49–010 

1 Report on the Role and Function of Credit Rating Agencies in the Operation of the Securities 

Markets, As Required by Section 702(b) of the Sarbanes-Oxley Act of 2002, U.S. Securities and 

Exchange Commission, January 2003. 

Calendar No. 590 

109TH CONGRESS REPORT " ! SENATE 2d Session 109–326 

CREDIT RATING AGENCY REFORM ACT OF 2006 

SEPTEMBER 6, 2006.—Ordered to be printed 

Mr. SHELBY, from the Committee on Banking, Housing, and Urban 

Affairs, submitted the following 

R E P O R T 

[To accompany S. 3850] 

The Committee on Banking, Housing, and Urban Affairs reported S. 3850, a bill to improve ratings quality for the protection 

of investors and in the public interest by fostering accountability, 

transparency, and competition in the credit rating industry. The 

Committee reports favorably an original bill, and recommends that 

the bill do pass. 

INTRODUCTION

In the wake of highly publicized failures by the large credit rating agencies to warn investors in a timely manner about the impending bankruptcies of Enron, WorldCom, and others, the Congress, in section 702(b) of the Sarbanes-Oxley Act of 2002, directed 

the Securities and Exchange Commission (‘‘SEC’’ or ‘‘Commission’’) 

to examine the role and performance of rating agencies, barriers to 

entry into the rating industry, and conflicts of interest plaguing 

rating agencies. The SEC published its Report on the Role and 

Function of Credit Rating Agencies in the Operation of the Securities Markets 1 in January 2003. In its review, the SEC documented 

its unsuccessful efforts since 1994 to define ‘‘nationally recognized 

statistical rating organizations’’ (‘‘NRSROs’’) and establish a regulatory program to oversee such NRSROs. 

Over the years, the SEC has been criticized at times for not 

awarding more NRSRO designations and thereby perpetuating an 

anticompetitive industry, and for failing to supervise and inspect 

NRSROs to ensure compliance with the federal securities laws and 

NRSRO requirements. NRSROs have been criticized by a broad 


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2 Rating agencies that use solely quantitative methods generally do not meet with issuers. 

3 17 CFR 243.100–243.103. 

array of interested parties with respect to conflicts of interest, ratings that significantly lag the markets, and anticompetitive and 

abusive business practices. 

PURPOSE OF THE LEGISLATION

The purpose of the ‘‘Credit Rating Agency Reform Act’’ (‘‘the Act’’) 

is to improve ratings quality for the protection of investors and in 

the public interest by fostering accountability, transparency, and 

competition in the credit rating industry. 

HEARINGS

On February 8, 2005, the Committee held a hearing titled ‘‘Examining the Role of Credit Rating Agencies in the Capital Markets.’’ The following witnesses testified at the hearing: Ms. Kathleen A. Corbet, President, Standard & Poor’s (‘‘S&P’’); Mr. Sean J. 

Egan, Managing Director, Egan-Jones Ratings Company; Mr. 

Micah S. Green, President, The Bond Market Association; Mr. 

Yasuhiro Harada, Executive Vice President, Rating and Investment 

Information, Inc.; Mr. Stephen W. Joynt, President and Chief Executive Officer, Fitch Ratings (‘‘Fitch’’); Mr. James A. Kaitz, President and Chief Executive Officer, Association for Financial Professionals; and Mr. Raymond W. McDaniel, Jr., President, Moody’s Investors Service, Inc. (‘‘Moody’s’’). 

On March 7, 2006, the Committee held a hearing titled ‘‘Assessing the Current Oversight and Operations of Credit Rating Agencies.’’ The following witnesses testified at the hearing: Mr. Paul 

Schott Stevens, President, Investment Company Institute; Mr. 

Glenn Reynolds, Chief Executive Officer, CreditSights, Inc.; Ms. 

Vickie Tillman, Executive Vice President for Credit Market Services, S&P; Mr. Frank Partnoy, Professor of Law, University of San 

Diego School of Law; Ms. Colleen Cunningham, President and 

Chief Executive Officer, Financial Executives International; Mr. 

Damon Silvers, Associate General Counsel, AFL–CIO; Mr. Jeffrey 

Diermeier, President and Chief Executive Officer, CFA Institute; 

and Mr. Alex Pollock, Resident Fellow, American Enterprise Institute. 

BACKGROUND AND NEED FOR LEGISLATION

A credit rating is a rating agency’s assessment with respect to 

the ability and willingness of an issuer to make timely payments 

on a debt instrument, such as a bond, over the life of that instrument. Investors use ratings to help price the credit risk of fixedincome securities. In order to determine an appropriate rating, 

credit analysts use publicly available information, market and economic data, and often engage in discussions with senior management of the debt issuer.2 The rating agencies also have access to, 

and receive, non-public information because of their exemption 

from Regulation Fair Disclosure,3 an SEC rule that prohibits companies from disseminating material information to a select audience. 

