Order Code RS22215
Updated July 13, 2006
CRS Report for Congress
Received through the CRS Web
Credit Rating Agencies: Current Federal
Oversight and Congressional Concerns
Michael V. Seitzinger
Legislative Attorney
American Law Division
Summary
Credit rating agencies rate the creditworthiness of public companies so that the
public will have an objective opinion as to the risk of investment. These ratings have
become an important component of the financial reputation of a rated company.
However, especially since the bankruptcies of Enron and WorldCom, whose debt had
been rated investment grade, there has been concern that perhaps credit rating agencies
should be regulated. Section 702 of the Sarbanes-Oxley Act of 2002 required the
Securities and Exchange Commission to study the role of credit rating agencies. Over
the years, the SEC has issued reports and proposed rules, in particular concerning
adoption of a definition for the term “nationally recognized statistical rating
organization,” but no statutory or regulatory requirements have been enacted or issued.
Congress may, however, continue to pursue the issue of regulation, since hearings have
been held on the issue and proposed legislation has been introduced. On June 14, 2006,
the House Committee on Financial Services approved an amended version of H.R. 2990,
the Credit Rating Agency Duopoly Relief Act of 2006, which would set out procedures
for registration by a credit rating agency with the SEC in order to be treated as a
nationally recognized statistical rating organization. On July 12, 2006, the House passed
H.R. 2990 in a version almost identical to the one approved by the Committee on
Financial Services. This report will be updated as needed.
Credit rating agencies rate the creditworthiness of public companies and the debts
of those companies so that a potential creditor or investor will have a presumably
professional, objective opinion as to the likely risk of any investment in a particular
company. These ratings have become an important component of the financial reputation
of a rated company.
Ratings have taken on great significance in the market, with investors trusting
that a good credit rating reflects the results of a careful, unbiased and accurate
assessment by the credit rating agencies of the rated company....
Congressional Research Service ˜ The Library of Congress

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Credit ratings, which are expressed in a letter grade, provide an assessment
of creditworthiness, or the likelihood that debt will be repaid.1
Over the past several years, particularly with the scandals involving such major
corporations as Enron and WorldCom, increased attention has been given to the role of
credit rating agencies in the operation of the securities markets.2 Section 702 of the
Sarbanes-Oxley Act of 20023 required the Securities and Exchange Commission (SEC or
Commission) to “conduct a study of the role and function of credit rating agencies in the
operation of the securities market.” In January 2003, the SEC issued its report, Report
on the Role and Function of Credit Rating Agencies in the Operation of the Securities
Markets. In June 2003, the Commission issued a concept release (the 2003 Concept
Release) in order to solicit public comments about issues concerning credit rating
agencies, including the issue of whether credit rating agencies should continue to be used
for regulatory purposes under the federal securities laws and whether, if these ratings are
used, there should be a formal process of determining whose ratings should be used and
what kind of oversight to apply to these credit rating agencies.4
The SEC’s 2003 Concept Release stems from ongoing concerns regarding the
development of the Nationally Recognized Statistical Rating Organization (NRSRO)
concept. In 1975, the Commission issued the Net Capital Rule,5 which set new net capital
requirements for broker-dealers and required these broker-dealers to take a larger discount
on below investment grade bonds than for investment grade bonds. The rule required that
the ratings come from a “nationally recognized statistical ratings organization.” There has
been no official federal statutory or regulatory definition of “nationally recognized
statistical ratings organization.” Instead, “[u]pon request the staff of the Division of
Market Regulation [of the SEC] provide a ‘no-action’ letter”6 to a credit rating agency if
it grants the agency’s request to obtain NRSRO status. The SEC has stated that there
have been nine firms identified by the Commission staff as NRSRO’s but that with
consolidation there are currently five: A.M. Best Company, Inc.; Dominion Bond Rating
Service Limited; Fitch, Inc.; Moody’s Investors Service, Inc.; and the Standard & Poor’s
Division of the McGraw Hill Companies, Inc.7
1 Staff of Senate Comm. on Governmental Affairs, 107th Cong., Financial Oversight of Enron:
The SEC and Private Sector Watchdogs 76-77 (S. Prt. 107-75 2002).
2 The major credit rating agencies maintained investment grade ratings on Enron’s debt until
close to the time of Enron’s bankruptcy filing. 60 WASH & LEE L. REV. 309, 323 (2003).
3 P.L. 107-204.
4 Securities Act Release No. 33-8236, 68 Fed. Reg. 35,258 (June 12, 2003).
5 Rule 15c3-1, 17 C.F.R. § 240.15c3-1.
6 S.Prt. 107-75, at 80. “[A] credit rating agency initiates the no-action letter process by requesting
a no-action letter that will state that the Commission staff will not recommend enforcement action
against persons who use the firm’s credit ratings for purposes of the Commission’s net capital
rule.” SEC proposed rule defining Nationally Recognized Statistical Rating Organization, 70
Fed. Reg. 21,306, 21,319 (April 25, 2005). After an investigation, the Commission’s staff
determine whether the credit rating agency meets NRSRO criteria and either issue or deny the
requested no-action letter.
7 70 Fed. Reg. 21,306-21,307 (April 25, 2005).

