over the NRSRO system ignores the single most important 

barrier to entry in the ratings market, and that is the S&P and 

Moody’s monopolies. 

11

In Fitch’s own experience, simply being recognized as an NRSRO 

or being registered will not ensure an organization’s ability to compete. An organization would need to devote significant resources in 

demonstrating a record of reliability in winning the support of investors. 

We are proud of our growth over the past 15 years. We now rate 

over 60 percent of the bonds issued world-wide, but we account for 

only 15 percent of world-wide revenue. Fitch believes that our 

emergence as a global full service rating agency has created meaningful competition in the ratings market for the first time in years. 

Fitch’s challenge to the Moody’s and S&P monopoly has enhanced innovation, forced transparency in the rating process, and 

improved service to investors, and created much needed price competition. 

If Congress wishes to address barriers to entry in the ratings 

market and ensure competition, legislation should be adopted that 

eliminates the barriers and outright prohibits anticompetitive conduct, such as coercion, tying, and discriminating against ratings by 

other rating agencies for the purpose of preserving market share. 

Fitch believes that this is an area where focused legislation 

might help to protect rating agency competition. Fitch believes that 

any rating agency found to be using anticompetitive practices or 

unfair business practices should be subject to a full range of appropriate sanctions. 

In conclusion, we reassert our belief in competition, the importance of focusing on objective standards that demonstrate reliability of ratings, and the need for any legislation to be specifically 

tailored to the uniqueness of the rating industry. We also do not 

believe that increased regulation typically fosters competition, and 

the vague standards for registration will do little to advance a 

more transparent process for the Commission. 

Thank you for your consideration of our views. We would be 

happy to answer any questions. 

[The prepared statement of Nancy Stroker can be found on page 

102 in the appendix.] 

Chairman BAKER.I thank the gentlelady. 

Our next witness is Mr. Sean Egan, managing director of EganJones Ratings Company. Welcome. 

STATEMENT OF SEAN EGAN, MANAGING DIRECTOR, EGANJONES RATINGS CO. 

Mr. EGAN. Thank you. We at Egan-Jones strongly support the 

proposed legislation for reforming the rating industry since it does 

not impair the freedom of speech defense afforded rating firms, and 

it addresses the two major problems that have long plagued the industry. 

Number one, the dearth of competition and, two, the failure of 

the current rating firms to provide timely, accurate ratings for protecting investors. 

Perhaps the most appealing aspect of the proposed legislation is 

that it removes the SEC from the role of recognizing rating firms, 

i.e., NRSRO firms, a role in which it has failed miserably. The 

SEC’s primary mandate is protecting investors. 

12

From the SEC’s Web site ′′Who we are′′, the primary mission of 

the SEC is to protect investors. 

Within the past 3 years, we have experienced two of the largest 

credit failures in U.S. History, Enron and WorldCom, failures that 

resulted in the loss of hundreds of billions of dollars, tens of thousands of jobs, and the pensions of thousands. 

After these colossal failures, one would expect that the agency 

charged with recognizing rating firms would have shown some initiative for addressing the problems so that they would not occur 

again. Unfortunately, this has not been the case. 

Instead, the SEC is continuing its study of the industry, a study 

which began in the early 1990s, 15 years ago, and is continuing 

today. While the first NRSRO firm was recognized in 1970, it is 

only 90 days ago that the SEC finally devised a definition of 

NRSRO. 

It seems obvious that a definition should have existed before the 

first NRSRO was designated. Furthermore the SEC’s proposal for 

NRSRO requires that rating firms provide their ratings free to the 

public, which effectively means that the rating firms have to seek 

compensation form the Enrons and WorldComs of the world, which, 

in many people’s view, is a system rife with conflict. 

Yes, the SEC has recognized two new NRSROs during the past 

18 months. However, neither firm warned investors about the recent major failures, nor did they provide any significant competition to the two partner monopoly firms, S&P and Moody’s. 

The SEC has indicated that it consults with major rating firms 

before proposing any changes to the regulation of the industry. Perhaps they should have consulted also with investors who have been 

and continue to be hurt by the flawed industry structure. 

Conspicuously absent from the SEC’s proposed definition of 

NRSRO rating firms are the following requirements. One is severing ties between the personnel of the issuers and the dealers. The 

ex-chairman of Moody’s should not have served as director of 

WorldCom, nor should the rating firm’s personnel be tied to brokerdealers or the broker-dealer industry association, such as the 

NASD. 

Two, discourage insider training. The proposal addresses the 

misuse of nonpublic information given to rating firms, but does not 

address misuse of information generated by the rating firms themselves, such as Moody’s informing Citigroup of its intention to 

downgrade Enron below investment grade before the fact. By the 

way, no investigation was made of Citigroup’s trading in advance 

of that downgrade. 

Three, take timely action. It has been over 3 years since the failure of Enron and yet the SEC has still not made any significant 

changes in the rating industry. 

Regarding Egan-Jones’ ratings, Kafkaesque is probably the best 

description of our experience with the SEC. We have regularly 

issued timely, accurate ratings and provided warning for the 

Enron, Genuity, Global Crossing and WorldCom failures. See the 

attachment. 

Furthermore, we consistently identify improving credits. Most of 

our ratings have been higher than S&P and Moody’s over the past 

3 years, thereby assisting issuers in obtaining more competitive 

13

capital. Our success has been recognized by the Federal Reserve 

bank of Kansas City, which compared our ratings and has attached 

the conclusion of that. 

Since missing the failures of Enron in 2001, Moody’s operating revenues have more than doubled from approximately $400 million 

to $814 million, and S&P’s have increased from $435 to $893, an 

indication of the severe lack of competition in this area. After all 

of these failures, S&P’s and Moody’s operating income has more 

than doubled. 

The proposed legislation provides some hope for reform and real 

competition in the ratings area. It is artfully drafted to preserve 

freedom of speech protections. We continue to support the standards of practices for participants in the credit rating process published by the Association of Corporate Treasurers, the Association 

of Financial Professionals, and the Association in France. 

Until the fundamental problems in the rating industry are addressed, investors, employees, pensioners, and ultimately issuers 

will needless be harmed. The SEC should gracefully withdraw from 

this area in the interest of protecting investors. 

[The prepared statement of Sean Egan can be found on page 64 

in the appendix.] 

Chairman BAKER. Thank you. Mrs. Biggert has requested the 

right to make the next introduction. Mrs. Biggert. 

Mrs. BIGGERT. Thank you very much, Mr. Chairman. I would like 

to welcome Mr. Alex Pollock back to the committee. And Mr. Pollock is an expert in banking and bond market matters. 

I would particularly like to highlight his experience, much of 

which he gained in the Windy City; that is Chicago. He served for 

12 years as president and CEO of the Federal Home Loan Bank 

of Chicago, and as principal at Nolan, Norton and Company, Chicago, and then a senior vice president of Corporate Planning, Research and Development at Continental Bank. 

In addition, he received one of his masters degrees at the University of Chicago. In his current capacity as a resident fellow of the 

American Enterprise Institute, Mr. Pollock has dedicated much of 

his time to the issue that brings us here today. So welcome Mr. 

Pollock. 

Thank you, Mr. Chairman. 

Chairman BAKER. Please proceed, sir. 

STATEMENT OF ALEX J. POLLOCK, RESIDENT FELLOW, 

AMERICAN ENTERPRISE INSTITUTE 

Mr. POLLOCK. Thank you, and thank you very much, Congresswoman. Mr. Chairman, Ranking Member Kanjorski, members of 

the subcommittee, I greatly appreciate the chance to testify on this 

important topic today. 

I spent 35 years in the banking business, dealt a lot with credit 

ratings, as you can imagine, including getting ratings for various 

entities. Thanks to the leadership of the chairman and the ranking 

member, I have spent a good bit of time over the last several 

months thinking about this issue while at the American Enterprise 

Institute. 

Based on all of that, it is a real pleasure to speak today in support of H.R. 2990. This is a pro-competitive bill. It is going to lead, 

14

if enacted, to more choice, more alternatives for the customers, and 

to reliance on market discipline, which is the best kind of discipline. 

It does this by moving from a regime of designation by regulation, by the SEC of course, to a regime of disclosure and competition. Having had the AEI be good enough to publish a paper of 

mine called ′′End the Government-Sponsored Cartel in Credit Ratings,′′ and I guess we should add, Mr. Chairman, ′′cartel′′ to the ′′opolies′′, my view is summarized by that title. 

It is my view that decisions about credit ratings and which credit 

rating agencies should prosper and which not prosper, should be 

made by investors, financial firms, issuers, and, in general, the 

market. 

I think, as do a number of others, that it would be better not to 

have an NRSRO designation at all, and really have a market solution. But we have had a problem in thinking about that because, 

as has been referred to, there is a very large, very complex interlocking web of regulations and statutes, both at the State and Federal level, which refer to this term, NRSRO, as Congressman Kanjorski mentioned. How to move toward a market solution when 

faced with this interlocking web—or to change the metaphor, a 

Gordian Knot—of regulation and rules did puzzle me. 

In my view, H.R. 2990 cuts this Gordian Knot in a quite brilliant 

and creative way by keeping the abbreviation but changing what 

the ′′R′′ stands for, from ′′recognized′′ to ′′registered′′. That actually 

completely changes the meaning of the term and how it would operate in the market, while leaving in place all of this complicated 

set of rules that can keep on referring to the term, but they will 

be referring to something different. 

