Credit Rating Agency Regulatory Reform: A Side-by-Side Comparison of H.R. 2990 and S. 3850

Credit Rating Agency Regulatory Reform: A Side-by-Side Comparison of H.R. 2990 and S. 3850

Order Code RL33651
CRS Report for Congress
Received through the CRS Web
Credit Rating Agency Regulatory Reform:
A Side-by-Side Comparison of
H.R. 2990 and S. 3850
September 19, 2006
Gary Shorter
Specialist in Business and Government Relations
Government and Finance Division
Congressional Research Service ˜ The Library of Congress

Credit Rating Agency Regulatory Reform:
A Side-by-Side Comparison of
H.R. 2990 and S. 3850
Summary
Credit rating agencies assess the probability that a securities issuer will default
by failing to repay principal and interest on the security. Globally, there are about
130 agencies, but Moody’s and Standard & Poor’s (S&P) combine for about 80% of
overall market share, with Fitch accounting for about a 15% share.
In 1975, the Securities and Exchange Commission (SEC) issued the Net Capital
Rule, which set new capital requirements for broker-dealers and required them to
take a larger discount on their bond holdings deemed to be below investment grade
by a rating agency that it recognized as a nationally recognized statistical rating
organization (NRSRO). Since then, a growing number of federal, state, and foreign
government statutes and regulations have adopted NRSRO ratings as reference points
or triggers. However, there is no statutory definition of an NRSRO. When a rating
agency requests NRSRO status, it applies to the SEC Division of Market Regulation
for NRSRO designation, a decision-making process that is often both uncertain and
of an indefinite time span.
Currently, five rating agencies have NRSRO designation: Fitch; Moody’s;
S&P; the A.M. Best Company, which rates insurance and reinsurance firms; and the
Dominion Bond Rating Service Limited, a Canadian-based firm.
Like other providers of financial market analysis, the major NRSROs play a
critical role as financial sentries or gatekeepers whose assessments can help warn
against corporate meltdowns. Their record, however, is imperfect. For example, in
2001, Moody’s, S&P, and Fitch issued favorable credit ratings of WorldCom bonds
three months before the company declared bankruptcy. Additional concerns exist
over the way in which the NRSRO process may impede non-NRSROs’ access to
more profitable segments of the rating industry.
In the 109th Congress, two legislative responses to the perceived shortcomings
of the NRSRO protocol are H.R. 2990 (Fitzpatrick), the Credit Rating Agency
Duopoly Relief Act of 2006, which passed the House on July 12, 2006, and S. 3850
(Shelby), the Credit Rating Agency Reform Act of 2006, which was voted out of the
Senate Banking and Urban Affairs Committee on August 2, 2006. Both bills would
scrap the current NRSRO designation process and instead would allow entities with
at least three consecutive years as rating agencies to register with the SEC as
NRSROs. S. 3850 would permit the SEC to reject a rating agency’s application for
NRSRO registration if it determined that the rater lacked sufficient financial and
managerial resources, whereas H.R. 2990 would impose no such test. Each bill, if
enacted, would be likely to significantly expand the number of NRSROs.
This report provides a side-by-side comparison of the bills’ major provisions;
it will be updated as events dictate.

Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
List of Tables
Table 1. A Comparison of Major Provisions of H.R. 2990 and S. 3850 . . . . . . . 3