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Ratings by NRSRO’s, despite no official federal statutory or regulatory definition,
are given significant weight in such areas as federal and state legislation, rules issued by
financial regulators, and private financial contracts. For example, a credit rating agency,
particularly one with NRSRO status, is exempted from certain federal securities
regulations. One such exemption concerns Regulation F-D,8 which prohibits issuers from
making selective disclosure of material information in order to attempt to make certain
that the public has information needed to make investment decisions. This prohibition
does not apply “[t]o an entity whose primary business is the issuance of credit ratings,
provided the information is disclosed solely for the purpose of developing a credit rating
and the entity’s ratings are publicly available.”9 Another exemption concerns SEC Rule
436,10 which was issued pursuant to section 11 of the Securities Act of 1933.11 The
statute provides for civil liabilities for those attesting to the information contained in a
registration statement. Rule 436 provides that a rating assigned by a nationally recognized
statistical rating organization is not to be considered a part of the registration statement,
thus arguably shielding an NRSRO from liability under section 11 of the Securities Act.
The rule states that “the term nationally recognized statistical rating organization
[emphasis in original] shall have the same meaning as used in Rule 15c3-1(c)(2)(vi)(F)
(17 CFR 240.15c3-1(c)(2)vi)(F)).”12
In 1997 the SEC proposed to amend the Net Capital Rule in order to define
NRSRO.13 Among other requirements in the proposal for receiving NRSRO status was
that a credit rating agency would be required to register as an investment adviser under
the Investment Advisers Act.14 The rule was not adopted, but in the apparently somewhat
informal process that the SEC uses in issuing its no-action letter to a credit rating agency,
providing it with NRSRO status, the SEC appears to desire registration under the
Investment Advisers Act by a credit rating agency seeking NRSRO status.
On April 25, 2005, in response to a number of concerns, the SEC published a
proposed new rule which would define “nationally recognized statistical rating
organization.”15 The rule, to be added to the Code of Federal Regulations at 17 C.F.R.
section 240.3b-10, would define the term as any entity that:
(a) Issues publicly available credit ratings that are current assessments of the
creditworthiness of obligors with respect to specific securities or money market
instruments;
(b) Is generally accepted in the financial markets as an issuer of credible and
reliable ratings, including ratings for a particular industry or geographic segment, by
the predominant users of securities ratings; and
8 17 C.F.R. Part 243.
9 17 C.F.R. § 243.100(b)(2)(iii).
10 17 C.F.R. § 230.436.
11 15 U.S.C. § 77k.
12 17 C.F.R. § 230.436(g)(2).
13 Release No. 34-39457, 62 Fed. Reg. 68,018 (Dec. 30, 1997).
14 15 U.S.C. §§ 80b et seq.
15 70 Fed. Reg. 21,306.