I find this both on the merits and also rhetorically a very pleasing and good solution. We ought to be moving toward a market discipline, as I said, where market actors are asked to make informed 

judgments and multiple decision-makers are acting on credit ratings. That will include multiple regulators because we have a lot 

of regulated entities using credit ratings. 

It will also include multiple pricing models in the business so 

that you can have pricing models paid for by both issuers and investors and we see what the market likes best. 

I would like to mention three clarifications. One is that there are 

high natural barriers to competition and barriers to entry in the 

credit rating business because of its dependence on judgment and 

on reputation and because of the conservative nature of risk policies. Therefore, when we do this, this is going to be an evolutionary 

transition. 

In my judgment, I do not see any disruption to markets or behavior because we are going to be going through an evolution in the 

face of natural barriers. 

The second is, whatever we do, we cannot hope to have no mistakes in ratings or perfect ratings. Anybody who is dealing with 

trying to anticipate the uncertainties and the risks of the future is 

going to make mistakes. 

I would hate to have the list of my own financial mistakes published. We have to address that as reality. The best defense to that 

reality is to have a vibrant marketplace of many competitors, many 

15

opinions, different kinds of analysis, different kinds of ideas for investors, and other users of ratings to choose from. That is the best 

possible defense. 

A third clarification is we want to make sure that the first ′′R′′ in NRSRO doesn’t inadvertently slip into changing from 

′′registered′′ to ′′regulated′′. We don’t want a nationally-regulated 

rating agency business. Fitch Ratings, in their written comments, 

suggested that this might be a risk. 

I do think that we ought to look carefully at the language of the 

bill just to make sure that that does not inadvertently happen and 

that we do indeed carry out what is clearly the pro-competitive intent. 

In summary, Mr. Chairman, H.R. 2990 is a very positive move 

toward a pro-competitive disclosure regime, as opposed to a regulatory designation regime. I believe this move would lead, as competitive markets always do, along with their greater competition, 

to more choice in the market for customers, better service, lower 

costs and more price competition, less duopoly profits and more innovation, the very benefits we always look to from a competitive 

world. 

Mr. Chairman, thank you very much again for the chance to be 

here today. 

[The prepared statement of Alex J. Pollock can be found on page 

99 in the appendix.] 

Chairman BAKER. Thank you, sir, for your statement. 

Our next witness is Rita M. Bolger, managing director and associate general counsel, Standard and Poor’s. Welcome. 

STATEMENT OF RITA M. BOLGER, MANAGING DIRECTOR AND 

ASSOCIATE GENERAL COUNSEL, STANDARD AND POOR’S 

Ms. BOLGER. Mr. Chairman, Ranking Member Kanjorski, members of the subcommittee, good morning. I am Rita Bolger, as introduced, managing director, global regulatory affairs and associate 

general counsel for Standard and Poor’s, a division of the McGraw 

Hill Companies. 

At S&P, we are extremely proud of our well-documented track 

record of providing the market with independent, objective, and 

credible rating opinions. Our ratings are publicly available without 

charge and our rating criteria and methodologies are published on 

our Web site and elsewhere. 

As a result, we are subject to the scrutiny of the financial markets every day. On behalf of Standard and Poor’s, I am pleased 

that the subcommittee has granted our request to be here. Standard and Poor’s has been and remains committed to constructive 

change that would eliminate unnecessary barriers to competition in 

our industry. 

However, we have serious concerns about H.R. 2990 and the disruptive effect it could have on the efficient operation of the capital 

markets. When the SEC asked market participants in connection 

with its 2003 concept release whether it should retain the NRSRO 

concept, the vast majority unequivocally said yes. 

These commenters represented that eliminating the NRSRO concept would be disruptive to the capital markets and would be costly 

and complicated to replace. 

16

We agree. As does the Bond Market Association, an organization 

that, according to their submission in connection with this hearing, 

speaks for the bond industry worldwide. As the BMA observed, the 

NRSRO designation serves a unique purpose in SEC regulations 

for which a substitute is either not available or not practical. 

Additionally, we believe that intrusive regulatory oversight of the 

sort contemplated by the bill will result in ratings of lesser, not 

higher, quality because credit ratings are opinions, as to which reasonable analysts can and do disagree; there is no one correct way 

to go about forming them. 

Comprehensive regulation could produce standardized approaches and rating opinions that do not reflect the uncompromised 

view of the rating committee. In addition, intrusive regulation is 

likely to erect new barriers to entry that will inhibit, rather than 

promote, increased competition as it will force new entrants to bear 

significant regulatory costs that they currently do not bear. 

Importantly, and as has already been raised this morning, we 

also believe that H.R. 2990 as written is unconstitutional on its 

face. Rating agencies have consistently been afforded a high level 

of First Amendment protection by numerous State and Federal 

courts. 

This is so because at their core, rating agencies such as S&P perform the journalistic activities of gathering information on matters 

of public concern, analyzing that information, forming opinions 

about it, and broadly disseminating those opinions to the general 

public. We believe that the bill would specifically violate the First 

Amendment by making it illegal for a credit rating agency to publish its opinions without first registering with the Government, providing mandatory disclosures about its business activities, and obtaining approval of that registration. 

No legislation could constitutionally require the licensing of Business Week or the Wall Street Journal because they offer their opinions as to the credit worthiness of certain entities. 

Also, intrusive Government involvement in the manner and 

method of generating credit ratings, such as contemplated by the 

bill, would be the equivalent of unconstitutional Government supervision of publishers from within their own newsrooms. This direct 

intrusion into the editorial process is precisely the type of governmental activity that the First Amendment prohibits. 

As discussed more fully in my statement for the record, positive 

steps have been taken over the past 2 years by both the SEC and 

IOSCO, the International Organization of Securities Commissions, 

with input from a diverse array of market participants. These initiatives are being implemented and include as goals increased competition and enhanced oversight. 

Based on these serious concerns about the bill, we believe the 

best approach would be to allow these initiatives to move forward. 

Once these initiatives have been given a chance, then Congress 

would be in a better position to assess the necessity of legislation, 

and it is our belief that after these initiatives have been tested, you 

will conclude legislation is not the best approach for the market. 

In conclusion, on behalf of S&P, thank you again for the opportunity to participate this morning. I would be happy to answer any 

questions. 

17

[The prepared statement of Rita M. Bolger can be found on page 

47 in the appendix.] 

Chairman BAKER.I thank the gentlelady for her statement. 

Our next witness is Mr. James A. Kaitz, president and CEO, Association for Financial Professionals. Welcome. 

STATEMENT OF JAMES A. KAITZ, PRESIDENT AND CEO, 

ASSOCIATION FOR FINANCIAL PROFESSIONALS 

Mr. KAITZ. Good morning, Chairman Baker, Ranking Member 

Kanjorski, and members of the committee. AFP appreciates the opportunity to participate in today’s hearings on the legislative solutions to the many issues and concerns raised with regard to the 

credit ratings market. 

AFP represents more than 14,000 finance and Treasury professionals, representing more than 5,000 organizations. Our members 

are responsible for issuing short and long-term debt and managing 

corporate cash and pension assets for their organizations. 

Previously, AFP has stated that the SEC’s existing recognition 

process has created an artificial barrier to entry to the credit ratings market. This barrier has lead to a concentration of market 

power with the recognized rating agencies and a lack of competition and innovation in the credit ratings market. 

To remove this barrier to entry and stimulate competition, AFP 

has long advocated that the commission clarify the recognition 

process. Further, we believe that recognition of credit rating agencies must be conditioned on whether an organization can consistently produce credible and reliable ratings based on adherence to 

published methodologies. 

We have also urged regulators to require that rating agencies 

document internal controls that protect against conflicts of interest 

and anticompetitive and abusive practices and ensure against the 

inappropriate use of nonpublic information. 

This past spring, the SEC issued a proposal that attempts to address some of the concerns we have raised. However, we do not believe that the SEC proposal would foster a truly competitive market and fails to address the need for ongoing oversight of the credit 

ratings market. 

The Credit Rating Agency Duopoly Relief Act of 2005, introduced 

by Representative Fitzpatrick, would require the SEC to register 

credit rating agencies based on the criteria recommended by AFP. 

By eliminating the ambiguous NRSRO designation process in favor 

of a more transparent registration process, the Act will foster 

meaningful competition in the credit ratings market. 

As such, AFP supports the legislative proposal before the committee today. 

Mr. KAITZ. In nearly 30 years since creating the NRSRO designation, there has been no review of the ongoing credibility and reliability of the ratings issued by the NRSROs. Any effort to address 

these concerns, either through regulation or voluntary agreement, 

will be entirely ineffective without an oversight and enforcement 

mechanism. 

AFP is pleased that the proposed legislation directs the Commission to censure, suspend, or revoke the registration of any regVerDate 0ct 09 2002 16:04 Mar 24, 2006 Jkt 000000 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 G:\DOCS\109.42 RODNEY
18

istered statistical rating organization that violates certain sections 

of the act or ceases to meet the registration criteria. 

If the credit ratings market is opened up to competition, it will 

be incumbent on the SEC to take an active role in the ongoing 

oversight of registered organizations to ensure that they continue 

to merit SEC registration. We believe that the proposed legislation 

gives the SEC the authority, flexibility, and guidance needed to 

conduct the necessary oversight without placing an overly restrictive legislative regime on either the Commission or the credit ratings agencies. For the committee’s consideration, we believe there 

are several key areas where additional clarification will strengthen 

the act. 