At the largest rating organizations, the process for developing an 

initial rating on an issuer is generally as follows: analysts (i) reVerDate Aug 31 2005 06:30 Sep 09, 2006 Jkt 049006 PO 00000 Frm 00002 Fmt 6659 Sfmt 6602 E:\HR\OC\SR326.XXX SR326

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4See, e.g., Mr. Alex J. Pollock, ‘‘End the Government-Sponsored Cartel in Credit Ratings,’’ American Enterprise Institute for Public Policy Research, January 2005, at 1. Mr. Pollock explains that the NRSRO designation is an ‘‘extremely valuable franchise’’ that ‘‘allows entry into 

a cartel with only three U.S. members, which represent about 95 percent of sector revenues’’

(at 1). 

view financial statements and draft a preliminary rating; (ii) visit 

management of the issuer; (iii) prepare a brief report explaining 

the rationale for the rating; and (iv) make a presentation to the 

rating committee, which then determines a final rating. The rating 

and report is sent to the issuer to ensure that it is factually accurate and does not disclose any confidential information. The rating, 

paid for by the debt issuer, is disseminated to the public at no cost. 

The report accompanying the rating is available to paid subscribers. Ratings are monitored on an ongoing basis. 

The agencies rate both long-term and short-term debt. S&P, 

Fitch, and others designate investment grade, or lower risk, longterm debt with ratings of AAA, AA, A and BBB, and speculative 

grade, or higher risk, with BB, B, CCC, CC, C and D. The rating 

classification system employed by Moody’s uses Aaa, Aa, A and Baa 

for investment grade and Ba, B, Caa, Ca and C for speculative 

grade. The historic default rate for AAA-rated securities is well 

under one percent in any given ten-year period. For B-rated securities, the ten-year probability of default is approximately 45 percent. 

The modern ratings business was founded nearly a century ago 

when Mr. John Moody first published ratings on railroad bonds. Although S&P and Moody’s remain the dominant companies, the industry has undergone dramatic changes in the past few decades. 

Around 1970, the leading credit raters moved away from a pure 

subscription model to a hybrid one where issuers pay for ratings 

and subscribers receive in-depth reports explaining the basis for 

each rating. In the past few decades, credit ratings have assumed 

increased importance due to regulatory decisions, the development 

of complex financial products such as asset-backed securities and 

credit derivatives, the globalization of financial markets, and other 

factors. The industry is much larger today simply because the bond 

markets have experienced such dramatic growth. For example, 

S&P has more than 700,000 ratings outstanding and issues 500– 1,000 rating actions each day. In recent years, the increase in 

structured finance transactions has been responsible for explosive 

revenue growth at the rating agencies. 

I. Overview of regulatory landscape 

The largest NRSROs, S&P and Moody’s, wield enormous power 

in the global capital markets system. Their ratings affect the cost 

of capital and the structure of transactions for debt issuers, and determine which securities may be purchased by money market mutual funds, banks, credit unions, insurers, state pension funds, 

local governments, and local school boards. Regulatory actions have 

tended to insulate industry leaders from competition.4 Yet, once accorded this privileged status, they are virtually unregulated. 

Following corporate scandals at Enron, WorldCom, and elsewhere, Congress and the securities regulators adopted new rules 

governing the conduct of public companies, corporate boards and officers, accountants, stock research analysts, investment bankers, 

and attorneys. Rating agencies are not subject to similar regulation 


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5 17 CFR 240.15c3–1. Adoption of Uniform Net Capital Rule and an Alternative Net Capital 

Requirement for Certain Brokers and Dealers, Release No. 34–11497 (June 26, 1975), 40 FR 

29795 (July 16, 1975). 

in spite of widespread criticism for failing to warn investors about 

several of the largest bankruptcies in U.S. history, conflicts of interest, anticompetitive and abusive business practices, and an absence of transparency, regulatory oversight, and meaningful competition. 

II. NRSRO system 

The SEC originally adopted the term ‘‘NRSRO’’ in 1975 solely for 

determining capital charges on different grades of debt securities 

under the Net Capital Rule.5 The Net Capital Rule requires brokerdealers, when computing net capital, to deduct from their net 

worth certain percentages of the market value of their proprietary 

securities positions. These ‘‘haircuts’’ provide a margin of safety 

against losses that might be incurred by broker-dealers in those positions. The Commission determined that it was appropriate to 

apply a lower haircut to securities held by a broker-dealer that 

were rated investment grade by a nationally recognized rating 

agency because those securities typically were lower-risk investments. The requirement that the rating agency be ‘‘nationally recognized’’ was designed to ensure that its ratings were credible and 

reasonably relied upon by the marketplace. 

Since 1975, increased marketplace and regulatory reliance on 

credit ratings has made use of the NRSRO concept more prevalent. 

Some regulations issued by the Commission incorporate the concept by cross-reference to the Net Capital Rule. For example, under 

Rule 2a–7 of the Investment Company Act of 1940, money market 

funds are limited to investing in securities rated by an NRSRO in 

the two highest ratings categories for short-term debt. Also, Congress has incorporated this concept into legislation such as the Federal Deposit Insurance Act. 