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(c) Uses systematic procedures designed to ensure credible and reliable ratings,
manage potential conflicts of interest, and prevent the misuse of nonpublic
information, and has sufficient financial resources to ensure compliance with those
procedures.16
On June 20, 2005, Representative Fitzpatrick introduced H.R. 2990, whose short title
is the Credit Rating Agency Duopoly Relief Act of 2005. The bill was referred to the
Committee on Financial Services (Committee), and on June 29, 2005, the Committee’s
Subcommittee on Capital Markets, Insurance, and Government-Sponsored Enterprises
held a hearing on legislative solutions for credit rating agencies. In his remarks to
announce introduction of the bill, Representative Fitzpatrick stated:
[E]very American remembers the financial hardships they faced when
WorldCom and Enron went belly up. I certainly remember the broken investment
accounts of my constituents and the people of Pennsylvania’s 8th Congressional
District. And it is extremely troubling that little known players in this crisis, Moody’s
and S&P, rated Enron and WorldCom at investment grade just days prior to the filing
of their bankruptcies.
Two firms dominate the ratings market with SEC approval, and this, Mr.
Speaker, creates an uncompetitive marketplace, stifles competition from other rating
agencies, lowers the quality of ratings and allows conflicts of interest to go
unchecked. It is bad for the market and it is hurtful to individual investors.
Last week, I introduced the Credit Rating Agencies Relief Act of 2005, H.R.
2990, which will inject greater competition, transparency and accountability in the
credit rating industry through market-based reform.17
After setting out findings by Congress, the bill adds two new definitions to the
Securities Exchange Act,18 codifying them at 15 U.S.C. sections 78c(a)(60) and (61):
“statistical rating organization” and “nationally registered [emphasis added] statistical
rating organization.”
Section 4 of the bill adds a new provision to the Securities Exchange Act to require
the registration with the SEC of any statistical rating organization using the mails or
interstate commerce in connection with its business. The registration procedures are
specified. The Commission must issue by rule the information which the statistical rating
organization must disclose, such information to include conflicts of interest faced by the
organization and the management of those conflicts, the procedures and methodologies
which the organization uses in determining ratings, ratings performance measurement
statistics over short-term and long-term periods, and procedures in place by the
organization to prevent the misuse of non-public information.
Section 5 requires every nationally registered statistical rating organization to keep
books and records and disseminate reports as required by the Commission.
Section 6 requires studies and reports by the Comptroller General of the United
States, including a study to identify the factors that have led to the consolidation of credit
16 70 Fed. Reg. 21,323.
17 151 CONG. REC. H5255 (daily ed. June 28, 2005).
18 15 U.S.C. §§ 78a et seq.

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rating organizations, the present and future impact of consolidation on the securities
markets, and solutions to any problems created by the impact of consolidation.
At the June 29, 2005, hearing on legislative solutions for credit rating agencies,
Representative Kanjorski inserted into the record a document which he had requested
from the SEC outlining key issues for a legislative framework for the oversight and
regulation of credit rating agencies. In this document the SEC stated that a legislative
approach could require registration with the SEC by credit rating agencies, broad
rulemaking authority, examination and inspection of books and records, and enforcement
authority.
On June 14, 2006, the House Financial Services Committee approved an amendment
offered, in the nature of a substitute, by Chairman Oxley. The amendment makes
significant changes in the bill as introduced. Instead of requiring registration with the
SEC by a statistical rating organization, the approved amendment states that a credit
rating agency which has been in business for at least the past three consecutive years and
which elects to be treated as a nationally recognized statistical rating organization for the
purposes of federal statutes, rules and regulations may be registered by filing with the
SEC an application for registration. The information which must be filed should describe
any conflicts of interest relating to the issuance of credit ratings by a nationally recognized
statistical rating organization; procedures and methodologies which the nationally
recognized statistical rating organization uses in determining credit ratings; credit ratings
performance measurement statistics over short-term, mid-term, and long-term periods of
the nationally recognized statistical rating organization; policies or procedures adopted
and implemented by the nationally recognized statistical rating organization to prevent the
misuse of material, non-public information; and the organizational structure of the
nationally recognized statistical rating organization. The SEC may prescribe the filing of
additional information as necessary or appropriate in the public interest or for the
protection of investors.19
The Committee-approved amendment specifies the procedure which the SEC shall
use in granting or denying approval of the application, the updating of information, the
availability to the public of the information, and the withdrawal from registration.20
Each nationally recognized statistical rating organization must establish and maintain
policies reasonably designed to address and manage conflicts of interest that can arise
from the business of a nationally recognized statistical rating organization. Certain
abusive practices, such as changing a credit rating based upon a company’s purchase of
additional services, are prohibited. A nationally recognized statistical rating organization
would also be required to appoint a chief compliance officer.21
On July 12, 2006 the House passed H.R. 2990 in a version almost identical to the
version approved by the Committee on Financial Services.
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19 Section 4 of Committee-approved amendment.
20 Id.
21 Section 4 of Committee-approved amendment.

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