The first area is with regard to ratings performance measurement statistics. As AFP has consistently suggested, the key criteria 

for rating agency recognition should be whether the rating agency 

can consistently produce credible and reliable ratings. We believe 

that it is imperative that the applicant not simply file statistics, 

but also demonstrate that its ratings are, in fact, credible and reliable. 

The second area in need of clarification is the registration requirement contained in section 4 of the legislation. The bill requires all credit rating agencies that meet the definition to register 

with the SEC, even those that do not seek to have their ratings approved for use by regulated portfolios. There are currently more 

than 130 ratings agencies, many of which have not sought and may 

not seek SEC recognition or registration. 

Further, new rating agencies that are established will not be able 

to file long-term ratings performance measurement statistics required for registration, shutting out these new market entrants. 

AFP recommends that the act limit registration requirements to 

those that seek approval for use by regulated portfolios or those 

that the Commission determines must be registered to protect the 

public interest. 

We also recommended that the act explicitly direct the Commission to develop an oversight and an examination regime that ensures that registered statistical rating organizations continue to 

issue credible and reliable ratings, that they have and adhere to 

policies that protect nonpublic information and prevent conflicts of 

interest and unfair and abusive practices. Such an oversight framework is described in the Commission staff outline of key issues for 

a legislative framework for the oversight and regulation of credit 

rating agencies, developed at the request of Ranking Member Kanjorski. This type of oversight will protect capital market participants without injecting regulators into the decision making of the 

rating agencies or impinging on their First Amendment rights. 

We believe that the registration process proposed in the Credit 

Rating Agency Duopoly Relief Act of 2005 will minimize barriers to 

entry and foster competition among existing NRSROs and those 

that may be later registered. The enactment of the bill, along with 

the development by the Commission of an oversight regime that 

ensures that registered statistical credit rating organizations continue to meet the registration requirements will improve investor 

confidence in the rating agencies and global capital markets. 

Thank you, Mr. Chairman. 

19

[The prepared statement of James A. Kaitz can be found on page 

72 in the appendix.] 

Chairman BAKER. I thank the gentleman for his statement. 

I would like to start my questions with Mr. Partnoy. 

As I understand the pending SEC proposal, it requires a firm to 

be generally accepted in the marketplace in order to be a first step 

to NRSRO designation by the SEC. In your observation, how would 

one become generally accepted in the market for some period of 

time, in other words, be utilized, if you don’t have the SEC designation to begin with? Is that a workable remedy to enhance competitive opportunity? 

Mr. PARTNOY. No, Chairman Baker, I think that is a very good 

point. It is what I would call a Catch 22. It is virtually impossible 

for an agency to establish that it is generally accepted if the 

NRSRO framework is in place and they are not a designated 

NRSRO. 

Chairman BAKER. So you would have to be in the rating business, expend the money to do the analyticals, convince companies 

to pay you, do that for some period of time on a national basis, 

when the companies know that it has no merit or impact on their 

publicly disclosed rating standard? 

Mr. PARTNOY. That is absolutely right. And companies know that 

loud and clear because they know about the proliferation of regulations that virtually require that you get a rating from an NRSRO 

so that you can sell it to folks who have to have one of those ratings. 

Chairman BAKER. So at the moment, we are not clear how we 

get additional competition in the marketplace because you have to 

be generally accepted, but you can’t be generally accepted without 

the designation? But that is the standard by which we gauge 

whether you can become one? 

Mr. PARTNOY. That is precisely right. And that is why it is a 

Catch 22, an intractable problem. And that is one reason why the 

idea of eliminating this notion of an NRSRO entirely is an attractive one. 

And that has a host of difficulties, as Mr. Pollock mentioned, but 

I completely agree. 

Chairman BAKER. Thank you. 

Mr. Egan, you have been critical this morning of rating agency 

performance. Is there, in your view, any consequence to a rating 

agency today that doesn’t meet, let’s just call it ′′fiduciary obligations,′′ in rating appropriately? Is there a professional standard of 

conduct which someone holds up and measures you and say, Oops, 

you didn’t do your job; here is the penalty box? 

Mr. EGAN. For the non—

Chairman BAKER. I think you just cut yourself off. 

Mr. EGAN. Thank you. 

Chairman BAKER. Thank you. 

Mr. EGAN. For the non-S&P and -Moody’s of the world, there is 

a very tough standard. In our case, we are paid by institutional investors. If we don’t succeed in issuing timely accurate ratings, clients will cut us off. It is just that simple. Their concerns are a little 

bit different from the issuers; issuers want the lowest cost of capital generally. 

20

On the national recognition, though, we do have that national 

recognition, have had it for a long period of time, and we still don’t 

know what the SEC wants for us to get—

Chairman BAKER. So you are saying you are nationally recognized with a record of accurate performance, and yet you are still 

mystified by what constitutes the remaining step for you to become 

nationally recognized? 

Mr. EGAN. That is correct. In fact, there is a study of our recognition versus DBRS, a Canadian firm. 

The SEC’s prior regulation is that an NRSRO has to be nationally recognized in the United States. We had more than four times 

the recognition of DBRS; and AM Best, I think we had five times 

recognition among users of credit ratings. These are institutional 

investors, mutual funds. We had more than four and five times the 

recognition of the other firms. We brought this to the SEC’s attention, and they said nothing. 

Chairman BAKER. It is your view, then, it is no longer an inability to meet their standard? You are meeting the standard, but you 

still can’t get an approval? 

Mr. EGAN. That is correct. And what they have said is they are 

going to wait until this NRSRO process plays out. 

Chairman BAKER. Is that like a 30-year wait? 

Mr. EGAN. I don’t know. They won’t set a time frame for it, which 

is very frustrating. 

Chairman BAKER. Let me get to Mr. Pollock before my time runs 

out. 

Do you believe, given your analysis of the market performance of 

S&P and Moody’s in a parallel path in a free market system, it is 

likely that two companies could own 80 percent of any market 

without some governmental grant of privilege? 

Mr. POLLOCK. Mr. Chairman, in my opinion, their market position and the market power reflects Government sponsorship 

through the NRSRO process, not unlike the Government sponsorship we have often discussed in the GSE world. 

Chairman BAKER. I don’t want not to get to Ms. Bolger. It is my 

expectation we will get to another round of questions, but with the 

number of members, I am going to stick to the 5-minute rule and 

recognize Mr. Kanjorski. 

Mr. KANJORSKI. Thank you, Mr. Chairman. 

Ms. Bolger, exactly why do you think that H.R. 2990 violates the 

First Amendment in specific? 

Ms. BOLGER. The proposed bill, the bill has a requirement, in effect, for—it is a licensing regime. There is a procedure for filing 

your application, documents, certain policies and procedures, all on 

issues that we believe are important to the market and to quality. 

But then the SEC would have the ability to accept or deny, and 

there is a process for denial of that application. 

So there is some—there is a mechanism built in here for not just 

notice filing of information to the SEC, but their evaluation and, 

ultimately, approval. And that licensing, in effect, requirement is 

not constitutionally viable. 

Publishers are free, by long-standing case law, to freely disseminate their opinions. And rating agencies are members of the financial press, the financial press being equally protected by case law. 

21

Mr. KANJORSKI. Thank you. To all of our witnesses, could I request that you review the SEC staff outline and send specific comments to the committee before the end of August? Is that a reasonable request? 

This is a very delicate area. I guess in the best of all worlds—

and I appreciate Mr. Egan’s problem; I have lived with his frustration on several hearings. Is there a possibility of having both the 

recognition and the registration concept? I mean, it seems to me 

that I don’t want the Good Housekeeping Seal of Approval out 

there to 100 different agencies who can qualify and register and 

then just offer themselves up for bidding purposes. Not that most 

would do that, but a few probably would. 

On past occasions I have expressed my concept of the ′′bastard 

rule′′. It is my rule about why we have so many laws and regulations. It is not that most of us need those rules or regulations, but 

there are always 3 to 5 percent of participants in any sector that 

go to the edge of the envelope or beyond for greed or for value. I 

assume that we would have to recognize that rule in this industry, 

that greed would be particularly attractive. 

So how would we avoid encouraging, recognizing, or registering 

agencies that are literally up for grabs to the highest bidder? 

Mr. KAITZ. I think we recommended in our oral testimony, sir, 

that, first of all, only those that would want to be in regulated portfolios would be one alternative. And as long as there is a process 

to determine credible and reliable ratings, I think that is going to 

put market disciplines on those ratings agencies or agencies shopping for the best deal. 

So I think you have to distinguish between 130 and those that 

would want to be in the regulated portfolios, and then make sure 

that there is a criterion to ensure that credible and reliable ratings 

are given over a period of time. 

Mr. KANJORSKI. But isn’t that an after-the-fact situation? 

Mr. KAITZ. No. You could look at—you could do some correlation 

analysis of their methodologies and go back and see how they did 

in the marketplace. 

The reality is, though, you would not probably look at a new organization that would want to be in a regulated portfolio. They 

likely would be already established agencies with a track record 

that the SEC could take a look at. 

Mr. KANJORSKI. So are we only arguing here whether or not we 

have just a limited number of recognized entities and we want to 

enlarge that number? Or are we just looking for a methodology to 

enlarge that number? 

