CREDIT RATING 

AGENCIES 

Alternative 

Compensation Models 

for Nationally 

Recognized Statistical 

Rating Organizations 

Report to Congressional Committees

January 2012 

GAO-12-240 

United States Government Accountability Office

GAO 
 United States Government Accountability Office 

Highlights of GAO-12-240, a report to 

congressional committees 

January 2012 

CREDIT RATING AGENCIES

Alternative Compensation Models for Nationally 

Recognized Statistical Rating Organizations 

Why GAO Did This Study 

Over the past decade, concerns 

repeatedly have been raised about the 

accuracy of credit ratings provided by a 

number of nationally recognized 

statistical rating organizations 

(NRSRO). NRSRO critics often point to 

the conflict of interest created by the 

industry’s predominant compensation 

model in which issuers of securities 

pay the rating agencies for their ratings 

(issuer-pays model). In 2006, 

Congress established Securities and 

Exchange Commission (SEC) 

oversight over NRSROs, and recently 

enhanced this authority through the 

Dodd-Frank Wall Street Reform and 

Consumer Protection Act (Dodd-Frank 

Act). This act also requires GAO to 

study alternative means for 

compensating NRSROs. This report 

discusses (1) alternative models for 

compensating NRSROs and (2) SEC’s 

actions to implement the act’s 

requirements specific to its oversight of 

NRSROs. To do this work, GAO 

leveraged its 2010 report on NRSROs 

(GAO-10-782), reviewed comment 

letters submitted to SEC as part of its 

study of alternative compensation 

models, proposed and finalized rules 

issued under the act; and interviewed 

SEC staff and authors of alternative 

compensation models. 

What GAO Recommends 

SEC should consult with the authors of 

the proposed models to obtain all 

available information as it considers 

the various alternative compensation 

models and any recommendations for 

statutory changes SEC determines 

should be made to implement the 

findings of its section 939F study. SEC 

agreed with the recommendation. 

What GAO Found 

As of January 2012, GAO identified seven alternative models for compensating 

NRSROs (see table below). These models generally were designed to address 

the conflict of interest in the issuer-pays model, better align the NRSROs’ interest 

with users of ratings, or improve incentives NRSROs have to produce reliable 

and high-quality ratings. However, the amount of detail currently available for 

each model varies and none has been implemented. According to some of the 

authors of the models, there is little incentive to continue developing these 

models because it appears unlikely they will receive attention from regulators or 

legislators. For example, these authors noted that SEC had not reached out to 

them to further discuss these models as part of its ongoing study of alternative 

compensation models for credit rating agencies. 

Identified Alternative Compensation Models for NRSROs 

Name Description 

Random selection Issuers continue to pay for ratings but payment is made to a ratings 

board that randomly assigns NRSROs to rate issuances. 

Investor-owned Institutional investors create and operate an NRSRO. Issuers are 

required to get two ratings, one from the investor-owned NRSRO and one 

from an NRSRO of their choice. 

Stand-alone NRSROs choose which issues to rate. A transaction fee for original 

issuance and fees from secondary market transactions pay for the 

ratings. 

Designation NRSROs choose which issues to rate and securities holders designate 

which NRSRO(s) would receive the fees they pay for rating(s). A third 

party collects and distributes fees. 

User-pays Third-party auditors determine who is “using” ratings and require that all 

“users” pay the NRSROs. 

Alternative user-pays Creditors’ resources are pooled and a government agency or 

independent board uses these resources to solicit ratings. NRSROs bid 

on the right to rate products. 

Issuer and investor-pays Issuers and investors pay a fee on the issuance of new debt and 

secondary market trades. NRSROs are placed in a continuous queue 

and assigned to rate issues as their number comes up. Assignment 

eventually is based on an NRSRO’s performance. 

Source: GAO summary of alternative compensation models. 

During debate on the Dodd-Frank Act, a model similar to the random-selection 

model was proposed through an amendment that would have added a section 

15E(w) to the Securities Exchange Act of 1934 (15E(w) model). Although the 

amendment was not included in the final legislation, section 939F of the DoddFrank Act requires SEC to study, among other things, alternative means for 

compensating NRSROs. It also authorizes SEC to, upon completion of the study, 

establish by rule a system for assigning NRSROs to determine initial credit 

ratings and monitor the ratings of structured finance products in a manner that 

prevents the arranger from selecting the NRSRO that will determine the credit 

rating should SEC conclude that an alternative system is necessary or 

appropriate. In issuing any rule, SEC also must give thorough consideration to 

the section 15E(w) model and implement the model unless it determines that an 

alternative would better serve the public interest and protect investors. As part of 

its solicitation of comments for its ongoing study of alternative compensation 

View GAO-12-240 and components. 

For more information, contact A. Nicole 

Clowers at (202) 512-8678 or 

clowersa@gao.gov. 
Highlights of GAO-12-240 (continued) 

 United States Government Accountability Office 

models, SEC requested that interested parties use the 

framework GAO developed in the 2010 report on NRSROs 

to evaluate the section 15E(w) and other models. GAO 

created this evaluative framework to help identify the 

relative strengths and weaknesses and potential trade offs 

(in terms of policy goals) of the models (see table below). 

Based on GAO’s analysis of comment letters to SEC, while 

a number of comment letters generally favored 

implementing the section 15E(w) model, slightly more 

opposed the implementation of any of the models. Those 

supporting the 15E(w) model highlighted the need to 

address the conflict of interests inherent in the issuer-pays 

model. Those opposed to the alternative compensation 

models cited concerns of replacing one set of conflicts of 

interest with another and the costs of implementation. A 

number of the letters either supported or made suggestions 

for improving existing SEC rules. A few comment letters 

also raised legal questions about the implementation or 

rulemaking for specific aspects of certain models. 

In addition to studying alternative compensation models, 

SEC has begun to implement a number of Dodd-Frank Act 

requirements pertaining to NRSROs. These requirements 

include additional rulemakings related to NRSROs’ 

disclosures of performance statistics, credit ratings 

methodologies, third-party due diligence for asset-backed 

securities, and analyst training and testing standards. Of 

nine rulemaking requirements, SEC has adopted three final 

rules that implement all or part of certain requirements and 

proposed rules for the remaining requirements. SEC also 

has been working to establish an Office of Credit Ratings 

as required by the act. Moreover, SEC examination staff 

completed the first cycle of annual examinations of each 

NRSRO as required by the Dodd-Frank Act and published 

their summary report in September 2011. As part of its 

study on alternative compensation models for NRSROs, 

SEC solicited comment on SEC’s authority to implement 

various alternative compensation models. According to 

SEC staff, they are reviewing the comment letters received 

and evaluating authority issues. Any recommendations for 

regulatory or statutory changes SEC determines should be 

made to implement the findings of the study are to be 

included in their report to Congress, due in July 2012. The 

model authors’ opinions of the extent to which statutory 

changes would be needed to implement their alternative 

compensation models vary, with one stating that current 

law provides SEC with the necessary authority and another 

anticipating the need for legislation. Given that NRSROs 

continue to primarily use the issuer-pays, and to a lesser 

extent, the subscriber-pays models, the use of any 

alternative model or models would likely have to be at the 

direction of SEC or Congress. However, the extent to 

which SEC’s existing authorities would allow it to 

implement any of the alternative models by rule largely will 

depend on the alternative model or models selected. 

Obtaining as complete information on the models as 

available, such as by consulting with the models’ authors, 

will be important for SEC to fully assess each model in 

order to make its decision and any recommendations for 

statutory changes SEC determines should be made to 

implement the findings of its section 939Fstudy.

Framework for Evaluating Alternative Models for Compensating NRSROs 

Factors Description 

 Independence The ability for the compensation model to mitigate conflicts of interest inherent between the entity paying for the rating and 

the NRSRO. Key questions include: What potential conflicts of interest exist in the alternative compensation model and 

what controls, if any, would need to be implemented to mitigate these conflicts? 

 Accountability The ability of the compensation model to promote NRSROs’ responsibility for the accuracy and timeliness of their ratings. 

Key questions include: How does the compensation model create economic incentives for NRSROs to produce quality 

ratings over the life of an issuance? How is NRSRO performance evaluated and by whom? 

 Competition The extent to which the compensation model creates an environment in which NRSROs compete for customers by 

producing higher-quality ratings at competitive prices. Key questions include: To what extent does the compensation 

model encourage competition around the quality of ratings, ratings fees, and product innovation? To what extent does it 

allow for flexibility in the differing sizes, resources, and specialties of NRSROs? 

 Transparency The accessibility, usability, and clarity of the compensation model and the dissemination of information on the model to 

market participants. Key questions include: How transparent are the model’s processes and procedures for determining 

ratings fees and compensating NRSROs? How would NRSROs obtain ratings business? 

 Feasibility The simplicity and ease with which the compensation model can be implemented in the securities market. Key questions 

include: What are the costs to implement the compensation model and who would fund them? Who would administer the 

compensation model? What, if any, infrastructure would be needed to implement it? 

 Market acceptance 

and choice 

The willingness of the securities market to accept the compensation model, the ratings produced under that model, and 

any new market players established by the compensation model. Key questions include: What role do market participants 

have in selecting NRSROs to produce ratings, assessing the quality of ratings, and determining NRSRO compensation? 

 Oversight The evaluation of the model to ensure it works as intended. Key questions include: Does the model provide for an 

independent internal control function? What external oversight does the compensation model provide to ensure it is 

working as intended? 