Credit Rating Agency Regulatory Reform:
A Side-by-Side Comparison of
H.R. 2990 and S. 3850
Introduction
Credit rating agencies assess the probability that a securities issuer will default
by failing to repay principal and interest on the security. Two rating agencies
dominate the rating industry — Moody’s and Standard & Poor’s (S&P) who combine
for about 80% of the overall market share. Fitch Ratings has about a 15% share.
Globally, there are about 130 agencies.
In 1975, the Securities and Exchange Commission (SEC) issued the Net Capital
Rule, which set new capital requirements for broker-dealers and required them to
take a larger discount on their bond holdings deemed to be below investment grade
by a rating agency that it recognized as a nationally recognized statistical rating
organization (NRSRO). Since then, a growing number of federal, state, and foreign
government statutes and regulations have adopted NRSRO ratings as reference points
or triggers. But there is no statutory definition of an NRSRO. When a rating agency
requests NRSRO status, it applies to the SEC Division of Market Regulation for
NRSRO designation. And through what is known as the no-action letter process,1 the
division can take an indefinite amount of time to determine whether to grant the
designation, a decision that is significantly based on whether the applicant is a
nationally recognized issuer of credible ratings.
Currently, five rating agencies have NRSRO designations: Fitch; Moody’s;
S&P; the A.M. Best Company, which rates insurance and reinsurance firms and
received NRSRO status in 2005; and the Dominion Bond Rating Service Limited, a
Canadian-based firm that was granted NRSRO status in 2003.
In addition to other sources of financial market analysis like securities analysts,
the major NRSROs also play a critical role as financial sentries or gatekeepers whose
assessments can help warn against corporate meltdowns. Their record, however, is
imperfect. In 2001, Moody’s, S&P, and Fitch issued favorable credit ratings of
WorldCom bonds three months before the company declared bankruptcy. Moody’s
and S&P provided favorable bond ratings for Enron corporate bonds just before the
firm’s bankruptcy. The collapse of these firms eventually cost investors billions of
1 A no-action letter is an SEC communication stipulating that the agency does not object to
a course of action proposed by a registrant. They are generally issued after an applicant has
made a request.

CRS-2
dollars and provoked widespread criticism of the agencies both in and out of
Congress.
These concerns, to which the NRSROs respond that they were themselves the
victims of corporate deceit, exist alongside criticism that the NRSRO selection
process is an anticompetitive mechanism that impedes non-NRSROs’ access to the
more profitable segments of the rating industry.
The congressional response to the perceived problems surrounding the NRSRO
process and its potentially undesirable consequences has led to the introduction of
two bills in the 109th Congress. H.R. 2990 (Fitzpatrick), the Credit Rating Agency
Duopoly Relief Act of 2006, passed the House on July 12, 2006, in a vote closely
divided along partisan lines. Soon afterwards, on August 2, S. 3850 (Shelby), the
Credit Rating Agency Reform Act of 2006, was voted out of the Senate Banking and
Urban Affairs Committee with significant bipartisan support.
Both bills would scrap the SEC’s current no-action-letter-based NRSRO
designation process with its central focus on whether an agency is nationally
recognized as an issuer of credible ratings, and with its indefinite decision making
time frames. Both would amend the Securities Exchange Act of 1934 to allow
interested entities with at least three consecutive years as rating agencies to register
with the SEC as NRSROs, which would involve the submission of performance
measurement statistics, a description of their rating methodology, details of ethics
policies, and disclosure of conflicts of interest. Under both bills, once the SEC
received a credit agency’s application to register as an NRSRO, it would have up to
120 days — with the possibility of an extension if deemed necessary — to determine
whether to deny or grant the registration.
S. 3850 would allow the SEC to reject a rating agency’s application for NRSRO
registration if it determined the applicant lacked sufficient financial and managerial
resources. H.R. 2990 has no such requirement.
S. 3850 would require NRSRO applicants to provide written certifications from
at least 10 of their institutional customers to the SEC. Applicants would also have
to provide a list of their 20 largest issuers and subscribers by the amount of net
revenues received in the previous year. Neither provision is part of H.R. 2990.
S. 3850 would also direct the SEC to issue rules on NRSRO conflicts of interest
and the misuse of non-public information conflicts of interest, provisions that are
absent from H.R. 2990.
Either bill, if enacted, would be likely to significantly expand the number of
NRSROs from the current five.
This report compares the major provisions of the two legislative proposals. Key
differences between the two bills have been italicized.