Over the past few decades, financial regulators have increasingly 

used credit ratings to help monitor the risk of investments held by 

regulated entities and to provide an appropriate disclosure framework for securities of differing risks. In fact, ratings by NRSROs 

today are widely used as benchmarks in federal and state legislation, rules issued by financial and other regulators, foreign regulatory schemes, and private financial contracts. Most of these laws 

and regulations define eligible portfolio investments for institutional investors as those rated in one of the highest investment 

grade categories by at least one NRSRO. Today, it has become 

standard industry practice for most issuers to purchase ratings 

from two or more rating agencies. 

The firms designated as ‘‘nationally recognized statistical rating 

organizations’’ are recognized as such by Commission staff through 

the no-action letter process. Currently, there are only five NRSROs: 

S&P, Moody’s, Fitch, Dominion Bond Rating Service Limited and 

A.M. Best Company. It is an extremely concentrated industry. The 

largest rating agencies—S&P and Moody’s—have approximately 80 

percent of industry market share as measured by revenues. S&P 

and Moody’s rate more than 99 percent of the debt obligations and 

preferred stock issues publicly traded in the United States. Hearing witnesses testifying before the Committee expressed concern 


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6Testimony of Mr. Sean Egan, Managing Director, Egan-Jones Ratings Company, before the 

Committee on Banking, Housing, and Urban Affairs, U.S. Senate, February 8, 2005, at 1–2. Mr. 

Egan asserted that it was a mistake to refer to S&P and Moody’s as an oligopoly. He said the 

two ratings firms were more accurately characterized by the Department of Justice as a ‘‘partner monopoly’’ because S&P and Moody’s ‘‘do not compete against each other for the two ratings 

which are normally required. This is important. They do not compete against each other . . . 

what I mean by that is that if S&P is brought into a transaction, Moody’s is soon to follow, 

so they both get paid for issuing.’’ See also the testimony of Mr. Glenn Reynolds, Chief Executive 

Officer, CreditSights, Inc., before the Committee on Banking, Housing, and Urban Affairs, U.S. 

Senate, March 7, 2006, at 4 (also referring to S&P and Moody’s as a ‘‘partner monopoly’’). 7Partnoy, op. cit., at 4. Mr. Partnoy also said ‘‘the NRSRO regime poses a serious threat to 

the financial system’’ (at 4). 8Pollock, op. cit. Mr. Pollock, in a subsequent opinion piece, suggests that ‘‘shared monopoly’’ may be the most accurate description. See ‘‘Cartel to Competition,’’ American Enterprise Institute for Public Policy Research, July 18, 2006. 9 Nationally Recognized Statistical Rating Organizations, Release No. 34–34616 (August 31, 

1994), 59 FR 46314 (September 7, 1994). 10 Capital Requirements for Brokers or Dealers Under the Securities Exchange Act of 1934, 

Release No. 34–39457 (December 17, 1997), 62 FR 68018 (December 30, 1997). 11 Interestingly, under the proposal NRSROs were required to register under the Investment 

Advisers Act of 1940 (‘‘Advisers Act’’) and access to corporate executives was one of the five factors weighed by Commission staff. 12 ‘‘Comments of the U.S. Department of Justice before the Securities and Exchange Commission,’’ March 1998. 13Order In the Matter of the Role of Rating Agencies in the U.S. Securities Markets Directing 

Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934, and Designating 

Officers for Such Designation (March 19, 2002). 14From all indications, these were the only comprehensive Commission inspections of the 

NRSROs since the designations were first awarded in 1975. 

about this level of concentration and called S&P and Moody’s a ‘‘partner monopoly’’ 6 and an ‘‘oligopoly.’’ 7 They have also been 

called a ‘‘government-sponsored cartel.’’ 8

III. SEC efforts to oversee the rating industry 

For more than a decade, the SEC has attempted to devise a regulatory scheme for rating agencies. These efforts were prompted by 

concerns that the SEC had never defined the term and that there 

was inadequate oversight of NRSROs. To address these issues, the 

Commission issued a Concept Release in 1994 9 soliciting public 

comment on the appropriate role of ratings in the federal securities 

laws and whether formal procedures were needed for recognizing 

and monitoring the activities of NRSROs. 

The 1994 Concept Release led to a rule proposal in 1997,10 which 

would have amended the Net Capital Rule by defining ‘‘NRSRO’’ and establishing a formal application process for NRSRO recognition. Under the proposal, Commission staff would consider five factors in deciding whether to grant the NRSRO designation. Whether 

an entity was ‘‘nationally recognized’’ would be accorded the most 

significance.11 The Department of Justice filed a comment letter 

stating that the recognition requirement ‘‘is likely to create a nearly insurmountable barrier to new entry into the market for NRSRO 

services.’’ 12 The proposed rule was never adopted. 