Mr. KAITZ. I think if you put the right discipline in the market, 

then you are going to get those agencies that are going to be the 

major players. Also, as an organization that represents the issuers, 

it is not in the issuers’ best interests to use a rating agency that 

is not going to be credible, that you now have to defend before the 

audit committee and the board. So our members have a fiduciary 

responsibility to make sure those ratings are accurate. 

Mr. KANJORSKI. If we open it up by registration, what is to prevent investment banking houses from making the decision of where 

the business goes and who makes the ratings? Aren’t they doing 

that to some extent today? 

22

After all, companies are doing that with the accounting firms 

that they hire and the legal firms that they hire. They are saying, 

you know, we are just not going to deal with this security unless 

these people put their opinions in place. They just don’t open it up 

to the whole bar or to the whole accounting profession. 

Mr. KAITZ. Again, from our—I don’t want to dominate here, but 

from our perspective, that is why it is critical that there is SEC 

oversight of the rating agencies and that they are really looking at 

credible and reliable ratings. I think that is the role, from AFP’s 

perspective, that we have envisioned. 

Mr. KANJORSKI. Mr. Egan, didn’t you suggest that the SEC 

should withdraw from this field? Is that the key point of your testimony? 

Mr. EGAN. Yes, I did. 

Mr. KANJORSKI. And who would be the regulator? Who would be 

the protector of the investor and the public if they withdraw? 

Mr. EGAN. I think you need a board of industry participants to 

be involved in the oversight. 

Mr. KANJORSKI. Self-regulatory? 

Mr. EGAN. Perhaps, but it would be broader, as it represents 

some individuals. 

The Bond Market Association is held up as representing the industry; we disagree with that. In our experience, they represent 

the interests of the larger rating firms and the larger broker-dealers. The interested parties is much broader than that. 

We don’t understand why the SEC has not taken action faster 

than this, but obviously, there must be some pressures there or 

they would have acted. So we think there should be a broad group 

that is represented. 

Mr. KANJORSKI. Isn’t it sort of underfunded? While the SEC was 

given all kinds of regulatory authority, they just don’t have the personnel and money to do the job? 

Mr. EGAN. I find that hard to believe. 

Mr. KANJORSKI. Well how about the problem we have here in 

Washington on unavailability of office space? You’re indicating another bureaucracy, if I understand it, or another agency or quasigovernmental agency to do this work? 

Mr. EGAN. I think it could be a rotating board of industry participants that are charged with overseeing this area until some—or 

perhaps with a new SEC commissioner, there will be some reasonable—

Mr. KANJORSKI. What kind of enforcement would be available if 

we have an industry board? What powers would they have? 

Mr. EGAN. I think, start with the recognition of ratings firms; 

and that has been a bottleneck for quite some time. There isn’t any 

real competition. Even with these new firms, they don’t present 

any real competition. 

As far as the oversight, I think that there has to be some review 

of the anti-competitive practices that are being undertaken by S&P 

and Moody’s. They have been raised a number of times; they are 

not addressed in the current NRSRO designation definition, and 

those should be addressed. 

23

So I think it would be this rotating advisory board that could be 

both in the front end of identifying companies and on the review 

process. 

Mr. KANJORSKI. Do you want to defend the monopolistic practices 

of your organization, Ms. Bolger? 

Ms. BOLGER. Yes. 

S&P has been on record for quite a long time as being fully supportive of more competition in the industry. We do, though, of 

course, see tremendous value in the market recognition and acceptance portion of the NRSRO designation. It is really the fundamental criterion to be an NRSRO and upon which—a premise for 

which a lot of regulations have embedded NRSRO ratings. So to 

strip that out, as the current bill does, would be—would have, we 

believe, a vast effect; and we believe other people have enunciated 

that view as well. 

In terms of any anti-competitive practices, we just feel that there 

is a tremendous amount of value out in the marketplace. And we 

believe that the initiatives that are already moving forward, both 

with the SEC’s proposed rule, which does enunciate criteria to 

judge market acceptance, which does open up the market to geographic-specific rating agencies and those with some industry specifics, that those initiatives should be allowed to proceed. 

I also want to mention in terms of oversight, a lot of work has 

been done internationally. You may have seen the IOSCO code of 

conduct that was concluded in December 2004. 

I believe the rating agencies have taken that very much on 

board, have been part of the process. These are global ratings agencies, and that has been the decision after some of these same questions have, over the last 2 years, been debated in Europe primarily. 

Things like an arbitration board or just having a few people decide 

has been ruled out in favor of more of a code industry standard and 

self-regulation to some extent, but knowing that credibility, if we 

don’t abide by a code, could certainly impact the bottom line. 

Chairman BAKER. The gentleman’s time has expired. 

Mr. Shays. 

Mr. SHAYS. Thank you very much. I am conflicted because I basically believe in open markets, and yet I have such a tremendous 

respect for McGraw-Hill and Standard & Poor’s. 

So that conflict notwithstanding, Mr. Partnoy, in your testimony 

you stated the philosophical approach the Commission has suggested with respect to NRSROs is inconsistent with its approach in 

other areas and, indeed, with legislation purposes, security laws. 

Could you please elaborate on this idea? 

And let me just throw this out as well. Are there other entities 

that the Securities and Exchange Commission approves? In the 

manner in which it approves rating agencies, does the Commission 

approve brokers, investment advisors, mutual funds? 

Mr. PARTNOY. Those are very good questions, and I think gibe 

well with the ranking member’s questions about how to have registration and recognition coupled in some way. 

The philosophical, the general philosophical approach is to permit companies to register and then have the markets work on the 

back end as the disciplining measure. And the attractiveness of 

that is that it ideally does precisely what the ranking member has 

24

said he would like legislation to do because it provides a disciplining function. But it also provides an initial screening function, 

so you can really have it both ways. 

And I think the U.S. Securities markets are the best in the world 

for precisely this reason, that we have achieved this balance by 

having oversight at the beginning in terms of who can register, 

which companies can raise money, and then let the markets do the 

oversight at the end. So that is what I meant by those sentences. 

And in terms of other—the second part was, with respect to other 

similar kinds of areas, there aren’t any explicit areas where the 

SEC, for example, will say, only these entities can come in, but 

there are somewhere implicitly. 

Accounting firms and underwriters are given special privileges. 

And to the extent there is not as much competition as people would 

like in the investment banking business or in the accounting Industry, where we see also not as much concentration as in credit ratings, but some concentration, I think that part of it is due to that 

at least implicit requirement that you be a Big Four accounting 

firm or you have a certain amount of reputational capital or that 

you are registered or licensed in a certain way. 

And let me just respond: This notion that licensing financial institutions somehow is a violation of the First Amendment is not 

something that—that argument shouldn’t apply uniquely to credit 

rating agencies. It should also apply in all these other areas that 

I think your question is getting to. And I don’t think it is correct 

to say that, for example, investment banking fairness opinions 

which are made public, or accounting opinions, which are in every 

Form 10-K filing, are subject to the same kinds of problems. 

Mr. SHAYS. Would any of the other panelists care to respond? 

Ms. BOLGER. If I could just address briefly to Mr. Partnoy’s point 

also, to point out that Standard & Poor’s is submitting a detailed 

memo on the First Amendment issues that are raised under the 

bill. So that will be submitted shortly. 

But there are distinctions in the case law, and I certainly won’t 

go into all the cites and details, but between—and among, actually—auditors, investment advisors, and ratings agencies, namely, 

based on the core function, a rating agency’s core function is the 

publication of rating opinions, whereas auditors are required by 

regulation to publish. Rating agencies, on the other hand, have the 

option; they have full editorial control. And unlike the case law on 

rating agencies, there simply is not case law that covers auditors 

to that extent. 

Mr. PARTNOY. May I briefly say one thing? 

Chairman BAKER. Really quick, and then we will go to Mr. Pollock. 

Mr. PARTNOY. The core function of a rating agency is not publication. It is not publication; it is not a publishing firm. 

Moody’s market capitalization is more than three times that of 

the New York Times. We don’t know what the S&P’s value is because they don’t say publicly. But that kind of value doesn’t come 

from publishing; it comes from selling ratings that unlock the keys 

to this regulatory compliance in the capital markets, not from publishing. 

25

Mr. SHAYS. If I have time, I want to get into the whole issue of 

shopping for ratings. 

But, Mr. Pollock. 

Mr. POLLOCK. Congressman, I think there is an interesting positive analogy of ratings and publishing. So I think we ought to think 

about applying the NRSRO concept as a mental experiment to publishing. 

Suppose we said we are going to have nationally recognized publishing companiesand a whole range of regulated entities—banks, 

pension funds, mutual funds—are only allowed to use the publications of these nationally recognized companies. I think we would all 

agree that would be a pretty foolish situation. 

What I like about this bill that is it moves the credit rating sector, which is a business, which does have analogies to publishing, 

into a competitive market like most, at least, of our market economy—namely, a disclosure and competition model, as opposed to a 

regulatory designation model. That seems to me very positive. 

Thank you. 

Mr. SHAYS. Thank you, Mr. Chairman. 

Chairman Baker. Gentleman yields back. 

Mr. Hensarling. 

Mr. HENSARLING. Thank you, Mr. Chairman. 