CRS-3
Table 1. A Comparison of Major Provisions of
H.R. 2990 and S. 3850

Provision
H.R. 2990
S. 3850
Cessation of the SEC’s
Within 30 days after the
Upon a designated effective
current No-Action Letter-
legislation’s enactment, the
date, an entity that previously
based NRSRO designation
SEC shall cease to designate
relied on the SEC’s no-action
process
persons and companies as
letter for its NRSRO status
NRSROs as it currently
may continue to use the
under rule 15c3-1 of the
designation if it has filed an
agency’s rules (17 CFR
application for NRSRO
240.15c3-1). In addition, the
registration that has been
SEC’s current no-action
approved by the SEC.
process for NRSRO
(Section 4)
designation would be voided.
(Section 4)
Defining a credit rating
A credit agency is defined as
A credit agency is defined as
agency
an entity that is engaged in
an entity that is engaged in
the business of issuing credit
the business of issuing credit
ratings on the Internet or
ratings on the Internet or
through another readily
through another readily
accessible means, for free or
accessible means, for free or
for a reasonable fee that
for a reasonable fee that
employs either a quantitative
employs either a quantitative
or qualitativea model, or both,
or qualitative model; or both,
and receives fees from either
and receives fees from either
issuers, investors, or other
issuers, investors, or other
market participants.
market participants.
(Section 3)
(Section 3)
Credit rating agency
To register as an NRSRO
To register as an NRSRO
experience needed to
with the SEC, a credit rating
with the SEC: (1) a credit
qualify for registration as
agency must have been in
rating agency must have been
an NRSRO
business for at least three
in business for at least three
consecutive years.
consecutive years; and (2)
(Section 3)
have received written
certifications from at least 10
“qualified institutional
buyers” (as defined in section
230.144 (a) of title 17, Code
of Federal Regulations).
(Section 3)

CRS-4
Provision
H.R. 2990
S. 3850
What the SEC is authorized
The SEC is authorized to
The SEC is authorized to
to require of credit rating
require a credit rating agency
require a credit rating agency
agencies interested in
that elects to be registered as
that elects to be registered as
registering as NRSROs
an NRSRO to file
an NRSRO to file
information that may include
information that may include
(1) any conflicts of interest
(1) any conflicts of interest
relating to the issuance of
relating to the issuance of
credit ratings; (2) the
credit ratings; (2) the
procedures and
procedures and
methodologies used in
methodologies used in
determining credit ratings; (3)
determining credit ratings; (3)
their credit ratings
their credit ratings
performance measurement
performance measurement
statistics over short-term,
statistics over short-term,
mid-term, and long-term
mid-term, and long-term
periods; (4) policies or
periods; (4) policies or
procedures adopted and
procedures adopted and
implemented to prevent the
implemented to prevent the
misuse of material,
misuse of material,
non-public information; and
non-public information; (5)
(5) its organizational
its organizational structure;
structure. (Section 4)
(6) a confidential list of the
20 largest issuers and
subscribers by the amount of
net revenues received in the
fiscal year prior to the
application date; and (7)
written certifications from at
least 10 “qualified
institutional buyers” who
have used the applicant’s
ratings. (Section 4)
The SEC’s review of an
Within 90 days after an
Within 90 days after an
NRSRO application
applicant has filed for
applicant has filed for
registration, the SEC shall
registration, the SEC shall
either grant NRSRO
either grant NRSRO
registration or begin
registration or begin
proceedings to determine
proceedings to determine
whether registration should
whether registration should
be denied. The proceedings
be denied. The proceedings
shall end within 120 days
shall end within 120 days
from the date that the
from the date that the
application was furnished and
application was received and
shall involve a determination
shall involve a determination
by the SEC on whether the
by the SEC on whether the
applicant is granted or denied
applicant is granted or denied
NRSRO registration. If the
NRSRO registration. If the
agency finds sufficient cause
agency finds sufficient cause
for an extension, it may
for an extension, it may
extend the NRSRO
extend the NRSRO
registration proceeding for up
registration proceeding for up
to 90 additional days.
to 90 additional days, or for
(Section 4)
longer periods with the
applicant’s consent.
(Section 4)