In 2002, the Commission issued an Order 13 directing investigation, pursuant to Section 21(a) of the Securities Exchange Act and 

the examination authority of the Advisers Act, into the role of credit rating agencies in the U.S. securities markets. These SEC examinations of the then-three NRSROs (S&P, Moody’s, and Fitch), ostensibly triggered by the NRSRO failures relating to Enron, revealed numerous problems.14 SEC examiners found (i) potential 

conflicts of interest resulting from the issuer-paid business model 

of the NRSROs; (ii) that NRSRO marketing of supplementary, feebased services, including corporate consulting, exacerbated the inherent conflict in the NRSRO business model; (iii) the potential for 


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15The Current Role and Function of Credit Rating Agencies in the Operation of the Securities 

Markets, Hearings Before the U.S. Securities and Exchange Commission (November 15 and 21, 

2002). Full hearing transcripts are available on the SEC’s Web site at http://www.sec.gov/spotlight/ratingagency.htm 16 Concept Release: Rating Agencies and the Use of Credit Ratings under the Federal Securities Laws, Release No. 33–8236 (June 4, 2003), 68 FR 35258 (June 12, 2003). 17Definition of Nationally Recognized Statistical Rating Organization, Release No. 34–51572 

(April 19, 2005), 70 FR 21306 (April 25, 2005). 18See, e.g., the testimony of Mr. Alex Pollock, Resident Fellow, American Enterprise Institute, 

before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, March 7, 2006, at 

1. 

the NRSROs, given their substantial power in the marketplace, to 

improperly pressure issuers to pay for ratings and purchase ancillary services; and (iv) evidence relating to whether NRSROs were 

adequately protecting confidential information. The examinations 

suffered from an overall lack of cooperation offered by the NRSROs 

with respect to document production. In addition, SEC examiners 

found evidence that the NRSROs were possibly in violation of Section 17(b) of the Securities Act of 1933, with respect to disclosure 

of fees from issuers. 

Later in 2002, the SEC held two days of public hearings 15 on the 

role and function of rating agencies. In 2003, the Commission 

issued the report on the operation of rating agencies that was mandated by the Sarbanes-Oxley Act. 

Later in 2003, the Commission issued another Concept Release 16

soliciting public comment with respect to whether credit ratings 

should continue to be used for regulatory purposes under the federal securities laws, and, if so, the process of determining whose 

credit ratings should be used, and the level of oversight to apply 

to such credit rating agencies. 

In 2005, the Commission proposed another rule 17 defining 

‘‘NRSRO,’’ which unlike the 1997 proposal, would not establish a 

formal application process or require Advisers Act registration. The 

2005 proposal, which has not been acted upon, would define 

‘‘NRSRO’’ as an entity (i) that issues publicly available credit ratings that are current assessments of the creditworthiness of obligors with respect to specific securities or money market instruments; (ii) is generally accepted in the financial markets as an 

issuer of credible and reliable ratings, including ratings for a particular industry or geographic segment, by the predominant users 

of securities ratings; and (iii) uses systematic procedures designed 

to ensure credible and reliable ratings, manage potential conflicts 

of interest, prevent the misuse of public information, and has sufficient financial resources to ensure compliance with these procedures. 

IV. Critiques of NRSRO system: Inadequate transparency, competition, and accountability 

Witnesses appearing before the Committee described the current 

system for approving rating agencies as vague, arbitrary, and anticompetitive.18 The term ‘‘NRSRO’’ remains undefined by the Commission after three decades. There is no formal application process. 

Some applicants have waited a decade without a final decision by 

the staff. SEC commissioners are not formally involved in the decision whether to recognize new NRSROs. The most important requirement for acquiring the coveted status presents an obvious 

‘‘Catch 22’’: to get the designation you must be nationally recogVerDate Aug 31 2005 06:30 Sep 09, 2006 Jkt 049006 PO 00000 Frm 00006 Fmt 6659 Sfmt 6602 E:\HR\OC\SR326.XXX SR326

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19Testimony of Mr. Yasuhiro Harada, Executive Vice President, Rating and Investment Information, Inc., before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, February 8, 2005, at 2. Mr. Harada explained that his ratings firm, the most recognized firm in 

Japan and the broad Asian markets, had unsuccessfully sought NRSRO status for a decade. He 

said it ‘‘has been an exercise in delay and disappointment’’ (at 2). 20See, e.g., the testimony of Mr. Paul Schott Stevens, President, Investment Company Institute, before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, March 7, 

2006, at 5–7. 21For a groundbreaking and highly influential analysis of credit rating agencies, see Mr. 

Partnoy’s law review article, ‘‘The Siskel and Ebert of Financial Markets?: Two Thumbs Down 

for the Credit Rating Agencies,’’ Washington University Law Quarterly, Fall 1999. 22See, e.g., Stevens, op. cit., at 7. 23Testimony of Ms. Colleen Cunningham, President and Chief Executive Officer, Financial 

Executives International, before the Committee on Banking, Housing, and Urban Affairs, U.S. 

Senate, March 7, 2006, at 4. 