Source: GAO.
Page i GAO-12-240 Credit Rating Agencies

Letter 1

Background 5

New Developments on Alternative Compensation Models Are 

Limited 7

Proposed Alternative Compensation Models 8

SEC Is Implementing the Dodd-Frank Act and Reviewing Its 

Authority to Implement the Alternative Compensation Models 18

Conclusion 27

Recommendation for Executive Action 28

Agency Comments and Our Evaluation 28

Appendix I Framework to Evaluate Alternative Compensation Models 30

Appendix II Comments from the Securities and Exchange Commission 31

Appendix III GAO Contact and Staff Acknowledgments 34

Table

Table 1: Summary of Existing Rules, Proposed Amendments, and 

Proposed New Rules Applicable to NRSROs and 

Promulgated under the Dodd-Frank Act, as of January 

2012 19

Contents
Page ii GAO-12-240 Credit Rating Agencies

Abbreviations 

CRARA Credit Rating Agency Reform Act of 2006

Dodd-Frank Act Dodd-Frank Wall Street Reform and Consumer 

Protection Act

MSRB Municipal Securities Rulemaking Board 

NRSRO nationally recognized statistical rating organization

OCIE Office of Compliance Inspections and Examinations 

SEC Securities and Exchange Commission

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Page 1 GAO-12-240 Credit Rating Agencies

United States Government Accountability Office

Washington, DC 20548

January 18, 2012

The Honorable Tim Johnson

Chairman

The Honorable Richard C. Shelby

Ranking Member

Committee on Banking, Housing,

 and Urban Affairs

United States Senate

The Honorable Spencer Bachus

Chairman

The Honorable Barney Frank

Ranking Member

Committee on Financial Services

House of Representatives

As the financial crisis unfolded in 2007 and 2008, questions were raised 

about the role that nationally recognized statistical rating organizations 

(NRSRO) played in the securitization of high-risk mortgages into 

investment grade securities, the accuracy of the credit ratings assigned to 

these securities, and the integrity of these NRSROs’ ratings process. 

Although ratings downgrades for investment grade securities are 

generally infrequent, a report by the Permanent Investigations 

Subcommittee of the Senate Homeland Security and Governmental 

Affairs Committee notes that by 2010, 90 percent of the residential 

mortgage-backed securities issued in 2006 and 2007 that had received 

an investment grade rating from the two largest NRSROs were 

downgraded to junk bond status.1

Moreover, in the early 2000s, the NRSROs were criticized for failing to 

warn investors in a timely manner about the impending bankruptcies of 

Critics of NRSROs pointed to the 

conflict of interest created by the industry’s predominant compensation 

model in which issuers of securities pay the rating agencies for their 

ratings (issuer-pays model) as a contributing factor to the poor ratings 

performance.

 1

Staff of Permanent Subcommittee on Investigations, Committee on Homeland Security 

and Governmental Affairs, 112th Congress, Wall Street and the Financial Crisis: Anatomy 

of a Financial Collapse, 263-267 (2011).
Page 2 GAO-12-240 Credit Rating Agencies

Enron and other issuers. Consequently, Congress required the Securities 

and Exchange Commission (SEC) to study the role and function of credit 

rating agencies in the securities markets.2 In its 2003 report, SEC 

identified multiple concerns, such as the concentration of credit rating 

agencies, the potential conflict of interest generated by the NRSROs’

issuer-pays compensation model, and the lack of a formal regulatory 

program to oversee NRSROs.3

To address these and other concerns, Congress passed the Credit Rating 

Agency Reform Act of 2006 (CRARA), which established SEC oversight 

over credit rating agencies registered as NRSROs.4

 2

In 2003 only three credit rating agencies were identified as NRSROs by SEC staff.

Currently, there are nine credit rating agencies registered as NRSROs with SEC.

In February and 

November 2009, SEC amended some of its initial NRSRO rules and 

issued additional rules intended to enhance NRSRO disclosures of 

performance-related data to investors, strengthen the integrity of the 

ratings process, and more effectively address the potential for conflicts of 

interest. SEC also held a roundtable relating to its oversight of credit 

rating agencies in April 2009, at which participants expressed concerns 

about, among other things, market concentration, and discussed 

proposed alternative means for compensating rating agencies that could 

3

See SEC, 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

(Washington, D.C.: Jan. 24, 2003). The practice of issuers paying for their ratings could 

create a conflict of interest. Arguably, the dependence of rating agencies on revenues 

from the companies they rate could induce them to rate issuers more liberally, and temper 

their diligence in probing for negative information. Furthermore, the rating agencies’

practice of charging fees based on the size of the issuance could exacerbate potential 

conflicts because large issuers could inordinately influence the agencies. 

4

Pub. L. No. 109-291, 120 Stat. 1327 (2006) (amending the Securities Exchange Act of 

1934 and codified at various sections of Title 15 of the U.S. Code).
Page 3 GAO-12-240 Credit Rating Agencies

reduce conflicts of interest and ways to increase NRSRO incentives to 

produce accurate ratings.5

More recently, the Dodd-Frank Wall Street Reform and Consumer 

Protection Act (Dodd-Frank Act) imposed new self-executing 

requirements on NRSROs, required SEC to adopt certain rules for 

NRSROs, and required SEC to conduct certain studies.6

The Dodd-Frank Act also requires us to study alternative means for 

compensating NRSROs (alternative compensation models), including any 

For example, 

SEC must periodically review the implementation of policies that 

NRSROs must establish concerning evaluations of possible conflicts of 

interest related to former employees. Other requirements relate to 

disclosures of performance statistics, credit ratings methodologies, thirdparty due diligence for asset-backed securities, and analyst training and 

testing standards. In addition, section 939F requires SEC to study, among 

other things, the credit rating process for structured finance products and 

associated conflicts of interest, the feasibility of establishing a system in 

which a public or private utility or a self-regulatory organization assigns 

NRSROs to determine the credit ratings of structured finance products, 

and alternative means for compensating NRSROs that would create 

incentives for accurate credit ratings (hereafter referred to as the 939F 

study). Section 939F requires SEC to submit to Congress the findings of 

the study and any recommendations for regulatory or statutory changes 

SEC determines should be made to implement the findings by July 21, 

2012.

 5

Subsequent to the SEC roundtable, we also discussed alternative compensation models, 

see GAO, Securities and Exchange Commission: Action Needed to Improve Rating 

Agency Registration Program and Performance Related Disclosures, GAO-10-782

(Washington, D.C.: Sept. 22, 2010). We issued the report in response to a mandate in 

CRARA. The report identified and described five alternative compensation models and 

provided an evaluative framework for assessing the models. In addition, the report 

examined how SEC implemented CRARA and the impact of SEC’s rules promulgated 

under CRARA on the quality of credit ratings, financial markets, competition in the credit 

rating industry, and the process for NRSRO registration.

6

Pub. L. No. 111-203, §§ 931-939H, 872 Stat 1376, 1872-1890 (2010). In addition to 

provisions related to oversight, the Dodd-Frank Act requires every federal agency to 

review regulations that require assessments of the creditworthiness of a security or money 

market instrument and any references to credit ratings in such regulations; to modify such 

regulations to remove any reference to, or requirement for, reliance on credit ratings; and 

substitute a standard of creditworthiness an agency deems appropriate. 15 U.S.C. § 78o-7 

note.
Page 4 GAO-12-240 Credit Rating Agencies

statutory changes that would facilitate the use of such an alternative 

model.7

To identify alternative compensation models, we conducted a literature 

search to identify academic, industry papers, or journal articles and we 

reviewed past GAO reports, notably our 2010 report that examined 

alternative compensation models, among other things.

In response to this mandate, this report discusses (1) alternative 

compensation models for NRSROs and (2) the actions SEC has taken to 

implement the Dodd-Frank Act requirements specific to SEC’s oversight 

of NRSROs and SEC’s authority to implement an alternative 

compensation model under current securities laws.

8

We conducted this performance audit from July 2011 to January 2012 in 

accordance with all generally accepted government auditing standards. 

Those standards require that we plan and perform the audit to obtain 

sufficient, appropriate evidence to provide a reasonable basis for our 

findings and conclusions based on our audit objectives. We believe that 

We also reviewed 

the comment letters submitted to SEC for the 939F study. We reviewed 

these letters to identify market participants’ views on the implementation 

of an alternative compensation model and, where possible, the perceived 

advantages and disadvantages of the models. In addition, we interviewed 

SEC staff and the authors of the compensation models discussed in our 

2010 report to identify any new models and obtain information on any 

additional work they have completed on the previously identified models.

We also solicited and obtained comments from the authors of the two 

models we identified since we issued the 2010 report. To identify the 

actions SEC has taken to implement various Dodd-Frank Act 

requirements, we reviewed SEC proposed and final rules issued pursuant 

to the act and interviewed SEC staff to identify prior and current 

regulatory actions that SEC has taken and challenges it has faced in 

implementing the requirements. To review SEC’s authority to implement 

alternative compensation models and statutory changes that would 

facilitate the use of an alternative means of compensation, we interviewed 

SEC staff and attorneys, reviewed the comment letters submitted to SEC 

for its 939F study, reviewed relevant statutory authority, and solicited 

comments from the authors of the compensation models, which included 

two law professors, an economist, and market participants.