CRS-5
Provision
H.R. 2990
S. 3850
Grounds for the SEC’s
The SEC shall grant NRSRO
The SEC shall grant NRSRO
decision to approve an
registration if it finds that the
registration if it finds that the
applicant’s registration as
requirements of the preceding
requirements of the preceding
an NRSRO
section are satisfied. It shall
section are satisfied. The
deny the registration if it does
agency shall deny
not make such a finding. In
registration if it finds that the
the event that the applicant is
applicant does not have
already registered, that
adequate financial and
registration would be subject
managerial resources to
to suspension or revocation.
consistently produce ratings
(Section 4)
with integrity and that
comply with its procedures
and methodology (as dis-
closed above). In the event
that the applicant is already
registered, that registration
would be subject to
suspension or revocation.
(Section 4)
Requirements for updating
Generally, credit agencies
Generally, credit agencies
an applicant’s information
that have gained NRSO
that have gained NRSO
registration would be
registration would be
required to promptly amend
required to promptly amend
their applications with the
their applications with the
SEC if developments have
SEC if developments have
rendered previous disclosures
rendered previous disclosures
to be materially inaccurate.
to be materially inaccurate.
And not later than 90 days
And not later than 90 days
after the end of each calendar
after the end of each calendar
year, they would also have to
year, they would also have to
file registration amendments
file registration amendments
with the agency, certifying
with the agency, certifying
the accuracy of their
the accuracy of their
disclosures and identifying
disclosures and identifying
any material changes since
any material changes since
the previous year’s filings.
the previous year’s filings.
(Section 4)
(Section 4)

CRS-6
Provision
H.R. 2990
S. 3850
The elements of the SEC’s
The SEC would have the
The SEC would have the
authority to enforce
authority to take action
authority to take action
NRSRO accountability
against NRSROs who violate
against NRSROs who violate
the procedures, criteria, and
the procedures, criteria, and
methodologies contained in
methodologies contained in
registration applications. It
registration applications. It
also would authorize the
also would authorize the
agency to censure, place
agency to censure, place
limitations on the activities,
limitations on the activities,
functions, or operations of,
functions, or operations of,
suspend for a period not
suspend for a period not
exceeding 12 months, or
exceeding 12 months, or
revoke the registration of any
revoke the registration of any
NRSRO or person associated
NRSRO or person associated
with an NRSRO has been
with an NRSRO has been
found to: a) have been in
found to: a) have been in
violation of certain federal
violation of certain federal
laws; b) have been convicted
laws; b) have been convicted
during the 10-year period
during the 10-year period
preceding the date of
preceding the date of
furnishing the NRSRO
furnishing the NRSRO
application; and c) have been
application; c) have been
punished for any crime that is
punished for any crime that is
punishable by imprisonment
punishable by imprisonment
for a period of one or more
for a period of one or more
years, or a substantially
years, or a substantially
equivalent crime by a foreign
equivalent crime by a foreign
court. (Section 4)
court; and d) have failed to
file the required certifications
or to maintain adequate
financial and managerial
resources to consistently
produce credit ratings with
integrity. (Section 4)
Limitations on the SEC’s
None of the legislation’s rules
None of the legislation’s rules
authority over NRSROs
on the SEC’s authority over
on the SEC’s authority over
the NRSRO registration
the NRSRO registration
process shall be interpreted to
process shall be interpreted to
give the agency the authority
give the agency the authority
to regulate the substance of
to regulate the substance of
credit ratings or the
credit ratings or the
procedures and
procedures and
methodologies by which
methodologies by which
NRSROs determine ratings.
NRSROs determine ratings.
Public availability of
Generally, upon being
Generally, upon being
information NRSROs
registered as an NRSRO by
registered as an NRSRO by
submit to the SEC
the SEC, a credit rating
the SEC, a credit rating
agency must make the
agency must make the
information and documents it
information and documents it
furnished to the agency as
furnished to the agency as
part of the registration
part of the registration
process publicly available
process publicly available
through either its website or
through either its website or
an alternative readily
an alternative readily
accessible means.
accessible means.