Ms. Bolger, I have listened a couple of times now, and it is a 

matter of great interest; and I look forward to reading the brief on 

the First Amendment implications because I am struggling a little 

bit with them in some respects. 

How would you address the argument that the SEC, de facto, has 

registered two rating agencies today through their regulations, and 

to this proposed legislation, as opposed to putting their imprimatur 

on two or perhaps five ratings agencies, they may end up putting 

their imprimatur on 100? 

So why don’t the same First Amendment concerns apply to the 

status quo? 

Ms. BOLGER. The status quo is not—rating agencies don’t have 

to be designated as an NRSRO, so there is not the same level or 

approach. With this front door, one must have a license before one 

can even speak or else it is an illegal type of approach. 

So there is a fundamental difference in the way the existing system works and even, we believe, with the proposed rule that the 

SEC has promulgated. There will certainly be, as we understand 

it, more clarity around the process than the actual criteria for designation. But we don’t take a position as to whether there is an ultimate perfect number of NRSROs or even credible rating agencies, 

but we do believe it is very important to still maintain that market 

acceptance factor, even putting aside the legal First Amendment 

issues just from a policy and market protection perspective. 

Mr. HENSARLING. Next question I have—and, first, I do have a 

bias in favor of competition and open markets. And I certainly respect and appreciate the approach of my colleague, Mr. Fitzpatrick, 

on this piece of legislation, and I haven’t studied it in detail. 

I have one issue that causes me a little bit of concern, and that 

might be the revelation of certain methodologies involved in ratings 

of various companies. I just want to know, is there any concern in 

the revelation of perhaps something that can be seen as propriVerDate 0ct 09 2002 16:04 Mar 24, 2006 Jkt 000000 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 G:\DOCS\109.42 RODNEY
26

etary, data that could actually prove to be an anti-competitive 

measure, as opposed to a pro-competitive measure? 

I understand that transparency is quite good and seeing one’s 

batting average and prognosticating on what has actually occurred, 

but I just wonder if there is any concern that at some point we 

cross the line to revelation of proprietary today and become more 

anti-competitive? 

Is there anyone who would like to take a shot at that? 

Mr. Egan, you look like you are going to the microphone. 

Mr. EGAN. I would be happy to because I think many market 

participants recognize our ratings as being the most timely and 

most accurate, not only domestically but internationally. We are 

not concerned about any sort of technology being distributed out 

into the marketplace and impeding us. 

I think at the base, it is really an understanding of the business. 

It is judgment. We got WorldCom right because we were concerned 

about the bear market in long distance capacity. We were concerned about Bernie Ebbers’ $400 million loan from the company. 

We are concerned about the deterioration in the company. You 

know, if we send the technology out into the marketplace, it is not 

going to hurt us very much. 

The technology is not proprietary. It is the judgment. 

Mr. PARTNOY. I will say briefly, I believe both Moody’s and S&P 

describe a fair amount of their process already. 

Mr. HENSARLING. Another question for you, Ms. Bolger. In your 

testimony, you talked about how Mr. Fitzpatrick’s bill could actually erect new barriers to competition through its burdensome mandates. Clearly, your opinion appears to be in the minority on this 

particular panel. 

But could you explain in a little greater detail because I don’t 

think I understand your position. 

Ms. BOLGER. I think, fundamentally, the issue is setting up a 

structure, this approval licensing regime, and the breadth of entities that would be covered essentially, since one would need a license in order to issue opinions. And if that is your primary business over, I believe, 3 consecutive years, it picks up a large group 

of entities, maybe intended, maybe unintended. That is not clear. 

But the cost of doing, of abiding by that type of system, of preparing the policies, of submitting to that, and adhering to the 

whole process, the 90 days here and there, could definitely pose an 

issue, we believe, for newcomers to the market. 

Mr. HENSARLING. But isn’t it true that the vast majority of your 

competitors, who don’t enjoy your designation, are on other side of 

this issue and believe it would be pro-competitive? 

Ms. BOLGER. Well, yes, and we don’t have a problem with that 

whatsoever. But our position is, the aim to open the industry up 

to more competition can be addressed in a way other than this bill. 

We really believe, after a lot of thought, that the bill simply doesn’t 

work, both for legal and policy reasons. And we would turn, as I 

mentioned, to some of these other initiatives that have opening up 

the market in mind as one of their goals. 

Mr. HENSARLING. Thank you. My time has expired. 

Chairman BAKER. Thank the gentleman. 

Mr. Fitzpatrick. 

27

Mr. FITZPATRICK. Thank you, Mr. Chairman. I appreciate the 

time and testimony and expertise of all the panelists. We have all 

found it very helpful in this process. 

I agree with Mr. Egan that there are questions to be answered, 

and I am perplexed as to why the SEC has not dealt with this in 

a more timely fashion, just following up on that question Mr. 

Hensarling asked of Ms. Bolger and her answer. 

Going to Mr. Partnoy, could you explain the SEC staff designation process and how that only adds to the duopolistic position of 

Moody’s and S&P? 

Mr. PARTNOY. Well, it is difficult to explain. It has been a bit of 

a black hole because there is not much specification. And you hear 

the frustrations from Mr. Egan here in trying to get designated. 

And he is certainly not alone; there are many entities that have 

tried. 

Formally, the process works through no-action letters. So it is an 

informal process, and the goal is to try to get the SEC to write a 

no-action letter. But just as we, Chairman Baker and I and others, 

have said, there isn’t even a definition of an NRSRO. There isn’t 

much guidance. So I describe it as a ′′black box.′′ I don’t think that 

anyone knows precisely what they need to do in order to qualify. 

Sorry I can’t give you a better answer to that, but I just don’t 

think there is one. 

Mr. FITZPATRICK. Mr. Pollock, you were at one time head of the 

Federal Home Loan Bank of Chicago, and you have significant experience in the financial services market. 

Could you explain your comments that you believe—and we have 

heard some concern here about disruption to the markets as a result of this bill. Do you believe that there would be no—I think you 

said ′′no disruption′′ to the fixed income markets, that there is a 

more competitive rating agency sector? 

Mr. POLLOCK. Congressman, that is my opinion, as I said in my 

testimony. These are big markets; they are full of sophisticated 

people. They will also, in my judgment, move in an evolutionary 

fashion because there are natural, conservative tendencies in anything that revolves around the question of estimating risks and estimating future losses and uncertainties. 

I think we should be moving the market to where all financial 

actors, both issuers and buyers of securities, creditors, and all 

users of these ratings, are asked to exercise their judgment, have 

that judgment as informed as possible, and then let the market action decide which ratings are successful, which pricing models they 

like, which ratings models the market will prefer. 

But I am convinced that all that would happen in an evolutionary, nondisruptive way because everybody is going to be very careful about this so that what we will see is a smooth transition from 

what we have now, the Government-sponsored cartel, to what we 

should have, which is a real competitive market. 

Ms. STROKER. If I can address that, as well, representing Fitch’s 

view. We are sort of the man in the middle here where we are an 

NRSRO and yet we are not S&P or Moody’s; we don’t have their 

market strength. 

I think the big concern that we share is that the process of getting from here to there, that it be constructive and evolutionary. 

28

And as Congressman Kanjorski pointed out, ratings are infused in 

numerous statutes—in the financial markets, in mutual funds—

and simply opening up the ability to be included to these 140 market participants, or whatever the number is, could be quite disruptive. 

Mr. EGAN. I would like to put things in perspective. You know, 

you have had major failures here, billions of dollars lost. And we 

are concerned because one, probably two, of the major rating firms 

whose revenues operating income, by the way, has doubled in the 

last couple of years, they are concerned about moving forward because they might lose the freedom of speech defense because they 

don’t want to be registered under this new scheme. 

It makes no sense to me. But then again, neither does the SEC’s 

registration process. So you really want to put the whole thing in 

perspective; people are getting hurt badly. And it has been 15 years 

since the SEC has been studying this. 

We have had an application in for 8 years. I am a patient man, 

but this is getting absolutely ridiculous. What do we need, another 

couple of Enrons to fail? 

Mr. FITZPATRICK. One more question, Ms. Bolger. In your written 

testimony, page 8, you liken this bill to—′′throwing the baby out 

with the bath water′′ is the analogy you use. 

I am wondering, who is the baby in this particular case and what 

is the bath water? 

Ms. BOLGER. The baby would be the test for market recognition 

since that would disappear under the bill. And we do believe, in response to some of the other statements and questions this morning, 

that this is not just a matter of terminology and changing 

′′recognized′′ for ′′registered′′ or whatever the term might end up 

being, because the premise, the fundamental premise upon which 

States and Federal regulations have embedded NRSRO ratings, 

has been market recognition. 

I think that has been the SEC’s key criteria for a long time, and 

while, perhaps, the process is not clear—and we are also on record 

as being very much in favor of a more transparent process and a 

more formalized process to increase competition and provide the 

quality ratings out there—it just seems that to eliminate the market recognition or acceptance, that is, you know, for independent 

credible ratings, is the wrong way to go. We think it is just too fundamental, the system. 

Chairman BAKER. I thank the gentleman and want to compliment him on his good work in this matter. 

I want to try to put in a construct that makes sense to me, the 

concerns that I think Mr. Fitzpatrick is addressing with the legislation. 

As indicated earlier by Mr. Pollock, there isn’t a Government 

agency that says, okay, you can be a newspaper. Under the First 

Amendment, not only are newspapers protected, I am protected. 