 7

Pub. L. No 111-203, tit. IX, § 939D, 124 Stat. 1376, 1888 (2010).

8

GAO-10-782.
Page 5 GAO-12-240 Credit Rating Agencies

evidence obtained provides a reasonable basis for our findings and 

conclusions based on our audit objectives.

A credit rating is an assessment of the creditworthiness of an obligor as 

an entity or in relation to specific securities or money market instruments.9

SEC first used the term “Nationally Recognized Statistical Rating 

Organization” in 1975 to describe those rating agencies whose ratings 

could be relied upon to determine capital charges for different types of 

debt securities (securities) broker-dealers held.10

NRSRO credit ratings are intended to measure the likelihood of default for 

an issue or issuer, although some also measure variables such as the 

expected value of dollar losses given a default. The NRSROs describe 

ratings as being intended only to reflect credit risk, not other valuation 

factors such as liquidity or price risk. To determine an appropriate rating, 

analysts at rating agencies use publicly available information and market 

and economic data, and may hold discussions and obtain nonpublic 

information from the issuer.

Since then, SEC has 

used the NRSRO designation in a number of regulations, and the term 

has been embedded in numerous federal and state laws and regulations, 

investment guidelines, and private contracts. As will be discussed, SEC 

has issued a series of proposals regarding the removal of references to 

credit ratings in its regulations in accordance with the Dodd-Frank Act.

 9

Section 3(a)(60) of the Securities Exchange Act of 1934 (codified at 15 U.S.C. § 

78c(a)(60)).

1017 C.F.R. § 240.15c3-1. Rule 15c3-1, also known as the net capital rule, establishes 

minimum regulatory capital requirements for broker-dealers. A broker-dealer calculates its 

actual net capital by subtracting prescribed percentages of the market value of its 

securities, known as a haircut, to discount for potential market movements. The net capital 

rule imposes a lower haircut for certain securities that are rated in higher ratings 

categories by NRSROs. The net capital rule also refers to NRSRO ratings in connection 

with the capital treatment of certain currency options, and the calculation of counterparty 

risk for broker-dealers and over-the-counter derivatives dealers under certain 

circumstances. In accordance with the he Dodd-Frank Act, in April 2011, SEC proposed 

regulations to remove from the net capital rule all references to credit ratings and to 

substitute an alternative standard of creditworthiness. SEC generally proposes that a 

broker-dealer take a 15 percent haircut on its proprietary positions in commercial paper, 

nonconvertible debt, and preferred stock unless the broker-dealer has a process for 

determining creditworthiness that satisfies certain criteria. SEC also proposes to remove 

references to NRSRO ratings from other rule provisions. See Removal of Certain 

References to Credit Ratings Under the Securities Exchange Act of 1934, 76 Fed. Reg. 

26550 (May 6, 2011).

Background
Page 6 GAO-12-240 Credit Rating Agencies

Issuers seek credit ratings for reasons such as improving the 

marketability or pricing of their securities or satisfying investors, lenders, 

or counterparties. Institutional investors, such as mutual funds, pension 

funds, and insurance companies, are among the largest owners of debt 

securities in the United States and are substantial users of credit ratings. 

Institutional investors may use credit ratings as one of several inputs to 

their internal credit assessments and investment analyses, or to identify 

pricing discrepancies for their trading operations. Broker-dealers also use 

ratings to recommend and sell securities to their clients or determine 

acceptable counterparties, and collateral levels for outstanding credit 

exposures.

CRARA established SEC oversight of credit rating agencies registered as 

NRSROs. Specifically, CRARA added section 15E to the Securities 

Exchange Act of 1934 to provide SEC with examination authority and 

establish a registration program for credit rating agencies seeking 

NRSRO designation. SEC adopted final rules for a formal registration and 

oversight program for NRSROs in June 2007.11 SEC amended several of 

these rules in February and December 2009 with the goal of further 

increasing transparency of NRSRO rating methodologies, strengthening 

the disclosures of ratings performance, prohibiting NRSROs from 

engaging in certain practices, and enhancing NRSRO record keeping.12

Since the implementation of CRARA, SEC has registered 10 credit rating 

agencies as NRSROs. One of these credit rating agencies has recently 

 11Oversight of Credit Rating Agencies Registered as Nationally Recognized Statistical 

Rating Organizations, 72 Fed. Reg. 33564, 33619-36 (June 18, 2007).(Final 

Rule).(codified, as amended, at 17 C.F.R. §§ 240.17g-1 – 240.17g-6 and 17 C.F.R. § 

249b.300) (2010).

12Amendments to Rules for Nationally Recognized Statistical Rating Organizations, 74 

Fed. Reg. 6456 (Feb. 2, 2009). (Amending 17 C.F.R. §§ 240.17g-2, 240.17g-3, 240.17g-5 

and Form NRSRO); Amendments to Rules for Nationally Recognized Statistical Rating 

Organizations, 74 Fed and Reg. 63833 (Dec. 4. 2009).(Amending 17 C.F.R. §§ 240.17g-2, 

240.17g-5 and 243.100). In December 2009, SEC proposed rules that would require 

NRSRO compliance officers to furnish an annual report to SEC, disclose additional 

information about sources of revenues on Form NRSRO, and make publicly available a 

consolidated report containing information about revenues of the NRSRO attributable to 

persons paying the NRSRO for the issuance or maintenance of a credit rating. Proposed 

Rules for Nationally Recognized Statistical Rating Organizations, 74 Fed. Reg. 63866 

(Dec. 4, 2009). (Proposed amendments to 17 C.F.R. §§ 240.17g-3, 249b.300 and Form 

NRSRO and proposed new § 240.17g-7).
Page 7 GAO-12-240 Credit Rating Agencies

withdrawn from registration as an NRSRO.13 Six NRSROs use the issuerpays compensation model and three operate primarily under the 

subscriber-pays compensation model, in which users pay a subscription 

fee to the NRSRO for access to its ratings. Despite the growth in the 

number of NRSROs and the availability of credit ratings from NRSROs 

operating under a subscriber-pays model, the market remains highly 

concentrated. In 2011, SEC reported that the three largest NRSROs 

(Standard & Poor’s, Moody’s Investment Services, and Fitch Ratings) 

issued approximately 97 percent of all outstanding ratings. Furthermore, 

NRSROs operating under the issuer-pays model issued approximately 99 

percent of the total currently outstanding NRSRO credit ratings. 

Economists note that the credit rating industry has exhibited a high level 

of concentration throughout much of its history. SEC and others have 

noted that the regulatory use of ratings, economies of scale, high fixed 

costs, and network effects (the value or utility of products or services 

increasing with the number of users) as factors that have created barriers 

to entry and led to concentration in the credit rating industry.

In our 2010 report, we identified five proposed models—random 

selection, investor-owned credit rating agency, stand-alone, designation, 

user-pays—and summarized key features of these proposed models.14

 13On October 13, 2011, Rating and Investment Information, Inc., which had been 

registered with SEC as an NRSRO since September 24, 2007, furnished SEC with a 

notice of withdrawal from registration as an NRSRO. The withdrawal became effective on 

November 27, 2011. See http://www.sec.gov/news/digest/2011/dig112811.htm. 

When we conducted our 2010 study, the level of development for each 

model varied and none had been implemented. Our current study 

identified two additional proposed models—the alternative user-pays 

model and the issuer and investor-pays model—and found that little 

additional work had been completed on the previously identified models 

that would provide further details about how each would function.

According to some of the authors of these models, there is little incentive 

to continue developing these models, as the issue of alternative 

compensation models for NRSROs and their possible implementation 

appears unlikely to receive much, if any, attention from regulators or 

legislators. For example, these authors told us that SEC had not reached 

out to them to further discuss these models as part of the 939F 

14For more information about how we identified the alternative compensation models, see 

GAO-10-782. 

New Developments 

on Alternative 

Compensation Models 

Are Limited
Page 8 GAO-12-240 Credit Rating Agencies

study. However, SEC did solicit public comments about the models 

through a public notice in conducting its 939F study. Furthermore, SEC 

staff said that they held follow-up discussions with the authors of some of 

the models after the 2009 SEC roundtable.15 While these models 

generally are intended to address the conflict of interest in the issuer-pays 

model, some comment letters to SEC for its section 939F study described 

a number of perceived disadvantages of these models. None of the 

models has been implemented as of January 2012.

As of January 2012, we have identified seven proposed alternative 

compensation models. The following summarizes the key features of 

each of these proposed models.

A ratings clearinghouse randomly would select NRSROs to rate a new 

issuance in this proposed model. The clearinghouse could be a nonprofit, 

a governmental agency such as SEC, or a private-public partnership that 

would design the criteria by which new entrants could qualify as a credit 

rating agency. All issuers or sponsors that wanted ratings for their 

issuances would request them from the clearinghouse, which would use a 

random number generator to assign an NRSRO registered in the relevant 

asset class to produce the rating. The clearinghouse would notify the 

NRSRO of the opportunity to rate the issuance and provide basic 

information on the type of issuance but not the issuer’s name. Not until 

the NRSRO agreed to complete the rating would the clearinghouse 

identify the issuer and details of the issuance. If the selected NRSRO 

agreed to rate the issuance, the issuer would pay a fee to the 

clearinghouse. The issuer also would pay to cover clearinghouse costs on 

top of those required to rate the security. Upon completion of the initial 

and maintenance ratings, the clearinghouse would distribute the fees to 

the NRSRO. The clearinghouse would set the ratings fees for the NRSRO 

depending on the type of security issued, but the letter rating would be 

free of charge to the public.