nized, but you cannot become nationally recognized without first 

having the designation. Mr. Yasuhiro Harada, Executive Vice 

President of Rating and Investment Information, Inc., expressed 

the almost universal view that the national recognition requirement was a ‘‘circular test.’’ 19 Several witnesses testifying before 

the Committee noted that the standard has served as a substantial 

barrier to entry for new entrants and that greater competition 

would benefit investors by generating more innovation and higher 

quality ratings at lower costs.20

Witnesses also testified that the absence of any meaningful SEC 

oversight of rating agencies has led to accountability problems and 

to questions relating to NRSRO compliance with federal securities 

laws and the criteria listed in the no-action letter. Mr. Frank 

Partnoy, Professor of Law, University of San Diego School of Law, 

asserted that the voluntary policing regimes are ‘‘self-serving and 

toothless’’ and that ‘‘NRSROs will not police their conduct without 

a credible enforcement mechanism.’’ 21 For these reasons, the witnesses urged the Committee to replace the NRSRO system with a 

registration system. 22 Ms. Colleen S. Cunningham, President and 

Chief Executive Officer of Financial Executives International, testified that ‘‘the most effective way to increase competition in the 

credit rating market would be to eliminate the broken ‘no action’

process and replace it with transparent registration requirements 

. . . By establishing stringent yet clear criteria for registration, 

Congress would . . . generate more competition . . . more choice 

for issuers; lower costs . . . and higher quality service.’’ 23

V. Reforms included in the credit rating agency reform act 

The Credit Rating Agency Reform Act establishes fundamental 

reform and improvement of the designation process. Most importantly, the Act replaces the artificial barriers to entry created by 

the current SEC staff approval system with a transparent and voluntary registration system that favors no particular business 

model, thus encouraging purely statistical models to compete with 

the qualitative models of the dominant rating agencies and investor 

subscription-based models to compete with fee-based models. The 

Committee believes that eliminating the artificial barrier to entry 

will enhance competition and provide investors with more choices, 

higher quality ratings, and lower costs. 

Credit rating agencies that choose to register as NRSROs must 

disclose important information such as ratings performance, conflicts of interest, and the procedures used in determining ratings. 

Rating performance statistics will be updated annually. This inforVerDate Aug 31 2005 06:30 Sep 09, 2006 Jkt 049006 PO 00000 Frm 00007 Fmt 6659 Sfmt 6602 E:\HR\OC\SR326.XXX SR326

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24 In testimony before the Committee, the NRSROs explained their performance by saying 

that Enron and WorldCom also misled them. 25 Egan, op. cit., at 1–2. Mr. Egan also referenced the California utilities, Global Crossing, 

AT&T Canada, and Parmalat as prominent examples where the NRSROs failed to protect investors. 26 Egan, op. cit., at 1–2. 27 Rating agencies acknowledge the inherent conflict of issuers paying for ratings. But they 

argue that it is effectively managed inasmuch as analysts do not benefit financially from any 

of their rating decisions. Analysts are not permitted to own any of the securities they follow. 

Also, because the fees from each issuer amount to less than one percent of overall revenues, 

the rating agencies argue that no issuer is likely to impair independence. 28See, e.g., testimony of Mr. James A. Kaitz, President and Chief Executive Officer, Association for Financial Professionals, before the Committee on Banking, Housing, and Urban Affairs, 

U.S. Senate, February 8, 2005, at 6. See also Partnoy, op. cit., at 4. 

mation will facilitate informed decisions by giving investors the opportunity to compare the ratings quality of different firms. 

Witnesses testifying at the Committee’s rating agency hearings 

asserted that the bankruptcies at Enron, WorldCom, and other corporations demonstrated that NRSROs are not providing investors 

with timely and accurate ratings.24 All of the then-three NRSROs 

rated Enron at investment grade until only four days before default. WorldCom was rated investment grade debt only 42 days 

prior to its bankruptcy filing. Mr. Sean Egan, Managing Director 

of Egan-Jones Ratings Company, citing these and other missed 

calls,25 testified that the rating industry is a ‘‘dysfunctional . . . 

partner monopoly’’ that is in ‘‘crisis.’’ 26

Several witnesses described the business model for the dominant 

rating agencies as inherently conflicted.27 Debt issuers pay the rating agencies for their rating. In addition, rating agencies increasingly market ancillary, fee-based consulting services, thus exacerbating the basic conflict.28 The Act addresses these concerns by requiring registration form disclosure of any conflict of interest relating to the applicant’s issuance of credit ratings, and by requiring 

the Commission to adopt rules prohibiting conflicts of interest or 

requiring the management and disclosure of such conflicts. 

Prior to the Committee mark-up of the Act, a broad coalition of 

interested parties that typically offer different ideological perspectives expressed support for the bipartisan product: 

The Investment Company Institute said the Act ‘‘brings much 

needed sunlight to credit ratings’’ and ‘‘will benefit a wide range of 

market participants.’’

The AFL–CIO expressed its ‘‘strong support’’ for the legislation 

and said it would ‘‘protect the investing public against conflicts of 

interest within the credit rating agencies . . . [and] encourages in 

a responsible manner greater competition.’’

The Association for Financial Professionals said the bill will ‘‘foster competition, stimulate innovation, hold credit rating agencies 

accountable, and improve the quality of information available to investors, and, as a result, restore confidence in the credit ratings 

market.’’ The Bond Market Association said the bill would create a ‘‘more 

competitive credit rating industry [that] will contribute to more robust and efficient capital markets that will ultimately benefit investors and the overall economy.’’ Consumer Federation of America wrote that it will ‘‘help ensure 

that only high quality ratings will be used for economically important regulatory purposes’’ and praised the bill’s requirements for ‘‘certifications by Qualified Institutional Buyers . . . and [for] givVerDate Aug 31 2005 06:30 Sep 09, 2006 Jkt 049006 PO 00000 Frm 00008 Fmt 6659 Sfmt 6602 E:\HR\OC\SR326.XXX SR326

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ing the . . . SEC . . . authority to deny NRSRO status to rating 

agencies that lack the financial and managerial resources to 

produce ratings of integrity.’’