I am going to make a statement you are going to disagree with 

it. I have the right to make the statement; I don’t have to be licensed to make the statement, and there are no consequences when 

I make the statement. Now, if Mr. Kanjorski and I agree and we 

introduce a bill, that might have consequences, but short of that, 

the statement itself has no effect. 

29

You were arguing that you have a First Amendment privilege as 

a result of your reaching and opining as to someone’s financial condition. Very similar in concept and scope to that of a CPA, now 

subject to the PCAOB in multiple regulatory levels. 

At the same time, you are saying that to be designated an 

NRSRO is of no consequence, but statutes make repetitive, duplicative reference to NRSRO; hence, the reason why we didn’t change 

NRSRO to another acronym, but rather ′′registered′′ as opposed to 

′′recognized,′′ so we didn’t have to change all the other statutes. It 

was a way to address the structural problems without getting into 

all that legislative, legal detail. 

The current system is a system which designates NRSROs as a 

result of an SEC governmental determination and establishes a 

status on those so designated. That is not an operative principle 

distinguished from a registration process. 

I have, as Exhibit Number 1, Mr. Egan, who is now an 8-year 

advocate for registration ′′recognition,′′ for nationally ′′recognized.′′

He can’t get there. So it is a barrier in performance of NRSRO obligations. 

The very thing you say you do not wish to see occur with the 

adoption of 2990, I suggest the current system, therefore, is unconstitutional and subject to First Amendment privilege. If we agree 

that you are now designated by governmental enterprise, and I 

even cede to you the point that there are First Amendment questions, I will refer you to Hudson v. New York in 1980, in which the 

Court held that should there be an overriding governmental reason 

and the remedy prescribed by the Government is reasonable and 

properly prescribed, then there even can be a prescription of First 

Amendment privilege based upon an overwhelming necessity for 

governmental action, the capital markets. 

If S&P determines that an enterprise is—an issuer’s ratings 

should fall below BBB, no longer investment grade, there are consequences. If an issuer wishes to go into the debt markets to provide security investments into its firm and does not get a rating of 

at least two independent enterprises, there is a market consequence. 

A newspaper writes a bad editorial; people get mad, but there is 

no measurable, quantifiable market effect. When you issue an opinion contrary to an issuer’s interest, there is a measurable, consequential effect. Therefore, preservation of a stable capital market 

is clearly in the interests of this committee and of the Federal Government, and it should have been under the purview of the SEC. 

And that is what gets us to the current moment. 

The SEC has not acted; for 30 years it has not acted. And we 

have a handful of individuals granted the responsibility to engage 

in this enterprise conduct, which is specifically referenced by Federal law for which there are market consequences if they are engaged and they, the issuers, do not meet your standards of performance. 

I am a free market guy. I find this extraordinarily troubling. You 

are what you are because of an act of a governmental agency. 

Now let’s take a look for a moment at your owner, McGraw-Hill. 

They are a publisher. They should be availing themselves of the 

30

First Amendment privilege, which you prescribe for your own interests since they are in the publishing business. 

I went to the Internet, and strange as it seems, I found on the 

Internet all of their financial disclosures, annual operating revenues of $5.25 billion—I won’t bore you with the details. Suffice it 

to say, they are Sarbanes-Oxley compliant and make all the disclosures that anyone should make in the current market environment 

for a corporate governance standard of conduct. While at the same 

time, S&P makes no disclosures of financial income or resources. 

There is no accountability for conduct which might not be a market 

standard of professional conduct. It is a large black box into which 

a lot of stuff goes and a few opinions leak out the back door. 

Now, according to another First Amendment-protected source, 

which shall remain named, the New York Times, alleged that 65 

percent of McGraw-Hill’s net operating profit was generated from 

Standard & Poor’s, which according to the numbers I calculated, 

that is only 491 million. Mr. Egan was referencing an $800 million 

figure. I don’t know who is right, but between 5 and $800 million, 

this leads me to conclude this could possibly be about money. I 

don’t know. Maybe that is a too pessimistic view. 

But you then have to look at the market performance and others 

have called into question market performance relating to the last 

decade. The response by S&P has been, well, people lied to us. 

What standard of due diligence does an analytical person have to 

look at the numbers? 

I read through the protocols provided to me by S&P and what 

is done in order to determine an issuer’s status; and there is no reference to a requirement to look at audited statements or to conduct 

an audit. It really is the best guess that one can make, given what 

is commonly available in the public markets. 

If one were really that good in a open competitive marketplace—

I want to make clear, if Moody’s and S&P could control 80 percent 

of the market in a free, open system, I would defend that right. I 

defend the right of anyone to go out and make money. It is my 

opinion, whether well-founded or not, that the current circumstance is the consequence of the governmental designation to 

the prejudicial effect of all those others who wish to compete in the 

marketplace. 

If 2990 is, on its face, defective, I need to hear specifics other 

than what I consider a specious First Amendment argument. And 

I know you will have briefs to forward for us to later review, and 

I look forward to that. 

But as to the elements of having someone register, putting that 

aside, knowing that your difficulty with registration is that you 

think that is an arbitrary and capricious inhibition to market function, what is the down side of what Mr. Fitzpatrick has established 

as the guiding principles for governance of a rating agency in the 

market structure we have described? 

Ms. BOLGER. You raised a number of very important issues—

Chairman BAKER. I hope so. 

Ms. BOLGER. —and a number that we very much agree with in 

terms of concerns. 

Putting aside the First Amendment issues, pure legal issues—

again, the main policy concern we have—I would suggest we cerVerDate 0ct 09 2002 16:04 Mar 24, 2006 Jkt 000000 PO 00000 Frm 00036 Fmt 6633 Sfmt 6633 G:\DOCS\109.42 RODNEY
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tainly would like to discuss this with you further. It is this whole 

element of market recognition. And I understand that that is not 

always well articulated or perhaps enunciated. 

I believe there is an effort, though, to more formally enunciate 

standards, to measure it. But to take that out of a system that has 

been in existence—and we would say, based on what others have 

also said, it is not just Standard & Poor’s; it has really worked extremely well. 

Chairman BAKER. Well, then is it that keeps Mr. Egan from getting his approval? What deficiency is there in his application? 

Ms. BOLGER. I cannot speak for the SEC. And, yes, we too have 

been, on occasion, frustrated with the SEC as well. We have a proposal in for an oversight framework, which I think has been alluded to this morning, that we have been working on at the SEC’s 

request and are awaiting comments from them on. And we do hope 

it proceeds. 

And I can go into a little more detail if you would like. 

Chairman BAKER. Let me rephrase it a different way. 

It is, rather than being so specific to another applicant, are there 

others who perform this function in the market today whom you 

believe should be designated NRSROs? 

Ms. BOLGER. I personally—and I don’t believe S&P has a view 

that there is one specific entity out there because we don’t necessarily know who may have applied or—

Chairman BAKER. In the general function of credit ratings, are 

there other companies who perform this duty in a manner which 

you think would be satisfactorily compliant with the SEC’s standards? 

Ms. BOLGER. Yes, I believe there probably are and probably not 

just here in the United States. This is a global business. So we also 

tend to look at these issues from a global perspective. 

So, yes. 

Chairman BAKER. So you would conclude that there are people 

that should be approved, but have not been, and we don’t know 

why? 

Ms. BOLGER. Well, again, I can’t speak to what the deficiencies 

might be or where they might be in the queue here and certainly, 

again, for what may be the situation with Egan-Jones. But we do 

share the goal of opening up the market to whomever it might be, 

but keeping in place some of the key fundamental standards, making them more formal, making them more transparent. I think to 

your point—

Chairman BAKER. But you are arguing, with due respect, against 

yourself. You are saying we need to have standards, we need to 

make sure we have the right people doing this work who are responsible in conduct, but at the same time you are telling me we 

should not have governmental oversight of the function. How is 

that consistent? 

Ms. BOLGER. The standards are ones that the SEC would articulate for designation. We don’t believe the current system of designating, because not everyone has to be an NRSRO, raises again the 

constitutional issues that we feel that the bill—

Chairman BAKER. Well, stay away from the Constitution. We are 

doing good here. We are getting disclosure. 

32

We agree there are other people who are out there who should 

be approved NRSROs. We don’t know the reasons within the SEC 

why they have not been. We are not sure who in the SEC is making the determinations. 

But moving forward, you are arguing that when we let those people in, they should meet certain standards of conduct. And those 

standards of conduct look pretty much to me, whether you call 

them ′′registration,′′ if you don’t fit this box, you don’t get in. That 

is where we are now. 

Ms. BOLGER. Yes. Let me clarify a couple of points. 

First of all, in terms of the whole NRSRO regime, we have been 

in favor and on record as having market participants also weigh in 

on the process, be it the initial designation or be it some ongoing 

surveillance, should one continue to be an NRSRO. I believe the 

SEC is looking at time frames to be an NRSRO. 

In terms of the standards issue, what we are looking at—and I 

believe the other rating agencies have also or are in the process of 

implementing our codes of conduct. These are not mandatory by 

regulation or law, but they are effectively industry standards. And 

given that this is a business largely built on credibility and reputation, one, we believe—I won’t talk for everybody, but I believe—just 

in our conversations, we all feel that this is very necessary. 