The proposed model incorporates a peer comparison review to create an 

incentive for NRSROs to produce quality ratings. As part of this review, 

the clearinghouse would evaluate the performance of all NRSROs on the 

 15Only one of the model authors submitted a comment letter to SEC for this study and 

none of the authors of the models we identified in our 2010 report submitted a comment 

letter. 

Proposed Alternative 

Compensation Models

Random Selection Model
Page 9 GAO-12-240 Credit Rating Agencies

basis of two empirical tests. For instance, if the default percentage of debt 

instruments rated by a given NRSRO differed from the default percentage 

of its peers by a set parameter, then the NRSRO would be subject to 

sanctions such as losing a percentage of business or rating fees. A 

second test would compare annual yields of identically rated debt 

securities from different asset classes. Securities in different asset 

classes that are rated similarly should have the same yield. An NRSRO 

would be subject to sanctions if the yields of identically rated securities 

differed by a certain threshold.

According to the author of this proposed model, by eliminating the linkage 

between the NRSRO and the issuer, this model would eliminate the 

conflict of interest stemming from the issuer-pays model. Furthermore, 

the author stated that the peer comparison review coupled with economic 

sanctions for poor performance would motivate the NRSROs to 

continually adjust their models and produce quality ratings.

Under this model, sophisticated investors—referred to as “highly 

sophisticated institutional purchasers” in the model—would create and 

operate an NRSRO that would produce ratings. Issuers would have to 

obtain two ratings—one from the investor-owned NRSRO and the second 

from their choice of NRSRO. More specifically, an NRSRO could not 

publicly release a rating for which an issuer or sponsor paid unless the 

NRSRO received written notification that the issuer had paid an investorowned NRSRO to publicly release its rating. The investor-owned NRSRO 

would publish its rating on or before the date on which the solicited 

NRSRO published its rating.

Institutional investors would have to qualify as highly sophisticated 

institutional purchasers before forming or joining an investor-owned 

agency. To qualify, an institutional investor would have to demonstrate 

that it was large and sophisticated, managed billions of dollars in assets, 

and could be relied upon to represent the buy-side interest in accurately 

rating debt market instruments. The investor-purchasers would hold 

majority voting and operational control over the agency, which could be 

for-profit or not-for-profit. Market forces would set the agency fees, which 

likely would be comparable to fees currently charged by dominant 

NRSROs. The letter rating and the underlying research would be free to 

the public.

Proponents of this model believe that it would improve the rating process 

by changing incentive structures. They said that investor-owned agencies 

Investor-Owned Credit Rating 

Agency Model
Page 10 GAO-12-240 Credit Rating Agencies

would introduce new competition to the industry and balance the 

investors’ interests against issuers’ interests.

NRSROs would only be permitted to produce credit ratings in this 

proposed model. They could interact with and advise organizations being 

rated, but could not charge fees for advice.16

Proponents of this model believe that by creating a funding source 

beyond the influence of both issuers and investors, NRSROs would focus 

on producing the most accurate and timely credit analysis rather than on 

satisfying the desires of any other vested interest.

Instead of receiving issuer 

fees, the NRSROs would be compensated through transaction fees for 

original issuance and secondary market transactions. The issuer or 

secondary-market seller would pay part of the fee, and the investor 

purchasing the security (in the primary or secondary market) would pay 

the other part. The NRSRO would be compensated over the life of the 

security based on these transaction fees. The letter rating would be free 

to the public.

In this proposed model, all NRSROs could opt to rate a new issuance and 

security holders would direct, or designate, fees to the NRSROs of their 

choice. When an issuer brought a security to market, it would have to 

provide all interested NRSROs with the information to rate the issuance 

and pay rating fees to a third-party administrator, which would manage 

the designation process.17 The investors that purchased the debt 

issuance would each designate one or several NRSROs that rated the 

security to receive fees, based on their perception of research underlying 

the ratings. The third-party administrator would disburse the fees in 

accordance with the designations.18

 16If the NRSRO was part of a larger company, interaction between the parent company 

and the NRSRO would be prohibited. 

After the initial rating, the issuer 

would continue to pay maintenance rating fees to the third-party 

administrator. A final rating fee would be paid in conjunction with the 

17The model as proposed did not specify how ratings fees would be determined, but 

suggested that issuers could negotiate with the NRSROs to determine the fee or the 

NRSROs could establish a schedule for different kinds of securities.

18The proposed model suggests that the issuer’s transfer agent could perform the 

responsibilities of the third-party administrator. The transfer agent currently is responsible 

for maintaining ownership records of security holders.

Stand-Alone Model

Designation Model
Page 11 GAO-12-240 Credit Rating Agencies

retirement (or repurchase) of the security. The letter rating would be free 

to the public, while the research underlying it would be distributed to 

security holders and (at the discretion of the relevant NRSROs) to 

potential security holders.

The authors of this proposed model said it would eliminate conflicts of 

interest resulting from issuers paying for ratings and increase competition 

by allowing all NRSROs access to the information necessary to rate any 

issuance. The authors also stated that this model encourages NRSROs 

to prepare ratings because each NRSRO that did could profit from its 

ratings to the extent investors or other users find the ratings useful.

Issuers would not pay for ratings under this proposed model; rather, all 

users of ratings would enter into a contract with an NRSRO and pay for 

rating services. The proposal defines “user” as any entity that included a 

rated security, loan, or contract as an element of its assets or liabilities as 

recorded in an audited financial statement. For example, users could be 

holders of long or short positions in a fixed-income instrument, parties 

that refer to a credit rating in contractual commitments (that is, as parties 

to a lease), or parties to derivative products that rely on rated securities or 

entities. A user would have to pay for ratings services supplied during 

each period in which it booked the related asset or liability.

The proposed model relies on third-party auditors to ensure that NRSROs 

receive payment for their services from users of ratings. The user would 

have to demonstrate to the auditors that the holder of a rated instrument 

or contract paid for the rating services. Until auditors were satisfied that 

NRSROs had been properly compensated, they would not issue audit 

opinions. The model would require the close cooperation of the auditing 

community and the Public Company Auditing Oversight Board.19

The authors of this model stated that, while more cumbersome, the model 

attempts to capture “free riders”—those users of ratings that do not 

compensate NRSROs for the use of their intellectual property—and 

requires them to pay for ratings.

 19The Public Company Accounting Oversight Board is a nonprofit corporation established 

by Congress to oversee the audits of public companies.

User-Pays Model
Page 12 GAO-12-240 Credit Rating Agencies

The alternative user-pays model would pool creditors’ resources to 

secure ratings before debt was issued. A government agency or 

independent board would administer a user-fee system financed by debt 

purchasers, which would fund a competitive bidding process for the 

selection of rating agencies. The agency or board would solicit ratings 

before the debt issuance and then pay for the expense and related 

administrative costs through the user fee.20

NRSROs would bid on the right to issue ratings with the agency or board 

determining how best to judge the bids and award the right to rate the 

issuance. For example, the agency or board could weigh factors such as 

price, extent of diligence the NRSRO proposed to undertake, and the 

disclosures the NRSRO would demand from issuers as a condition for the 

rating. The author believes the bidding process would serve to contain the 

costs for ratings through price competition, level the playing field for 

smaller competitors and new entrants, and balance the desire for marketbased assessments of risk with a greater role for the government agency,

such as SEC, or an independent board in defining rating agencies’

responsibilities.

The user fee could be 

assessed through a flat fraction of a percentage fee on the initial 

purchasers of debt offerings. The user fee would allow the agency or 

board to finance initial ratings on a rolling basis, with the ratings for a 

given debt issuance being secured before the issuance of the debt.

Although the fee could be assessed in many ways, the author of the 

model suggests a one-time fee at initial sale for administrative ease.

According to its author, this user-fee model creates additional 

accountability mechanisms. Users of ratings would be given enforceable 

rights and would require NRSROs to assume certification and mandatory 

reporting duties to creditors. The system would set up creditor 

committees that would serve as a channel for creditors to monitor ratings 

and assert limited rights against NRSROs. If an NRSRO breached duties 

owed to the creditors, the committee would serve as the representative in 

any potential actions and preempt actions brought by individual creditors. 

The model would require that all contracts with NRSROs detail duties 

owed to their creditors, to delineate the potential liability exposure for 

 20In instances in which companies fail to issue rated debt, SEC could be empowered to 

impose the user fee on the issuers themselves since they would be the only readily 

identifiable beneficiaries of information on their creditworthiness, according to the authors 

of this proposed model.. 

Alternative User-Pays Model
Page 13 GAO-12-240 Credit Rating Agencies

breach of these duties, and channel adjudication of any disputes to an 

SEC administrative process. For example, NRSROs could be required to 

certify on a quarterly basis that they exercised reasonable care in 

conducting due diligence of issuers’ financial and nonfinancial disclosures 

to make accurate assessments of risk exposure. To provide NRSROs 

with incentives for compliance without jeopardizing their financial viability, 

the model would limit NRSRO financial liability to cases of gross 

negligence, coupled with an earnings-based cap on liability and other 

safeguards.