Financial Executives International said the bill ‘‘positively addresses three issues of great importance to our members: competition, accountability, and conflicts of interest,’’ and ‘‘urge[d] Congress to enact this important legislation this year.’’

Fitch said it ‘‘represents a significant step forward to prudently 

enhance competition in the rating agency industry.’’

Fidelity Investments said the bill ‘‘will improve ratings quality 

by fostering transparency and accountability.’’

Ratings and Investment Information, Inc. commended the bill for 

‘‘establishing a much more transparent application process and, 

most importantly, prescribing a specific timeline within which the 

agency must act.’’

COMMITTEE CONSIDERATION

On August 2, 2006, the Committee considered a managers’

amendment offered by Chairman Shelby and Senator Sarbanes 

that revised the base text of the Committee Print. The managers’

amendment made essentially two changes. First, it ensured that 

the SEC would not regulate the rating methodologies used to determine ratings. Second, it clarified that rating agencies registering 

under the bill would not in any way waive or otherwise diminish 

any right, privilege, or defense that such rating agencies may otherwise have under State or Federal law. The amendment also made 

some technical changes to the Committee Print. On a unanimous 

vote, the Committee reported the bill, as amended, to the Senate 

for consideration. 

SECTION-BY-SECTION ANALYSIS OF THE ACT

Section 1. The Short Title is ‘‘Credit Rating Agency Reform Act 

of 2006.’’

Section 2. Findings are based on the SEC study issued pursuant 

to Section 702 of the Sarbanes-Oxley Act, Senate Banking Committee and House Financial Services Committee hearings in the 

108th and 109th Congresses, comments on the SEC Concept Releases and Proposed Rules, and ‘‘facts otherwise disclosed and 

ascertained.’’ Specifically, Congress finds that: (1) Credit ratings, 

reports, and related documents are distributed and contracts negotiated by use of the mails and means of interstate commerce; (2) 

ratings related to the purchase and sale of securities traded on exchanges and in interstate commerce; (3) the transactions ‘‘substantially . . . affect interstate commerce and securities markets, the 

national banking system, and the national economy’’; (4) oversight 

of such credit rating agencies serves the compelling interest of investor protection; (5) the two largest rating agencies serve the vast 

majority of the market, and additional competition is in the public 

interest; and (6) the Commission has indicated it needs statutory 

authority to oversee the credit rating industry. 

Section 3. Definitions are added to Section 3(a) of the Exchange 

Act for CREDIT RATING, CREDIT RATING AGENCY, NATIONALLY RECOGNIZED STATISTICAL RATING ORGANIZATION, 

PERSON ASSOCIATED WITH A NATIONALLY RECOGNIZED 


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STATISTICAL RATING ORGANIZATION, and QUALIFIED INSTITUTIONAL BUYER (‘‘QIB’’ or ‘‘QIBs’’). 

Section 4. Registration creates a new Section 15E of the Exchange Act with subsections as follows: 

(a) A credit rating agency that wants to become an NRSRO must 

furnish an application that contains the following required information: (i) rating statistics over short-, mid-, and long-term periods; (ii) procedures and methodologies that the rating agency uses 

to determine ratings; (iii) policies or procedures to prevent misuse 

of material nonpublic information; (iv) organizational structure; (v) 

whether the rating agency has a code of ethics and, if not, the reasons; (vi) conflicts of interest related to the issuance of ratings; (vii) 

the types of ratings it intends to issue (financial institutions; 

broker-dealers; insurance companies; corporate issuers; issuers of 

asset-backed securities; and issuers of government securities); (viii) 

on a confidential basis, a list of the 20 largest issuers and subscribers that use the rating services; (ix) on a confidential basis, 

certifications from at least 10 QIBs that they have used the ratings 

for at least the three most recent years, including two certifications 

for each type of rating it will issue—no QIB will be liable in any 

private right of action for what it states in a certification; and (x) 

other data the SEC requires. 

Within 90 days of receiving the application, the SEC shall grant 

registration or institute proceedings to determine whether registration should be denied, which will be concluded within 120 days unless extended for good cause. The Commission will grant registration unless it finds that ‘‘the applicant does not have adequate financial and managerial resources to consistently produce credit 

ratings with integrity and to materially comply with the procedures 

and methodologies’’ disclosed and with certain of its other representations. Upon granting the registration the completed application 

will be made public. 

With respect to the certifications from QIBs stating that they 

have ‘‘used’’ the agencies’’ ratings, the Committee intends ‘‘used’’ to 

mean that the QIB seriously considered the ratings in some of their 

investment decisions. Thus, a QIB whose analysts regularly read 

and consider an agency’s ratings in the course of making investment decisions would have ‘‘used’’ them under the meaning of the 

bill. A QIB whose employees subscribe to or regularly receive the 

ratings but do not read them or, if they read them, rarely or never 

consider them in making their investment decisions would not be 

deemed to have ‘‘used’’ the ratings. 