This code goes to the transparency of the process, it goes to how 

we do our business, and it goes to a number of other issues that 

are both covered by the bill as concerns and the SEC has enunciated as policy issues. But they are not mandatory by law, and 

that is why there is a distinction in approach. 

Chairman BAKER. Well, I have gone way beyond reasonable time, 

and I should afford Mr. Kanjorski an opportunity, if he chooses, to 

make another round. 

Mr. KANJORSKI. Just a few questions. 

Chairman BAKER. Mr. Kanjorski, let me conclude. 

I hope I have made clear the basis on which Chairman Oxley and 

I are both concerned about the current methodology. We are 

strongly supportive of Mr. Fitzpatrick’s approach, but we would 

welcome constructive comment going forward about how we get out 

of this conundrum where we have five—at most, two—controlling 

80 percent of the market. It is very restrictive, noncompetitive. 

But we are not in the business of promoting nonprofessional individuals to frivolously rate issuers and create havoc in markets. 

That is not where we want to wind up. We want what you want, 

respected people doing professional work for the benefit of an active 

and vibrant capital market, and we think we can enhance that opportunity. 

And there are reasonable questions, we believe, on our side of 

table to be resolved. And I thank you. 

Mr. Kanjorski. 

Ms. BOLGER. Yes. And thank you, Mr. Chairman. We share your 

concerns and hope to continue the dialogue. 

Mr. KANJORSKI. Maybe I should raise the question, Mr. Chairman, but rather than having this panel here today, we should have 

had the SEC here again today and in order to find out how they 

put this scheme together, as well as why and what they are doing 

about it to make it a fairer situation. 

33

It is very difficult on my side of the aisle to argue against H.R. 

2990 or anything else in terms of total competition, in which you, 

Mr. Chairman, always state you are for. Then why should we have 

any designation? We could just let the marketplace play out. 

Chairman BAKER. I will sign on. 

Mr. KANJORSKI. Well, why then are we looking for a regulatory 

scheme of any sort? Let’s just declare it open, because it is my 

thought that ultimately we would end up with a somewhat similar 

structure. Investment banking houses, investors, and the consuming public has to have had some insight as to where to put 

their money before the designation of NRSROs, like Standard & 

Poor’s, Moody’s, Fitch, and others existed, didn’t they? Yes, sir. 

Okay, what happened when they existed without this designation? Did they occupy a large portion of the market? Did they get 

that market share because of their credibility or did they get it because they were monopolistic? 

Mr. PARTNOY. May I address that? 

The business was significantly different. It was actually more 

like a publishing business and more like the business that Mr. 

Egan’s company engages in. It was actually a very well functioning 

market, and those same entities participated. There was lots of 

competition during the 19—

Mr. KANJORSKI. Why did we change it? 

Mr. PARTNOY. We changed it because the SEC promulgated one 

rule in 1975, and then it was off to the races. And people saw that 

it was easy. Instead of making a determination on their own as a 

regulator as to, for example, what net capital requirements could 

be, it was easy just to push that off onto the private sector and in 

this peculiar way pushing it off only onto a handful of folks. 

And it really hasn’t been done in other areas before, but it was 

easy, and it just—it was a monster; it got out of control. And if you 

look, I have written a couple of articles on this and just shown the 

simple chart that shows growth in regulations, and it goes up, up, 

up, up, up. 

Mr. KANJORSKI. What is your opinion and the rest of the panel; 

should we go back to the pre-1975 world? 

Mr. PARTNOY. I think there is a strong argument for going back 

to eliminating this concept of NRSROs entirely. I have said there 

are alternatives. 

For example, you could have decisions made based on the market 

spreads, the credit spreads that exist in the market, which would 

be a nice way of capturing all of the information in the market, not 

just the information associated with credit rating agencies. I think 

that is a viable alternative. 

I have submitted that to the SEC. I don’t think that it has been 

considered adequately. It would be something on the plate for this 

committee to think about. 

I think it is a very difficult problem. I think that the bill that 

we were talking about now is actually a nice compromise. But 

going back to pre-1975, ironically, even with all the modernization 

of financial markets, actually a nice way to think about what we 

should try to do is go back before we had this regulatory superstructure. 

34

Mr. KAITZ. It might be a nice way to think about it, but it is totally unrealistic. You have to undo legislation and regulation and 

all those regulated portfolios to do away with the NRSRO—

Mr. KANJORSKI. Congress doesn’t have to do anything? 

Mr. KAITZ. It is embedded in insurance, mutual fund, banking 

regulation. You would have to then address each one of those separate pieces of legislation. 

Mr. KANJORSKI. We have created a monster. Now we have to 

dress that monster? 

Mr. KAITZ. I am afraid you have to. I don’t think it is realistic 

to just go back to 1975. 

Mr. KANJORSKI. Mr. Egan, would that solve your problem if we 

went back to pre-1975? 

Mr. EGAN. The short answer is, I don’t know. I know it is not 

working right now. It is not working because of the odd process for 

becoming an NRSRO, the fact that applicants are not told specifically what the requirements are, what has to be done. 

Mr. KANJORSKI. We are going back. We are going to throw that 

out and go back to pre-1975. Would that solve your problem? 

Mr. EGAN. I think there are some suggestions about spreads and 

other quantitative measures. We use them internally. And, in fact, 

there is a big—there is an organization called KMV that uses equity-based information. 

The problem with some of these approaches is that they have 

some flaws that when you have the rating firm overlooking, you 

offset those flaws. For example, spreads, if there is a spread-based 

system, you get traders together and you could manipulate the 

spreads. 

I think the core issue—and I agree, you can’t go back to the old 

system because it would be too disruptive to the market. I think 

what really needs to be done is, the process has to be cleaned up. 

It is a mystery why the SEC is acting the way it is, but you need 

somebody else to look over it, to review the industry. 

But I don’t think you can go back to what was done before because it would be too disruptive in the short run to the market. 

Mr. KANJORSKI. But if I hired all of Mrs. Bolger’s analysts in a 

new company called Apex, I couldn’t qualify for an NRSRO rating, 

yet I would have all her expertise, a new entity, and a want to go 

into business. 

Now why shouldn’t I then be able to issue opinions if I have got 

the best analysts in the field, assuming Standard & Poor’s has the 

best in the field? Yeah, I know that you would argue that point, 

but I assume that they are and I hire them in bulk. I am a John 

Mack. 

Mr. EGAN. You would go bankrupt. 

Mr. KANJORSKI. I am going to the start a whole new business. 

Mr. EGAN. You would go bankrupt in a short period of time because you wouldn’t have the revenues to offset expenses. The competition will come from firms like us, that are fast, aggressive, 

know what they are doing, are recognized by the market, and don’t 

have the size of S&P and Moody’s, but have the—

Mr. KANJORSKI. So nobody in the marketplace really cares how 

qualified the analysts are or how good they are; they care about a 

name. If I understand what you are saying, I would go bankrupt. 

35

There is maybe really little value to having all this analysis and 

all these formulas and all these models. 

Mr. EGAN. It is the weight of the name in the marketplace. 

Everybody knew that the auto companies were under pressure a 

couple of years ago in fact. But the market moved dramatically 

when S&P changed the rating—I forget whether it was GM or 

Ford, just because there is so much tied into it. 

Mr. KANJORSKI. Only because of their name? 

Mr. EGAN. Correct. 

Mr. KANJORSKI. If Apex did it with all their analysts, nobody 

would pay any attention. 

Mr. EGAN. It is the typical thing with a monopoly. Is Microsoft 

software the very best software for an operating system? The answer is probably no, it is not. It is just that they have all these different tie-ins. 

That is the core problem here. The term used by the Justice Department for describing this industry is a ′′partner monopoly′′, and 

it has all the problems associated with a monopoly. It is not that 

S&P and Moody’s are incredibly smart. It is not that they are fast. 

In fact, you can show time and time again that they are slow, and 

yet, at the same time, the operating revenues are double. 

Mr. KANJORSKI. But it sounds to me like you want to break up 

this monopoly in a little way and put a few more people into the 

game to maintain the monopoly. If you are really competitive, let’s 

wipe them out and let everybody play the game. 

Mr. EGAN. Too disruptive to the market. 

Mr. KANJORSKI. Mr. Pollock, I see you are smiling and being entertained by my examination. 

Mr. POLLOCK. I think your examination is very good, Congressman. It raises the question that you rightly asked, how did all of 

the current dominant rating agencies start? They were all started 

early in the 20th century in 1910-1920 era by entrepreneurs doing 

exactly what you just said, hiring some analysts, starting to publish ratings, going around trying to get customers, getting people 

to pay. Standard & Poor’s was originally the Poor’s Publishing 

Company, I believe, and John Moody, and I guess there was a Mr. 

Fitch. 

Ms. STROKER. Yes. 

Mr. POLLOCK. And they all succeeded doing exactly what you just 

said. I agree that ought to be an opportunity that is open in this 

sector, as it should be open in every other sector. 

But as has been pointed out—and as you, yourself, Congressman, 

pointed out—we have got dozens and dozens of regulations and 

laws affecting thousands of regulated entities with this term 

′′NRSRO′′. That is why I thought the bill’s approach was so clever 

in making a move toward a disclosure registration competitive regime that could live with the existing complex, interacting regulations. Moving toward a more competitive regime would allow entrepreneurs like you to try to get into this business if you wanted to. 

Mr. KANJORSKI. Does anyone else want to respond? 