This proposed model incorporates characteristics from a number of the 

models described earlier and leverages an existing structure as the basis 

for collecting and distributing ratings fees. Under the proposed issuer and 

investor-pays model, accredited NRSROs would be assigned to rate new 

issuances. Initially, all NRSROs would be placed in a continuous queue 

and would receive rating assignments when their respective numbers 

came up, unless they were unable or unwilling to rate a particular issue. 

In the future, ratings would be assigned based on the performances of the 

NRSROs, with those agencies that produced superior performance 

receiving more assignments. Performance would be measured as the 

correlation between an NRSRO’s ratings and default and recovery rates 

on issues rated, and tracked using a common, transparent, and 

defensible methodology. To help ensure rigor and fairness, at least two

and possibly three NRSROs would be assigned to rate each issuance.

Payments for ratings would come from a fee levied on issuers of new 

debt issues and investors as parties of secondary market trades. These 

fees would be deposited in a dedicated fund—the U.S. Ratings Fund—

and would be determined and reset periodically. The periodic review 

would consider the historic and projected volumes of primary issuances 

and of secondary market trading to determine a fee that would in the 

aggregate allow the ratings business to attract and retain qualified 

individuals. This fund would be modeled after the Municipal Securities 

Rulemaking Board (MSRB), which is authorized to collect fees on new 

and secondary market municipal issues to fund its activities, and would 

be overseen by a governing board representing issuers, investors, rating 

agencies, intermediaries, and independent directors. The fees collected 

would be used to pay the selected accredited NRSROs for issuing each 

solicited rating and other necessary administrative activities such as 

tracking NRSRO’s performance and tracking deals to be rated. The 

authors note that these other activities could be outsourced or performed 

by the U.S. Ratings Fund. The Fund also would advise SEC on the 

eligibility and accreditation of the NRSROs. All ratings and related 

Issuer and Investor-Pays Model
Page 14 GAO-12-240 Credit Rating Agencies

research reports paid for through the U.S. Ratings Fund would be freely 

available to the public.

According to the authors, NRSROs would have incentives to provide 

accurate ratings and be objective because ratings would be monitored by 

a regulator and the accreditation of NRSROs would be subject to periodic 

renewal. The authors also note that legislation likely would be required to 

set up the new rating agency compensation model. Specifically, the 

authors said that legislation would need to enumerate the functions and 

the governance structure of the U.S. Ratings Fund, provide its mandate 

and methodology for determining the fees to be charged for ratings, and 

elaborate on how the new rating model would be introduced.21

During debate on the Dodd-Frank Act, a system similar to the random 

selection model was proposed through an amendment to the Securities 

Exchange Act of 1934. Proposed section 939D would have added a 

section 15E(w) to the Exchange Act which would require SEC to establish 

a Credit Rating Agency Board that was a self-regulatory organization 

subject to SEC’s oversight. The Board would determine NRSROs that are 

eligible to issue initial credit ratings for structured finance products and 

assign NRSROs to rate the issuances (NRSROs could decline). The 

method for selecting the qualified NRSROs would be based on a Board 

evaluation of alternatives designed to reduce the conflicts of interest 

under the issuer-pays model, including a lottery or rotational assignment 

system. Although the section 939D amendment was passed by the 

Senate, it was not included in the final legislation. However, the Dodd-

 21A variant of the issuer and investor pay model—with similar features and legislative 

needs—is a “market pay” model concept in which the credit rating agencies would be part 

of a cooperative overseen by a board made up of individuals representing institutional and 

retail investor interests. The board’s primary functions would be to approve credit rating 

agencies eligible to rate issuances and collect and distribute fees to the selected credit 

rating agencies that provided rating services. Implementation of this model would also 

likely require legislation; such as to enumerate the functions and the governance of the 

oversight board, as well as to establish the cooperative framework. Unlike the issuer and 

investor pay model, this variant would generate funds to pay the rating agencies’ fees 

(and potentially board costs) by incorporating a market-wide fee into the issuances’

coupon rate, i.e., a payment strip. It also differs by allowing the issuer and investors (as a 

group) each to select the credit rating agencies in the cooperative they would like to rate 

the issuances. There would be a limit to the number of rating agencies selected, 

potentially up to two selected by an issuer and two by the investors. As with the issuer and 

investor pay model, all ratings and related research would be freely available to the public. 

Comment Letters to SEC 

Supported Implementing 

One Alternative Model or 

Enhancing Existing Rules
Page 15 GAO-12-240 Credit Rating Agencies

Frank Act provides that upon completion of the section 939F study, SEC 

shall, as it determines is necessary or appropriate in the public interest or 

for the protection of investors, establish by rule a system for the 

assignment of NRSROs to determine the initial credit ratings and monitor 

the credit ratings of structured finance products in a manner that prevents 

the arranger from selecting the NRSRO that will determine the credit 

rating. In issuing any rule, the act requires SEC to give thorough 

consideration to the provisions of section 15E(w) of the Exchange Act, as 

that provision would have been added by section 939D as passed by the 

Senate on May 20, 2010, and SEC must implement the system described 

in such section 939D unless SEC determines that an alternative system 

would better serve the public interest and the protection of investors.

In May 2011, SEC requested that interested parties provide comments on 

whether any potential alternative compensation model, including four of 

the models we described in our 2010 report and discussed previously 

would provide a reasonable alternative to the section 15E(w) model in 

terms of objectives and goals. SEC omitted the random selection model 

from its request for comment because it is similar to the section 15E(w) 

model. As part of this solicitation of comments, SEC requested that 

interested parties use the evaluative framework we developed for our 

2010 report to evaluate the section 15E(w) and other alternative 

compensation models.22

Our analysis of the comment letters that various market participants and 

observers submitted on SEC’s section 939F study found that while some 

supported implementing the section 15E(w) model, others preferred 

enhancing existing SEC rules. Of the 30 comment letters submitted, our 

assessments found that 11 generally favored implementing an alternative 

compensation model, 13 opposed the implementation of an alternative 

compensation model, and 5 did not comment on the need for an 

The comment period ended in September 2011.

 22We developed a framework to assist regulators and policymakers identify a model’s 

relative strengths and weaknesses, potential trade-offs in terms of policy goals, or areas in 

which further elaboration or clarification would be warranted. See appendix I for more 

information on our evaluation framework.
Page 16 GAO-12-240 Credit Rating Agencies

alternative compensation model.23 Sixteen comment letters either 

supported or made suggestions for improving existing SEC rules. None of 

the comment letters supported any of the other alternative compensation 

models described by SEC in its request for comment.24

Only the section 15E(w) model received specific support from those that 

supported the implementation of an alternative compensation model. 

Generally, these letters highlighted the need to address the conflict of 

interest inherent in the issuer-pays model. For example, one commenter 

stated that an assignment system—such as the one proposed in the 

model—best serves the public interest by increasing competition to allow 

for new NRSRO participants. The author of another comment letter stated 

that on balance he favored a system—such as the one proposed in the 

15E(w) model—that would separate issuer payment for ratings on 

structured finance products from issuer selection of NRSROs.

Only seven 

addressed the alternative models individually and all were critical of these 

alternatives.

Those opposed to the implementation of an alternative compensation 

model, including the section 15E(w) model, cited concerns such as 

replacing one set of conflicts of interest with another and raised issues 

about the cost of implementation. According to a few comment letters, 

each of the proposed models presents its own unique set of issues and 

often substitutes one type of conflict of interest for another. For example, 

one comment letter stated that each compensation model has 

unavoidable conflicts of interest and that none of the alternatives 

presented by SEC would offer practical or effective solutions to the risks 

of potential conflicts engendered by the issuer-pays model. Another 

 23One commenter submitted two comment letters, both in favor of the 15E(w) model. We 

counted this commenter’s support only once when tallying the letters for or against the 

implementation of an alternative compensation model. Of the five that did not comment on 

the need for an alternative compensation model, three discussed the models but did not 

specifically comment on the need for one and two did not address the alternative 

compensation models. SEC staff are in the preliminary stages of analyzing the comment 

letters. 

24SEC staff also interpreted one comment letter as supporting a combination of the 

15E(w) model and the stand- alone model. We interpreted this to be a unique alternative 

compensation model and thus the letter was not showing support for any of the other 

alternative compensation models described by SEC in its request for comment. We 

described the model put forth in this comment letter earlier as the alternative user-pays 

model.
Page 17 GAO-12-240 Credit Rating Agencies

comment letter cited specific conflicts various market participants may 

have, concluding that changing “who pays” the credit rating agency will 

not eliminate the potential for conflicts: it will only shift the conflicts from 

one set of interested parties to another.25

Many of the letters opposed to the implementation of an alternative 

compensation model noted the need for the improvement of existing 

rules. For example, multiple comment letters suggested that SEC’s rule 

17g-5, which is designed to make it more difficult for issuers to exert 

influence over NRSROs by making the information necessary to rate the 

issuance available to all NRSROs, addresses many of the concerns that 

the alternative compensation models propose to address. They added 

that this rule could be improved by increasing the percent of “free peeks”

an NRSRO would be allowed before having to produce an unsolicited 

rating. 

Comment letters also stated 

that some of the models would create large costs. For example, one 

comment letter stated that the selection board created in the section 

15E(w) model would need to employ a significant staff with highly 

specialized skills to credibly carry out its responsibilities. Another letter 

described the extensive amount of infrastructure that would be needed to 

assess fees on each trade, such as those required by the stand-alone 

model.