(b) An NRSRO must update its application ‘‘promptly’’ if the application becomes ‘‘materially inaccurate’’ except with respect to its 

ratings performance statistics and the QIB certifications. An 

NRSRO must annually certify that the application documents 

(other than the QIB certifications) remain accurate and list any 

material changes that occurred. 

(c) The SEC has the authority to prevent NRSROs from issuing 

‘‘credit ratings in material contravention of those procedures’’

which such NRSROs included in their applications and reports. 

The SEC’s rules ‘‘shall be narrowly tailored to meet the requirements of this title . . . and shall not purport to regulate the substance of credit ratings or the procedures and methodologies’’ by 

which such NRSROs determine their ratings. 


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(d) The SEC can by order censure, limit, suspend, or revoke registration of the NRSRO, after notice and comment, for the protection of investors and in the public interest if the NRSRO commits 

any of a variety of specified types of misconduct, if the NRSRO 

‘‘fails to file the [annual] certification required,’’ or ‘‘fails to maintain adequate financial and managerial resources to consistently 

produce credit ratings with integrity.’’ (e) An NRSRO can terminate registration voluntarily, subject to 

the terms and conditions of the SEC. 

(f) An NRSRO may not represent that it ‘‘has been designated, 

sponsored, recommended, or approved, or that the abilities or qualifications thereof’’ have been ‘‘passed upon’’ by the United States or 

any U.S. agency or employee. A rating agency that is not registered 

may not state that it is an NRSRO. 

(g) The Commission must promulgate rules to require NRSROs 

to establish, maintain, and enforce written policies and procedures 

to prevent the misuse of material nonpublic information that it obtains. 

(h) The Commission must promulgate rules to require NRSROs 

to prohibit, or require the management and disclosure of, any conflicts of interest that arise from their business. These rules must 

address: (A) compensation of the NRSRO for ratings and other 

services; (B) the provision of consulting services to companies the 

NRSRO rates; (C) conflicts in business relationships with the 

NRSRO and an entity it rates; (D) affiliations between an NRSRO 

and a securities underwriter; and (E) other potential conflicts that 

the SEC deems appropriate in the public interest or for the protection of investors. 

(i) The Commission must promulgate rules to require NRSROs to 

address any acts or practices that the Commission determines to 

be ‘‘unfair, coercive, or abusive,’’ including those related to: (A) conditioning or threatening to condition an issuer’s credit rating on the 

purchase of other services or products; (B) lowering or threatening 

to lower a credit rating, or refusing to rate securities or money 

market instruments issued by an asset pool, unless a portion of the 

assets in the pool also is rated by the NRSRO; and (C) modifying 

or threatening to modify a credit rating based on whether the 

issuer or an affiliate will purchase other services from the NRSRO. 

The Committee intends that the Commission, as a threshold consideration, must determine that the practices subject to prohibition 

under this section are unfair, coercive, or abusive before adopting 

rules prohibiting such practices. 

With respect to the activities described in subparagraph (B), the 

Committee recognizes that there are instances when a rating agency may refuse to rate securities or money market instruments for 

reasons that are not intended to be anticompetitive. Indeed, in this 

section, the Committee intends that the Commission, after resolving the threshold consideration described above, should prohibit 

only those rating refusals that occur as part of unfair, coercive, or 

abusive conduct. 

(j) Each NRSRO must designate an individual responsible for 

compliance with the securities laws. 

(k) Each NRSRO shall on a confidential basis furnish the Commission with financial statements as the Commission determines 

by rule to be necessary or appropriate. 


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(l) Upon enactment of the Act, a credit rating agency can only be 

registered as an NRSRO by applying under the new law. Existing 

NRSROs will no longer be able to rely on the no-action letters the 

Commission staff has issued. The Commission will notify other 

Federal agencies that use the NRSRO designation in their rules 

and regulations about its actions to implement the new law. 

(m) (1) Registration does ‘‘not constitute a waiver of, or otherwise 

diminish, any right, privilege, or defense that a nationally recognized statistical rating organization may otherwise have under any 

provision of State or Federal law, including any rule, regulation, or 

order thereunder.’’ (2) The law does not create a private right of action regarding any report furnished by an NRSRO under this law. 

(n) The Commission shall issue rules implementing the new law, 

and review and amend (as appropriate) existing rules, within 270 

days after the date of enactment. 

(o) This section shall become effective on the earlier of the date 

on which regulations are issued in final form or 270 days after enactment of this section. 

(p) Conforming amendments [to various statutory provisions]. 

Section 5. Any report that an NRSRO is required by Commission 

rules to make is deemed to be ‘‘furnished’’ and not filed. The SEC 

is authorized to adopt reporting and recordkeeping requirements 

for NRSROs. 

Section 6. The Commission annually shall report to the Senate 

Banking Committee and House Financial Services Committee 

about the applicants for registration, actions taken on these applications, and views of the Commission on the state of competition, 

transparency, and conflicts of interest among NRSROs. 

Section 7. The Government Accountability Office shall study and 

report to the Senate Banking Committee and the House Financial 

Services Committee within 3–4 years after enactment on the impact of the new law on the quality of ratings; the financial markets; 

competition among NRSROs; the incidence of inappropriate conflicts and sales practices; and the process for registration. Also, the 

GAO would report on the problems, if any, faced by business organizations resulting from the Act’s implementation and recommended solutions to such problems. 