Ms. STROKER. I would just add, I wouldn’t give up on your business plan yet. I think Fitch has demonstrated over the past several 

years that we have been able to grow and compete by offering innoVerDate 0ct 09 2002 16:04 Mar 24, 2006 Jkt 000000 PO 00000 Frm 00041 Fmt 6633 Sfmt 6633 G:\DOCS\109.42 RODNEY
36

vative research and good criteria and price competition and different things that the market values. 

So while you might not have the NRSRO status on the first day 

that you open your doors, I think others have proven the ability to 

grow and be recognized without it. 

Mr. KANJORSKI.Isn’t really the essence of one of the problems 

here is where the funds come from and how the profit is made, as 

opposed to on the publishing side or on the getting paid for the 

analysis? If in some way we didn’t have that conflict, and the 

money is to be made on the publishing side, wouldn’t that release 

the pressures that are here? It would probably dozens Standard & 

Poor’s an awful lot of money. I suspect they are not making it on 

the publishing side; they are probably making it on the fee side to 

get in there. But maybe that, in itself, is an inherent conflict. 

Mr. EGAN.It is an inherent conflict. However, that is a secondary 

problem to the structure of the industry. 

There is no question that the problems that existed in the equity 

research side of the business, whereby Jack Grubman was getting 

paid via investment banking fees and that the same problem does 

exist in the rating industry. I think it makes total sense to address 

the conflict problem. It is just that I think you want to address the 

industry’s structural problems first, and that is a lack of competition. 

In fact, it is kind of odd that on the one hand, the SEC is fining 

all of those broker-dealers because they are getting paid by investment banking fees, but at the same time, in the latest NRSRO definition, they are locking it in that you must get paid by the issuers, 

by the very fact that they are insisting that those ratings be made 

free to the public. And perhaps that is an indication of the influence of the current market participants. 

Chairman BAKER. Mr. Fitzpatrick I think had a follow-up. 

Mr. FITZPATRICK. Just following up on that issue of 

anticompetitives leading to potential conflict. There has been little 

discussion of some of the anticompetitive practices that you have 

witnessed, such as offering unsolicited ratings. 

I was wondering if any of the panelists have any comment on 

those practices and, specifically, whether you think that they 

should be prohibited? 

Ms. STROKER. I would like to take that, because Fitch does engage in unsolicited ratings, and we do it to be procompetitive rather than anticompetitive. 

In order to establish our name and reputation in the marketplace, we have had to grow our coverage to a level that interests 

investors and grabs their attention and gives us an opportunity to 

comment across a wide range of credit categories. So we feel that 

it has been an important tool for us to grow. And we do it in ways 

and in a style that is not meant to be abusive or coercive or any 

of those bad words, but it is meant to inform investors. 

Mr. PARTNOY. Let me just mention one other area that has not 

been covered so far that I think should be in the back of everyone’s 

mind, and that is structured finance. 

Increasingly, institutions are using structured finance techniques 

to game ratings, to take advantage of ratings. And the ranking 

member was discussing what would it matter. It often helps when 

37

a rating is wrong, paradoxically. When ratings are wrong, that can 

create incentives for people to create transactions, and there are 

now trillions of dollars of credit derivatives in particular, or 

collateralized debt obligations, which were essentially created just 

because there are regulations that gives a ratings benefit. 

And it goes back. It is the same rationale, going back to Orange 

County, where there were created all of these AAA-rated instruments that were really wolves in sheep’s clothing. The same sort 

of thing is happening right now in the collateralized debt obligations market. 

And if you look at the fastest growth area of the NRSROs and 

where a lot of the profit is coming from, you will see that it is from 

structured finance. And that is a deeply troubling piece of this market, where institutions are trying to take advantage of the fact that 

regulations depend on ratings to have transactions that are rated 

inaccurately. 

Mr. KAITZ. I would just suggest that if you are an issuer that 

gets an unsolicited rating with no competition in the marketplace, 

you have absolutely no place to go. And while it might be pro-business for Fitch, it is certainly not viewed that way by the issuer, 

who is then faced with having to essentially give in or be coerced 

or have to pay for a rating, especially if they are going to be issuing 

debt. So what looks as pro-business from Fitch’s perspective, is not 

the same from the issuer perspective. 

Chairman BAKER. I would like to ask for a point of clarification. 

If you are the victim of an unsolicited rating and there is some confusion about whether you should pay or not, is that a segue into 

being on a watch list? 

What is the consequence of nonpayment? 

Ms. STROKER. There is absolutely none. The analysts that are 

opining on the creditworthiness of the issuers and the securities 

they rate are blind to whether there is compensation involved or 

not. So there is no consequence. 

In fact, we have arrayed our ratings to see if there are any difference between unsolicited ratings across the spectrum and solicited ratings. 

Chairman BAKER. But I understand your point, that the analyst 

conducting the evaluation may be blind to the revenue situation, 

but somebody in management back in Fitch has got to measure 

and match those things up or you are going to have a lot of unpaid 

bills and nobody is watching. How does that work? 

Ms. STROKER. Again, it is based on our need to have coverage, 

sufficient coverage to serve investors well. 

Chairman BAKER. I understand the point and why it is done. But 

I am just saying that as a practical matter, somebody within an organization has to know to whom invoices were sent and whether 

they are paid or not; and that has some consequence at some point, 

if the issuer calls you up and says I would like to now have a rating, and are you delinquent on an unsolicited? 

Ms. STROKER. Right. 

Mr. KAITZ. The unsolicited rating forces the issuer to then engage in formal discussions. That is essentially how it works. 

Chairman BAKER. That is what I was trying to get at: What is 

the consequence? 

38

Mr. KAITZ. The consequences is, in most cases, having to then engage with the rating agency. 

Chairman BAKER. You have no other choice. The friendly monthly payment plan. 

Mr. EGAN. By the way, the Washington Post had a very good description of that process whereby the Washington Post said that 

Moody’s shook down a German insurance company. They issued an 

unsolicited rating. They asked for payment. They did not get payment. And over a period of about 2 years, Moody’s kept asking. 

When the issuer refused, Moody’s would take a negative action. 

And that documents some of the negative publicity surrounding unsolicited ratings. 

Keep in mind, though, for firms such as Egan-Jones that are not 

paid by the issuers, by definition all of our ratings are unsolicited. 

Mr. FITZPATRICK. Does Fitch also engage in the practice known 

as notching? 

Ms. STROKER. No, we don’t. Just to clarify the point, notching 

would be if we penalized the ratings of other ratings service in the 

way we analyze a portfolio of securities. 

We do not notch the ratings of S&P and Moody’s 

Mr. FITZPATRICK. Do other firms notch? 

Ms. STROKER. Yes. S&P and Moody’s notch Fitch ratings and 

each others’ ratings. 

Mr. KANJORSKI. Mr. Chairman, maybe I can direct this inquiry 

at the author of H.R. 2990. Maybe using the SEC as the enforcement mechanism for competitiveness in this field is the wrong way 

to go. In most instances, I think of the SEC as an entity that determines disclosure and transparency in corporate life, as opposed to 

the enforcement of competitiveness. 

I think of enforcement of competitiveness as being in the jurisdiction of the Federal Trade Commission or the Justice Department. 

Maybe that is one of the hang-ups that I have. This bill is sort of 

looking to change the culture of the Securities and Exchange Commission. Maybe they are resisting it because it is not in their nature to worry about competition; that is not one of their considerations. Their major consideration is to make sure that there are 

rules and regulations in place for full and adequate disclosure. 

Should we look at changing the enforcement mechanism in this 

situation? Maybe if the panel wants to look at that, we should. 

Mr. EGAN. The primary obligation is protecting investors. That 

is what they say. Job number one is protecting investors. They 

have not protected investors. 

Mr. KANJORSKI. But they do not do it by nurturing competition. 

That has never been their charge. 

Mr. EGAN. Perhaps not. But why not recognize some rating firms 

that have succeeded in pointing out the problems with Enron and 

WorldCom. They have refused to. 

Mr. KANJORSKI. Mr. Egan, you get a 30-second advertisement in 

here regardless of how we decide. 

Mr. EGAN. I am sorry. If you were looking at this area for 8 years 

and got no response, you would feel the same way. 

Mr. KANJORSKI. I understand. I just want to compliment you. 

Whoever is your PR firm, fire them and hire yourself. 

39

Chairman BAKER. I thank the gentleman for his observations. 

And I had previously erred in not submitting for the record a letter 

from the Investment Company Institute signed by Mr. Schott, its 

president, relative to their position on H.R. 2990. I would make 

that part of the record. 

I also want to express my appreciation to you and disclose a side 

bar conversation I had with Mr. Kanjorski, the content of which is 

in going forward there is no rush to judgment. The Fitzpatrick 

measure is a point of departure, but it is a meaningful statement, 

I think, on at least our thinking of where we might go. And we appreciate the exchange of views presented here today. It is indeed 

helpful to the committee’s work in going forward. 

I would just make the comment that although we will not move 

precipitously or with an unwarranted proposal, we certainly do 

want to move because we believe this is an area where action is 

fully appropriate and necessary for the conduct of a vibrant capital 

market. 

And with that, I would adjourn our meeting. Thank you. 

[Whereupon, at 12:10 p.m., the subcommittee was adjourned.] 

(41)

A P P E N D I X

June 29, 2005

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