26

 25Similarly, in our 2010 report we noted that the subscriber-pays model also is subject to 

conflicts of interest because the investors could influence the NRSRO to upgrade or 

downgrade securities investors were holding to their advantage. For example, subscribers 

may want to hold only investment-grade securities because their investment guidelines 

require this. An upgrade to investment grade would allow subscribers to hold that security.

See 

Others advocated the removal of the requirement entirely or 

replacing the “unsolicited rating requirement” with a requirement that 

ratings agencies provide a specified number of “rating commentaries or 

other credit quality statements.” Finally, some advocated for the 

GAO-10-782.

26Rule 17g-5 requires an NRSRO hired to determine initial credit ratings for structured 

finance products to maintain a password-protected Internet website containing a list of 

each such structured finance product for which it currently is in the process of determining 

an initial credit rating. The rule is designed to make it more difficult for arrangers to exert 

influence over the NRSRO they hire because any inappropriate rating could be exposed to 

the market through the unsolicited ratings issued by NRSROs not hired to rate the 

structured finance product. However, the rule limits the number of times an NRSRO can 

access the information without having to produce its own credit ratings. An NRSRO that 

accesses information 10 or more times during the calendar year must produce a credit 

rating for at least 10 percent of the issues for which it accessed information. See 17 

C.F.R. § 240.17g-5(a)(3).
Page 18 GAO-12-240 Credit Rating Agencies

information provided to the selected NRSRO to be made more broadly 

available, particularly to investors.

The Dodd-Frank Act requires SEC to take a number of actions regarding 

its oversight of NRSROs including issuing a number of rulemakings, 

establishing an Office of Credit Ratings, and studying, among other 

things, the feasibility of an assignment system for the ratings of structured 

finance products and alternative means for compensating NRSROs. As 

part of this study, SEC has solicited comment on its authority to 

implement the alternative compensation models.

Since the enactment of the Dodd-Frank Act in July 2010, SEC has taken 

a number of steps to implement the parts of the act pertaining to 

NRSROs. Of the 15 requirements for SEC contained in Title IX of the 

Dodd-Frank Act, 9 require SEC to issue rules. As of January 2012, SEC 

has adopted three final rules that implement all or part of certain 

requirements and proposed rules to implement the remaining 

requirements. Specifically, SEC has adopted rules removing the 

exemption for NRSROs from the Fair Disclosure Rule; requiring NRSROs 

to include a report accompanying a credit rating for an asset-backed 

security describing representations, warranties, and enforcement 

mechanisms available to investors; and removing references to NRSRO 

credit ratings from certain securities registration requirements. SEC has 

also proposed a number of amendments to existing rules or new rules to 

implement the remainder of the Dodd-Frank Act requirements applicable 

to NRSROs. Table 1 provides a summary of these proposals.

SEC Is Implementing 

the Dodd-Frank Act 

and Reviewing Its 

Authority to 

Implement the 

Alternative 

Compensation Models

SEC Has Taken a Number 

of Steps to Implement 

Dodd-Frank Act 

Requirements
Page 19 GAO-12-240 Credit Rating Agencies

Table 1: Summary of Existing Rules, Proposed Amendments, and Proposed New Rules Applicable to NRSROs and 

Promulgated under the Dodd-Frank Act, as of January 2012

Rule number Summary of existing rules

Summary of proposed 

amendments to existing rules Summary of proposed new rules

Rule 17g-1 Prescribes how an NRSRO must 

apply to be registered with SEC, 

keep its registration up-to-date, and 

comply with the statutory 

requirement to furnish SEC with an 

annual certification. Specifically, all 

of these actions must be 

accomplished by furnishing SEC 

with information on a Form NRSRO. 

As part of registration, NRSROs 

must disclose certain performance 

statistics and general descriptions of 

their ratings processes and 

methodologies.

Revises instructions to exhibit 1 of 

Form NRSRO to standardize the 

manner in which NRSROs present 

performance measurement statistics 

and define important terms such as 

“default.”

Requires that all exhibits (1-9) to 

Form NRSRO be made available to 

the public from an easily accessible 

portion of the NRSRO’s website.

N/A

Rule 17g-2 Requires an NRSRO to make and 

retain certain types of business 

records and disclose certain ratings 

history data.

Updates rule to include new recordkeeping requirements resulting from 

amendments to other rules or new 

rules. For example, to identify the 

internal control structure, an NRSRO 

must document the structure in a 

record that must be retained.

Enhances ratings history disclosures 

to require NRSROs to disclose the 

rating histories for any credit rating 

that was outstanding as of June 26, 

2007, and repeals a rule requiring 

issuer-pays rating agencies to 

disclose a random 10 percent sample 

of outstanding ratings in each class 

of ratings in which they have more 

than 500 issuer-paid ratings. Also, it 

would move the provisions of the 100

percent rule to 17g-7.

N/A

Rule 17g-3 Requires an NRSRO to furnish SEC 

with four, or in some cases five, 

financial reports annually. The first 

report requires the submission of 

audited financial statements. The 

remaining reports are unaudited. 

Also requires the NRSRO to provide 

SEC with an unaudited report of the 

number of credit rating actions 

during the fiscal year in each class 

of credit rating for which it is 

registered. 

Requires an NRSRO to file an 

unaudited report on the NRSRO’s 

internal control structure with its 

annual submission of reports. The 

proposal also requires a statement 

signed by the CEO or person 

performing similar functions, attesting 

that the report fairly presents a 

description of the responsibilities of 

management in establishing and 

maintaining an effective internal 

control structure. 

N/A
Page 20 GAO-12-240 Credit Rating Agencies

Rule number Summary of existing rules

Summary of proposed 

amendments to existing rules Summary of proposed new rules

Rule 17g-4 Prescribes minimal requirements for 

the policies and procedures that 

registered NRSROs are required to 

establish, maintain, and enforce to 

address specific areas in which

material, nonpublic information could 

be inappropriately disclosed or used. 

N/A N/A

Rule 17g-5 Prohibits certain actions that 

constitute an impermissible conflict 

of interest and prescribes 

requirements to manage other 

inherent conflicts of interest.

Requires an NRSRO hired by an 

arranger to rate a structured finance 

product to obtain representation 

from the arranger that it will provide 

information it has been given to the 

nonhired NRSROs.

Identifies a new prohibited conflict, 

sets forth the finding the 

Commission would need to make to 

grant a small NRSRO an exemption 

from the prohibition, and sets forth 

the standard for suspending or 

revoking an NRSRO registration for 

a violation of any rule under section 

15E(h). Includes a new absolute 

prohibition on an NRSRO issuing or 

maintaining a credit rating where a 

person within the NRSRO who 

participates in the sales or 

marketing of a product or service of 

the NRSRO also participates in 

determining or monitoring the credit 

rating, or developing or approving 

procedures or methodologies used 

for determining the credit rating. 

SEC can determine that separation 

of production and sales and 

marketing is not appropriate for 

small NRSROs and waive the 

requirement for these NRSROs. 

N/A

Rule 17g-6 Prohibits any act or practice by an 

NRSRO that SEC determines to be 

unfair, abusive, or coercive. 

N/A N/A

Rule 17g-7 N/A N/A Requires an NRSRO to include in a 

report accompanying a credit rating 

for an offering of asset-backed 

securities describing the 

representations, warranties, and 

enforcement mechanisms available 

to investors; and how they differ 

from representations, warranties, 

and enforcement mechanisms in 

issuances of similar securities. Also 

information on any preliminary 

ratings. (Adopted Jan. 20, 2011.)

Enhances the 100 percent rule to 

require disclosure of information 

about all outstanding credit ratings 

in each class and subclass of credit 

ratings for which the NRSRO is
Page 21 GAO-12-240 Credit Rating Agencies

Rule number Summary of existing rules

Summary of proposed 

amendments to existing rules Summary of proposed new rules

registered, within certain prescribed 

time frames. The rule would apply to 

any credit rating that was 

outstanding as of June 26, 2007, but 

the rating histories disclosed for 

these credit ratings would not need 

to include information about actions 

taken before June 26, 2007. 

Rule 17g-8 N/A N/A Requires the NRSRO to establish, 

maintain, and enforce policies and 

procedures reasonably designed to 

ensure that in any case in which an 

employee of a person, issuer, 

sponsor, etc. subject to a credit 

rating was employed by the NRSRO 

and participated in any capacity in 

determining the credit rating for that 

person during the 1-year period 

preceding the date an action was 

taken on that rating the NRSRO will 

conduct a review to determine if 

there were any conflicts of interest.

If a conflict is found, the NRSRO 

shall

(1) immediately place the credit 

rating on credit watch, including 

providing users of credit ratings with 

immediate notice.

(2) promptly determine if the credit 

rating must be revised.

(3) promptly publish a new rating or 

reaffirm the existing rating.

Requires NRSROs to ensure that 

credit ratings are determined using 

procedures and methodologies, 

including qualitative and quantitative 

data and models, which are 

approved by the board of the 

NRSRO, or a body performing a 

function similar to that of a board. It 

also would require an NRSRO to 

ensure that when material changes 

are made to credit rating procedures 

and methodologies, to the extent 

that changes are made to credit 

rating surveillance procedures and 

methodologies, the changes are 

applied to then-current credit ratings 

by the NRSRO within a reasonable 

time period.
Page 22 GAO-12-240 Credit Rating Agencies

Rule number Summary of existing rules

Summary of proposed 

amendments to existing rules Summary of proposed new rules

Rule 17g-9 N/A N/A Requires that any person employed 

by an NRSRO to perform credit 

ratings meets standards of training, 

experience, and competence and is 

tested for knowledge of the credit 

rating process. The proposed rule 

also identifies certain factors that an 

NSRO must consider in designing 

its standards and two factors that 

must be incorporated into the 

standards.