CHANGES IN EXISTING LAW

On August 2, 2006, the Committee unanimously approved a motion by the Chairman to waive the Cordon rule. Thus, in the opinion of the Committee, it is necessary to dispense with the requirement of section 12 of rule XXVI of the Standing Rules of the Senate 

in order to expedite the business of the Senate. 

REGULATORY IMPACT STATEMENT

In accordance with paragraph 11(b), rule XXVI, of the Standing 

Rules of the Senate, the Committee makes the following statement 

concerning the regulatory impact of the bill. 

The Act seeks to improve ratings quality for the protection of investors and in the public interest by fostering accountability, transparency, and competition in the credit rating industry. It would result in no significant costs to either the Federal Government or 

state, local, and tribal governments. The Act’s provisions requiring 

certain public disclosures and establishing rules relating to conVerDate Aug 31 2005 07:05 Sep 09, 2006 Jkt 049006 PO 00000 Frm 00012 Fmt 6659 Sfmt 6602 E:\HR\OC\SR326.XXX SR326

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flicts of interest and other matters would impose mandates on the 

private sector resulting in de minimis costs. 

COST OF LEGISLATION

Section 11(b) of rule XXVI of the Standing Rules of the Senate, 

and Section 403 of the Congressional Budget Impoundment and 

Control Act, require that each Committee Report on a bill contain 

a statement estimating the cost of the proposed legislation. The 

Congressional Budget Office has provided the following cost estimate and estimate of costs of private-sector mandates. 

U.S. CONGRESS, CONGRESSIONAL BUDGET OFFICE, Washington, DC, September 1, 2006. 

Hon. RICHARD C. SHELBY, 

Chairman, Committee on Banking, Housing and Urban Affairs, 

U.S. Senate, Washington, DC. 

DEAR MR. CHAIRMAN: The Congressional Budget Office has prepared the enclosed cost estimate for the Credit Rating Agency Reform Act of 2006. 

If you wish further details on this estimate, we will be pleased 

to provide them. The CBO staff contacts are Susan Willie (for federal costs), and Paige Piper/Bach (for the impact on the private sector). 

Sincerely, 

ROBERT T. MURPHY

(For Donald B. Marron, Acting Director). 

Enclosure. 

Credit Rating Agency Reform Act of 2006 

The legislation would require the Securities and Exchange Commission (SEC) to establish a registration process for credit rating 

agcncies (organizations that determine the credit worthiness of securities or money market instruments) that seek to be designated 

by the SEC as a nationally recognized statistical rating organization (NRSRO). Under current law, thcre is no formal registration 

process; SEC staff currently identifies five credit rating agcncies as 

NRSROs. 

Under the bill, SEC would impose disclosure and filing requirements on credit rating agencies seeking registration. The SEC 

would prohibit certain activities of registered credit rating agencies, including issuing or modifying ratings on the condition that 

the customer purchase other services from the credit rating agency. 

Registered credit rating agencies would be subject to new rules developed by the SEC designed to protect private information held by 

the agencies and prevent conflicts of interest. Based on information 

from the Commission and assuming the availability of appropriated 

funds, CBO estimates that implementing the registration and enforcement requirements of the bill would cost $3 million over the 

2007–2011 period. Enacting the bill would not affect direct spending or revenues. 

The bill contains no intergovernmental mandates as defined in 

the Unfunded Mandates Reform Act (UMRA) and would impose no 

costs on state, local, or tribal governments. 


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The bill would impose a new private-sector mandate as defined 

in UMRA on credit rating agencies that are currently identified as 

NRSROs. Under current law, credit rating agencies are identified 

as NRSROs upon receiving a ‘‘no-action’’ letter from the Securities 

and Exchange Commission. The bill would defme the term ‘‘nationally recognized statistical rating organization’’ and void any ‘‘no-action’’ letters previously received from the SEC. Thus, the bill would 

require credit rating agencies that currently are identified as 

NRSROs to register with the SEC and follow certain requirements 

if they want the NRSRO designation as defined under the bill. According to government sources, only five credit rating agencies are 

currently identified as NRSROs. Based on information from government sources, CBO estimates that the incremental cost for those 

agencies to register and follow any prescribed rules would be small 

and fall below the annual threshold for private-sector mandates established by UMRA ($128 million in 2006, adjusted annually for inflation). 

On June 29, 2006, CBO transmitted a cost estimate for H.R. 

2990, the Credit Rating Agency Duopoly Relief Act of 2006, as ordered reported by the House Committee on Financial Services, on 

June 14, 2006. Both this bill and H.R. 2990 would require the SEC 

to establish a registration process for credit rating agencies; accordingly, CBO’s cost estimates are the same. 

The staff contacts for this cost estimate are Susan Willie (for federal costs), and Paige Piper/Bach (for the impact on the private-sector). This estimate was approved by Paul R. Cullinan, Unit Chief 

for the Human Resources Cost Estimate Unit, Budget Analysis Division. 

Æ 


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