Reforming Credit Rating Agencies
House Financial Services Committee
Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises
September 30, 2009
Daniel Gallagher, Co-Acting Director, Division of Trading and Markets, U.S. Securities
and Exchange Commission (SEC)
Raymond McDaniel, Chairman and Chief Executive Officer, Moody's Corporation
Deven Sharma, President, Standard & Poor's
Stephen Joynt, President and Chief Operating Officer, Fitch Inc.
Robert Dobilas, President and Chief Executive Officer, RealPoint LLC
James Gellert, President and Chief Executive Officer, Rapid Ratings International Inc.
Kurt Schacht, Managing Director, CFA Centre for Financial Market Integrity
During a House Financial Services Subcommittee on Capital Markets, Insurance, and
Government Sponsored Enterprises hearing on credit rating agency (CRA) reform,
Chairman Paul Kanjorski (D-PA) said CRAs failed to fully learn about the quality of the
products they were rating, specifically mortgage-backed securities, which betrayed the
trust of investors who came to rely on them. Chairman Kanjorski said his discussion draft
legislation, the Enhanced Accountability and Transparency in Credit Rating Agencies
Act, would balance improving the oversight of CRAs while creating incentives for them
to do a better job. He said his legislation would “promote accountability” through the
threat of liability.
The chairman noted the provision that would require nationally recognized statistical
rating organizations (NRSROs) to verify other NRSROs’ rating information and be liable
for the actions of their competitors even if they did not rate a bond that defaults is not the
only way to make them more accountable for their ratings and that he is “open to other
Chairman Kanjorski added that while he proposes to eliminate all federal requirements of
NRSRO ratings, he has “serious concerns” of the unintended consequences of doing so.
Ranking Member Scott Garrett (R-NJ) said he had concerns with the chairman’s
proposal, specifically the provision that would hold NRSROs financially liable.
“I do not believe the solution to all society’s ills is through more lawsuits,” Ranking
Member Garrett said. He said he was concerned about the practicality of the collective
liability among NRSROs and that he did not see “what positive can come of holding all
NRSROs accountable for the bad actions of one.” Ranking Member Garrett said by
introducing a shared financial accountability among NRSROs will discourage new entry
into the business.
Rep. Brad Sherman (D-CA) said that CRAs devised an “issuer-pleasing model” as the
key to obtaining more business.
“We either have to remove the incentive to please the issuer … or counterbalance that
with liability,” Rep. Sherman said. “Ratings are necessary ... that’s why people rely on
them,” he said. “We have to make them reliable ... and one way to do that is to
counterbalance the risk that they will give too liberal a rating with liability.”
Rep. Andre Carson (D-IN) said that Congress cannot ignore the NRSROs relation to
systemic risk. Rep. Carson said Congress needs to consider including the possibility of
using a global approach, both macro and micro, that includes all market participants,
when writing reforms.
Rep. Bill Foster (D-IL) said he supports introducing an oversight board, similar to the
Public Company Accounting Oversight Board (PCAOB), to oversee credit rating
agencies. Rep. Foster said he also would like to see a standardization of ratings
terminology. He said that industry-wide standards are needed so that a given rating to
municipal securities and will have the default probabilities as a corporate security.
Rep. Jeb Hensarling (R-TX) said that while credit rating agencies badly missed the
housing bubble, he still advocates for more investor due diligence and personal
responsibility. Rep. Hensarling said an increase in lawsuits from the liability provision
will become a barrier for new entry to the business.
“No nation can sue its way into financial stability,” he said.
Rep. Mary Jo Kilroy (D-OH) said that CRAs occupy a unique and powerful role in the
financial industry. Rep. Kilroy said that rating agencies should be part of the equation
when making an investment decision, just not the decision.
Rep. Kilroy said the chairman’s proposal seeks to deal with CRAs that act with
malfeasance and that they should not be allowed unfettered Constitutional protection.
Daniel Gallagher, co-acting director of the Division of Trading and Markets at the SEC,
said the SEC has been working on rating agency reform since 2006 when Congress
enacted the Rating Agency Act, which mandated that the Commission establish a
registration and oversight program for NRSROs. Gallagher said that on September 17,
the commission embarked on further rulemaking designed to promote greater
accountability, foster competition, decrease the level of undue reliance on NRSROs and
empower investors to make more informed decisions.
Ray McDaniel, Chairman and CEO of Moody’s Corporation, said that Moody’s supports
efforts in the discussion draft to increase the transparency of ratings performance and
methodologies. McDaniel said Moody’s generally supports the provision that would
establish an office within the SEC to oversee the CRA industry.
He said that the use of ratings as a regulatory tool for oversight of regulated entities can
adversely affect the behavior of market participants, encourage both over-reliance on
ratings and ratings shopping, and reduce incentives to compete based on the quality of
ratings. McDaniel said that Moody’s supports the goal of removing references to credit
ratings in regulation. Moody’s is opposed to the provision that would impose a collective
liability regime on all NRSROs, he said. McDaniel said there is no truth to the popular
notion that CRAS are somehow immune from liability.
“No less than any other market participants, CRAS have potential liability, for example,
if they knowingly make false statements, engage in fraudulent conduct, or issue opinions
that they genuinely hold,” he said. He said Moody’s and other NRSROs are being sued in
numerous cases in federal and state courts.
Deven Sharma, president of Standard and Poor’s, said the agency shares the view that
further regulation is necessary and that he supports some of the recent proposals to do so,
including holding the agencies more accountable through enforcing SEC rules and
requiring more issuer disclosure.
Sharma said that the collective liability provision would “seriously disrupt the capital
markets” and provide strong disincentives for new entry into the business.
“No NRSRO should have to act as an insurer for its competitors,” he said.