Rule 17g-10 N/A N/A Provides that the signed written 

certifications of providers of thirdparty due diligence services 

required must be made on Form 

ABS Due Diligence-E15.

Regulation FD N/A Removes the specific exemption 

that allowed an issuer to not make 

public the disclosure of material 

nonpublic information if the only 

disclosure of that information is 

made to a credit rating agency that 

makes its credit ratings publicly 

available (adopted September 29, 

2011).

N/A 

Rules 134, 138, 

139, 168, Form S3, Form S-4, Form 

F-3 and Form F-4

N/A Remove references to credit ratings 

(adopted July 27, 2011).

N/A

Rule 2a-7, Form NMFP, Forms N-1A, 

N-2, and N-3

N/A Remove references to credit ratings 

or eliminate the disclosure of credit 

ratings (proposed March 3, 2011).

N/A

Rule 6a-5 N/A Replaces references to credit 

ratings with a new standard of 

creditworthiness. Under the new 

standard, a security is eligible for 

investment by a specific type of 

company if the board of directors or 

members of the company determine 

that the debt security is (i) subject to 

no greater than moderate credit risk 

and (ii) sufficiently liquid that the 

security can be sold at or near its 

carrying value within a reasonably 

short period of time (proposed 

March 3, 2011).

N/A
Page 23 GAO-12-240 Credit Rating Agencies

Rule number Summary of existing rules

Summary of proposed 

amendments to existing rules Summary of proposed new rules

Rules 15c3-1, 

15c3-3, 17a-4; 

Rules 101 and 102 

of Regulation M 

and 10b-10 and 

Form X-17A-5 

Part IIB.

N/A Remove references to credit ratings 

and in certain cases substitute 

alternative standards of 

creditworthiness (proposed April 27, 

2011).

N/A

Source: GAO summary of SEC Proposed Rule Release.

Note: All of the proposed amendments to existing rules and new rules were proposed on May 18, 

2011, and published in the Federal Register on June 8, 2011, unless otherwise noted in the table. 

According to its website, SEC plans to finalize the remaining proposed rules and amendments 

between January and June 2012. However, SEC proposed rules for the removal of statutory 

references to credit ratings from specific laws, and regulations require SEC to coordinate with other 

federal regulators. Thus, it is unclear when SEC may adopt final rules pertaining to other rules and 

regulations this issue.

In addition to its work on NRSRO oversight rules, SEC continues to work 

on other Dodd-Frank Act requirements related to NRSROs. These 

requirements include completing four studies on various aspects of the 

credit rating industry.27

 27Section 939A requires SEC to review any regulation that requires the use of an 

assessment of the creditworthiness of a security and any references to or requirements in 

such regulations regarding credit ratings. SEC provided this report to Congress on July 

21, 2011. Section 939C requires SEC to study the independence of NRSROs and how the 

independence of NRSROs affects the ratings issued by the NRSROs. This report is to be 

completed not later than 3 years after the date of enactment of the Dodd-Frank Act. As 

described previously, section 939(h) requires SEC to study, among other things, the 

feasibility and desirability of standardizing credit rating terminology, standardizing market 

stress conditions under which ratings are evaluated, and requiring a quantitative 

correspondence between credit ratings and a range of default probabilities and loss 

expectations under standardized conditions of economic stress. This study was to be 

completed no later than 1 year after the date of enactment of the Dodd-Frank Act. Section 

939F requires SEC to study the rating process for structured finance products and 

associated conflicts of interest, the feasibility of an assignment system, metrics to 

determine the accuracy of ratings, and alternative means for compensating NRSROs. This 

report is to be completed not later than 24 months after the date of enactment of the 

Dodd-Frank Act.

As of January 2012, SEC has completed one of 

the four studies and issued a report which provided a summary of SEC 

regulations requiring the use of an assessment of the creditworthiness of 

a security or money market instrument and any references to or 

requirements in such regulations regarding credit ratings. According to 

SEC’s website, SEC plans to complete two of the remaining three studies 

by July 2012; the completion date for the other study has yet to be 

determined.
Page 24 GAO-12-240 Credit Rating Agencies

Finally, the Dodd-Frank Act requires SEC to establish an Office of Credit 

Ratings and complete annual examinations of each NRSRO. Once 

established, this office will be responsible for administering the rules of 

SEC in certain areas, promoting accuracy in credit ratings, and 

conducting annual examinations of each NRSRO.28 Although the office 

has yet to be established, NRSRO examination staff from SEC’s Office of 

Compliance Inspections and Examinations (OCIE), staff from OCIE’s 

investment adviser/investment company and broker-dealer examination 

groups, and NRSRO specialists from SEC’s Division of Trading and 

Markets recently completed the first cycle of annual examinations of each 

NRSRO as required by the Dodd-Frank Act. SEC made public a staff 

report summarizing the examinations in September 2011.29

 28According to SEC, in order to establish this office in fiscal year 2011, SEC needed 

approval to reprogram funds for this purpose from both the House and Senate 

Appropriations Subcommittees on Financial Services and General Government but was 

not able to reach agreement with the subcommittees. SEC maintains that with the 

enactment of SEC’s fiscal year 2012 regular appropriation, the SEC can now establish the 

office.

According to 

this report, limited SEC resources required that this year’s examinations 

focus on reviewing the areas mandated by section 15E(p)(3)(B)—

specifically, whether the NRSRO conducts business in accordance with 

its policies, procedures, and rating methodologies; management of 

conflicts of interest; implementation of ethics policies; internal supervisory 

controls; governance; activities of the designated compliance officer; 

processing of complaints; and NRSRO’s policies governing the postemployment activities of former staff of the NRSRO. The report 

summarized the examination staff’s notable observations and concerns 

and the recommendations the staff made to each NRSRO about these 

observations and concerns related to the following required review areas: 

conducting business in accordance with policies, procedures, and 

methodologies; management of conflicts of interest; internal supervisory 

controls; and designated compliance officer activities. The report notes 

that, as of the date of the report, SEC had not determined that any finding 

constituted a “material regulatory deficiency,” but noted that the 

Commission may do so in the future. The staff also made the observation 

that NRSROs appear to be trending even more toward employing the 

issuer-pays business model, noting that two of the subscriber-pays 

29See SEC, 2011 Summary Report of Commission Staff’s Examinations of Each 

Nationally Recognized Statistical Rating Organization, As Required by Section 15(p)(3)(C) 

of the Securities Exchange Act of 1934 (Washington, D.C.: September 2011).
Page 25 GAO-12-240 Credit Rating Agencies

NRSROs recently have taken steps to focus more on issuer-pays 

business, particularly with respect to ratings of asset-back securities.

Section 939F of the Dodd-Frank Act requires that SEC conduct a study 

that addresses, among other things, the feasibility of establishing a 

system in which a public or private utility or an SRO assigns NRSROs to 

determine the credit ratings of structured finance products. SEC’s report 

on the study, due by July 21, 2012, must include any recommendations 

for regulatory or statutory changes that SEC determines should be made 

to implement the findings of the study. As part of this study, SEC solicited 

comment on its authority to implement various alternative compensation 

models. According to SEC staff, the staff is reviewing the comment letters 

received and is evaluating authority issues.

Section 939F requires that, after submission of the report to Congress 

resulting from the study, SEC shall, by rule, as the SEC determines is 

necessary or appropriate in the public interest or for the protection of 

investors, establish a system for the assignment of NRSROs to determine 

the initial credit ratings of structured finance products, in a manner that 

prevents the issuer, sponsor, or underwriter of the structured finance 

product from selecting the NRSRO that will determine the initial credit 

ratings and monitor such credit ratings. In issuing any rule, SEC is 

required to give through consideration to the provisions of section 15E(w) 

of the Securities Exchange Act of 1934, as that provision would have 

been added by section 939D of H.R. 4173 (111th Congress), as passed by 

the Senate on May 20, 2010, and shall implement the system described 

in such section 939D unless the Commission determines that an 

alternative system would better serve the public interest and the 

protection of investors. The need for any statutory changes likely will 

depend on the system that SEC decides to implement. Therefore, 

obtaining as complete information on the models as available, such as by 

consulting with the models’ authors, will be important for SEC to fully 

assess each model in order to make its decision and any 

recommendations for statutory changes SEC determines should be made 

to implement its findings.

As part of its request for public comment in connection with its study, SEC 

requested comment on whether the securities laws provide SEC with 

authority to implement the 15E(w) system and the four other models it 

outlined. In particular, SEC asked for comment on whether, in terms of 

legal feasibility, the role of SEC in overseeing the Credit Rating Agency 

Board raised legal issues. Few comment letters directly addressed SEC’s 

SEC Is Conducting Its 

Required Study of

Alternative Compensation 

Models, but Has Yet to Talk 

to the Models’ Authors
Page 26 GAO-12-240 Credit Rating Agencies

questions concerning its authority to implement one or any of the 

alternative compensation models outlined in its request for comment. 