Sharma said that by lowering the threshold to bring suits against NRSROs it would likely
cause them only to rate securities that are least likely to default, thereby creating a
challenge for issuers that are relatively new to the debt markets. They will have a harder
time accessing a rating and the market in general, including green companies and
broadband providers, Sharma said. This result could have a detrimental effect on
economic growth, he added.
Stephen Joynt, president and CEO of Fitch, Inc., said he would like to see enhanced
public disclosure of structured finance securities. Fitch has repeatedly suggested that the
information made available to the rating agencies as part of the ratings process for
securitization be made available to all investors, and that responsibility for disclosing that
should rest with the issuers, he said.
Joynt said that removing all references of ratings in federal regulations and then
significantly enhancing the federal regulatory requirements and burdens on NRSROs is
Joynt said that a rating is a forward-looking opinion of creditworthiness, not a backward-
looking verification of financial statements as conducted by accountants. Creating an
additional and separate liability standard solely for NRSROs as envisioned by the bill is
“unprecedented and unnecessary,” he said.
“The idea that we should be responsible for verifying other NRSROs’ information and be
liable for the actions of another rating agency even if we did not rate the bond is very
problematic,” he said.
Robert Dobilas, president and CEO of RealPoint LLC, said Realpoint was concerned
about the joint liability issues. He also said he was concerned about the related proposal
that would essentially require every NRSRO to review and approve other NRSRO’s
work. He said such measures would rule out smaller NRSROs.
“At RealPoint, we offer and provide our research and best opinions regarding the
likelihood of payment of a financial obligation, but we cannot be a financial guarantor on
the $780 billion of commercial mortgage-backed securities we have rated,” he said.
Dobilas said that the SEC measure that would require an issuer that is seeking a credit
rating from a NRSRO to disclose the same financial information given to its solicited
NRSRO to all other NRSROs is one of the “most important reforms undertaken by the
government in response to the credit crisis,” he said. The public benefits of such a move
that allows more than just two chosen NRSROs are “immediate and manifest.”
Dobilas said the discussion draft’s proposal that all NRSROs publicly disclose
information on initial ratings and subsequent changes to them would drain Realpoint and
other subscriber-based NRSROs’ income. “Without a substantial time lag, this
requirement is antithetical to the subscriber-based business model since selling this
information is how we produce revenues,” he said.
Dobilas said that the proposals being considered are aimed at two “entirely different
types of companies, with entirely different business models.”
“If Congress applies a multitude of new rules, regulations and procedural controls on
NRSROs which inevitably and disproportionately disadvantage smaller companies,” he
James Gellert, Chairman and CEO of Rapid Ratings International, Inc., said that
Congress should not create more legislation for legislation’s sake. Gellert said that as a
subscriber-based rating agency that currently has not applied for NRSRO status, he said
for new players that want the designation, NRSRO status must have value and not carry
massive compliance costs and legal liability.
Gellert asked why any small rating agency would want to become an NRSRO by “joining
a group dominated by three players with an iceberg of lawsuits looming on their
Kurt Schacht, Managing Director at the CFA Institute Centre for Financial Market
Integrity, said CFA is supportive of calls for transparency, managing conflicts of interest
inherent in the issuer-pay model, and providing the SEC with strong oversight authority,
but was concerned about the degree of detail presented in Chairman Kanjorski’s
The draft has “many instances where there is an effort to legislate what is more typically,
and we believe more appropriately, in this case, left to the regulatory agency to
implement,” Schacht said.
Schacht said that Congress should eliminate the effective exemption from liability
provided to CRAs under Section 11 of the Securities Act of 1933 for ratings paid for by
Question and Answer
Chairman Kanjorski said he is supportive of allowing the issuer-pays model to continue,
but increase their liability.
Rep. Spencer Bachus (R-KY) said he was concerned about the fact that joint liability
would find a rating agency liable, even if they that had not participated in the ratings of
Rep. Joe Donnelly (D- IN) asked what problem would occur if investors paid for ratings,
instead of issuers.
“To the extent that issuers are going to rating agencies, they are doing so in the traditional
context in order to meet investor demand,” Joynt said. “The issuer would certainly like to
make choices that are most favorable to themselves. It’s one of the reasons why we are
supportive of a reduction of use of ratings in regulation. It would return more of the
demand for ratings to the investor choice as expressed through who the issuer reaches
with its ratings request.”
Rep. Jackie Speier (D-CA) asked whether any action was taken against the analysts who
rated American International Group (AIG) and Lehman Brothers as triple- and double-A
“minutes before they were collapsing.”
None of the “big three” rating agency CEOs said any action was taken on the analysts.
Ranking Member Garrett asked Gellert why his firm chose not to apply for a NRSRO
Gellert said that because for the last number of years, watching the regulatory and
legislative debate, there was “too much uncertainty and new ideas and concepts continue
to come up” that the significant amount of risk from an ever-changing atmosphere
outweigh the advantages.
Ranking Member Garrett asked the panel what the downsides were to removing the
Dobilas said that investors do depend on a benchmark. Joynt pointed to the money
market fund industry as an investor base that relied on having minimum standards and
that the government supports that practice with the NRSRO designation.
Rep. Bachus asked whether rating agencies might rely less on the company they are
rating for financial information.
Joynt said he assumes that issuers would be doing their due diligence, but that Fitch is
“way more cautious now” and that if they are uncomfortable with the quality of
information, “we won’t rate them.”
Sharma said Standard and Poor’s relies on different market participants, including
issuers, but also their own criteria. “If we are not comfortable, we do not rate,” he said.
McDaniel said a cure to getting correct issuer information is to make that information that
the CRA is collecting also available to the investing public.