However, a few of the comment letters discussed potential legal 

questions surrounding the implementation of or rulemaking for specific 

aspects of certain models, or general constitutional questions. For 

instance, two commenters argued that in their view, NRSRO ratings 

legally are viewed as opinions and may not be subject to being proven 

true or false. Thus any system that utilizes the accuracy of ratings as 

criteria to determine which NRSROs would be eligible to rate certain 

categories of securities—such as the 15E(w) system—may face legal 

challenges.30 One comment letter also argued that any system aimed at

defining “quality” ratings could run afoul of Section 15E(c)(2) of the 

Exchange Act, which provides that SEC may not “regulate the substance 

of credit ratings or the procedures and methodologies by which any 

NRSRO determines credit ratings.”31

The model authors also hold varying opinions on the extent to which 

statutory changes would be necessary to implement their alternative 

compensation model. For example, in their paper introducing the model 

and in our discussions with them, the authors of the proposed issuer and 

investor-pays model discussed that they anticipate that legislation would 

likely be required to implement their proposed model. Specifically, authors 

of the model stated that legislation would likely be necessary to establish 

the self-regulatory organization and provide it with the authority to create 

a fund to collect fees and impose data collection requirements on 

The letter states that any decision 

by SEC that an NRSRO’s ratings (and, by extension, the criteria and 

methodologies by which those ratings were formed) lack “quality” and 

therefore must be changed to maintain participation in the proposed 

system could well violate this provision. In addition, three comment letters 

raised constitutional questions. Two comment letters questioned how 

certain of the alternative models might affect an NRSRO’s right to form 

and publish opinions under the First Amendment. Another questioned the 

ability of the government to force one private party to deal with another 

private party of the government’s choosing in a private business 

transaction, which the commenter argues would occur if SEC 

implemented the section 15E(w) model.

 30Currently, no widely accepted measure of ratings accuracy exists. According to SEC 

staff and comment letters, developing such a measure would be difficult.

3115 U.S.C. § 78o-7(c)(2).
Page 27 GAO-12-240 Credit Rating Agencies

issuances, the governance structure of the fund, the methodology for 

determining fees, an initial rotating system of assignments of issues to be 

rated, and broad parameters for incentive compensation. Alternatively, 

the author of the proposed investor-owned credit rating agency model we 

interviewed believes that current law, even before the Dodd-Frank Act 

was passed, provides SEC with the authority to implement the model as a 

means of managing the conflicts of interest generated by the issuer-pays 

model.32 Specifically, the author points to sections 15E(h)(2) of the 

Exchange Act, which grants SEC the authority to issue rules to prohibit, 

or require the management and disclosure of, any conflicts of interest 

relating to the issuance of credit ratings by the NRSRO.33 This includes 

the authority to issue rules relating to the manner in which an NRSRO is 

compensated by the issuer for issuing credit ratings. The author also 

stated that section 15E(i)(1), which provides that SEC shall issue rules to 

prohibit any act or practice relating to the issuance of credit ratings by an 

NRSRO that SEC determines to be unfair, coercive, or abusive provides 

additional statutory authority for the implementation of the investor-owned 

credit rating agency model.34 As previously discussed, SEC has not 

spoken to the authors of the proposed models to solicit additional details 

about their models—information that could help inform SEC’s analysis of 

the alternative compensation models and its report to Congress 

containing any recommendations for regulatory or statutory changes that 

it determines should be made to implement the findings of its study.

In recent years, academic researchers and industry experts have begun 

to develop a number of alternative compensation models for credit rating 

agencies in response to concerns about conflict of interest, ratings 

integrity, and competition. As of January 2012, none of these models 

have been fully developed, and given that NRSROs continue to primarily 

use the issuer-pays, and to a lesser extent, the subscriber-pays models, 

the use of any alternative model or models would likely have to be at the 

 32However, one paper we reviewed noted that significant legal difficulty arises with 

proposals to mandate behavior by investors—two of the models require the users of credit 

ratings to pay a fee—because SEC and other securities regulators have no delegated 

power over investors as a group. See John C. Coffee, Jr., Ratings Reform: The Good, The 

Bad, and The Ugly, 1 Harv. Bus. L. Rev. 231, 259 n.72 (2011).

3315 U.S.C. § 78o-7(h)(2).

3415 U.S.C. § 78o-7(i)(1).

Conclusion
Page 28 GAO-12-240 Credit Rating Agencies

direction of SEC or Congress. As directed by section 939F of the DoddFrank Act, SEC is currently studying, among other things, alternative 

means for compensating NRSROs that would create incentives for 

accurate credit ratings. As part of its study, SEC solicited public comment 

on various alternative compensation models and whether it has sufficient 

authority to implement these models. Few of the comment letters SEC 

received specifically addressed the alternative models or SEC’s authority 

to implement them, and only one of the model authors submitted a 

comment letter to SEC. Currently, the staff is reviewing the comment 

letters received and evaluating authority issues, however the extent to 

which SEC’s existing authorities would allow it to implement any of the 

alternative models by rule largely will depend on the system selected. As 

part of its 939F study, SEC has not met with the authors of the various 

alternative compensation models to discuss the models in greater detail. 

Doing so could help ensure that SEC has thoroughly explored all of the 

available options in sufficient enough detail to adequately consider them. 

Without consulting the authors to gain a comprehensive understanding of 

the proposed models, SEC may not have complete information available 

to be able to fully determine the authorities it may need to implement a 

particular model.

As SEC continues to study the various alternative means for 

compensating NRSROs, as well as determine whether a system for the 

assignment of initial credit ratings for structured finance products is 

necessary or appropriate in the public interest or for the protection of 

investors, SEC should consult with the authors to better ensure it has all 

available information on the models to make its decision, and include in 

its report to Congress any recommendations for statutory changes the 

SEC determines should be made to implement the findings of the study.

We provided a draft of the report to the Chairman of the Securities and 

Exchange Commission (SEC) for her review and comment. SEC’s written 

comments are reprinted in appendix II. We also received technical 

comments from SEC that were incorporated, where appropriate. In its 

written comments, SEC agreed with our recommendation. In describing 

its statutory responsibilities and the steps it has taken to implement them, 

SEC noted that as it continues working on its 939F study, the 

Commission staff will seek to consult further with the parties that have 

proposed alternative compensation models for NRSROs to better ensure 

that the Commission has all available information on such models.

Recommendation for 

Executive Action

Agency Comments 

and Our Evaluation
Page 29 GAO-12-240 Credit Rating Agencies

We are sending copies of this report to SEC, appropriate congressional 

committees and members, and other interested parties. The report also is 

available at no charge on the GAO website at http://www.gao.gov.

If you or your staffs have any questions about this report, please contact 

me at (202) 512-8678 or clowersa@gao.gov. Contact points for our 

Offices of Congressional Relations and Public Affairs may be found on 

the last page of this report. GAO staff who made major contributions to 

this report are listed in appendix III.

A. Nicole Clowers

Director,

Financial Markets and

 Community Investment Issues
Appendix I: Framework to Evaluate Alternative 

Compensation Models

Page 30 GAO-12-240 Credit Rating Agencies

To assist Congress and others in assessing these proposed alternative 

compensation models, we developed an evaluative framework for our 

2010 report with seven factors that any compensation model should 

address to be fully effective. The framework can help identify a model’s 

relative strengths and weaknesses, potential trade-offs (in terms of policy 

goals), or areas in which further elaboration or clarification would be 

warranted using the following factors:

• Independence. The ability for the compensation model to mitigate 

conflicts of interest inherent between the entity paying for the rating 

and the nationally recognized statistical rating organization (NRSRO).

• Accountability. The ability of the compensation model to promote 

NRSROs’ responsibility for the accuracy and timeliness of their 

ratings.

• Competition. The extent to which the compensation model creates 

an environment in which NRSROs compete for customers by 

producing higher-quality ratings at competitive prices.

• Transparency. The accessibility, usability, and clarity of the 

compensation model and the dissemination of information on the 

model to market participants.1

• Feasibility. The ease and simplicity with which the compensation 

model can be implemented in the securities market.

• Market acceptance and choice. The willingness of the securities 

market to accept the compensation model, the ratings produced under 

that model, and any new market players established by the 

compensation model.

• Oversight. The evaluation of the model to help ensure it works as 

intended.

See GAO-10-782 for more detailed descriptions of the seven factors.

 1

Transparency in this context does not refer to the transparency or disclosure regime of 

the NRSROs but is specific to the transparency of the model. 

Appendix I: Framework to Evaluate 

Alternative Compensation Models
Appendix II: Comments from the Securities 

and Exchange Commission

Page 31 GAO-12-240 Credit Rating Agencies

Appendix II: Comments from the Securities

and Exchange Commission
Appendix II: Comments from the Securities 

and Exchange Commission

Page 32 GAO-12-240 Credit Rating Agencies
Appendix II: Comments from the Securities 

and Exchange Commission

Page 33 GAO-12-240 Credit Rating Agencies
Appendix III: GAO Contact and Staff 

Acknowledgments

Page 34 GAO-12-240 Credit Rating Agencies

A. Nicole Clowers, (202) 512-8678 or clowersa@gao.gov

In addition to the individual named above, Karen Tremba (Assistant 

Director), Rachel DeMarcus, Patrick Dynes, Matthew Keeler, Patricia 

Moye, Barbara Roesmann, and Jessica Sandler made key contributions 

to this report.

Appendix III: GAO Contact and Staff 

Acknowledgments

GAO Contact

Staff 

Acknowledgments

(250632)
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