CRS-7
Provision
H.R. 2990
S. 3850
SEC adoption of rules to
The SEC shall adopt rules or
The SEC shall adopt rules or
prevent misuse of nonpublic
regulations to require policies
regulations to require policies
information
or procedures designed to
or procedures designed to
prevent NRSROs from the
prevent NRSROs from the
misuse of the material,
misuse of the material,
nonpublic information that
nonpublic information that
they collect. (Section 4)
they collect. (Section 4)
SEC adoption of rules for
The SEC, as it deems
The SEC shall issue rules to
the prevention of conflicts
necessary or appropriate,
prohibit, or require the
of interest
shall adopt rules or
management and disclosure
regulations to prohibit, or
of, any conflicts of interest
require the management or
relating to the issuance of
disclosure of, any conflicts of
ratings by an NRSRO that
interest relating to the
shall include (1) the manner
issuance of ratings by an
of an NRSRO’s
NRSRO that shall include (1)
compensation for ratings or
the manner of an NRSRO’s
related services; (2) the
compensation for ratings or
consulting, advisory, or other
related services; (2) the
services provided by an
consulting, advisory, or other
NRSRO; (3) the nature of the
services provided by an
business ties, ownership
NRSRO; (3) the nature of the
interests, or other financial or
business ties, ownership
personal associations between
interests, or other financial or
an NRSRO and entities who
personal associations between
do business with it; (4)
an NRSRO and entities who
affiliations between an
do business with it; and (4)
NRSRO and entities that
affiliations between an
underwrite the securities or
NRSRO and entities that
money market instruments
underwrite the securities or
rated by the NRSRO; and (5)
money market instruments
any other potential conflicts
rated by the NRSRO.
of interest that the SEC
(Section 4)
deems necessary for the

public interest or for the
protection of investors.
(Section 4)

CRS-8
Provision
H.R. 2990
S. 3850
SEC adoption of rules for
The SEC may adopt rules or
The SEC may adopt rules or
the prevention of
regulations relating to
regulations relating to
prohibited acts and
NRSROs: (1) seeking
NRSROs : (1) seeking
practices
payment for a credit rating
payment for a credit rating
that has not been specifically
that has not been specifically
requested by the issuer (an
requested by the issuer (an
unsolicited rating); (2)
unsolicited rating); (2)
conditioning or threatening
conditioning or threatening
to condition the issuance of a
to condition the issuance of a
credit rating on the issuer’s
credit rating on the issuer’s
purchase of other services or
purchase of other services or
products; (3) lowering or
products; (3) lowering or
threatening to lower a credit
threatening to lower a credit
rating on, or refusing to rate,
rating on, or refusing to rate,
securities or money market
securities or money market
instruments issued by an asset
instruments issued by an asset
pool unless a portion of the
pool unless a portion of the
assets within such pool also is
assets within such pool also is
rated by the NRSRO; and (4)
rated by the NRSRO; and (4)
modifying or threatening to
modifying or threatening to
modify a credit rating or
modify a credit rating or
otherwise departing from its
otherwise departing from its
standard methodologies for
standard methodologies for
determining credit ratings,
determining credit ratings,
based on whether an issuer
based on whether an issuer
pays or will pay for the credit
pays or will pay for the credit
rating or any other of the
rating or any other of the
NRSRO’s services or
NRSRO’s services or
products. (Section 4)
products. (Section 4)
NRSRO requirements for
Each NRSO shall designate a
Each NRSO shall designate a
compliance officers and
compliance officer with
compliance officer with
financial condition data
responsibility for ensuring
responsibility for ensuring
compliance with the
compliance with the
securities laws.
securities laws.
In addition, the SEC is given
In addition, the SEC is given
the authority to require
the authority to require
NRSROs to provide it with
NRSROs to provide it with
confidential, independently
confidential, independently
audited financial statements
audited financial statements
on their financial conditions,
on their financial conditions,
the specific nature of the
the specific nature of the
filings and the interval
filings and the interval
between such filings to be
between such filings to be
determined by the agency.
determined by the agency.
(Section 4)
(Section 4)
Notice to other agencies of
Within 30 days after the date
Within 30 days after the date
the changes in the
of enactment, the SEC shall
of enactment, the SEC shall
treatment of the term
notify federal agencies whose
notify federal agencies whose
NRSRO
rules or regulations use the
rules or regulations use the
term “nationally recognized
term “nationally recognized
statistical rating organization”
statistical rating organization”
of the law’s changes in the
of the law’s changes in the
treatment of the term.
treatment of the term.
(Section 4)
(Section 4)

CRS-9
Provision
H.R. 2990
S. 3850
No waiver of right of action
None
NRSRO registration does not
and no creation of a private
constitute a waiver of any
right of action
right that the NRSRO might
otherwise have under state or
federal law. No reports
provided by an NRSRO shall
create a private right of
action. (Section 4)
Review of existing
Within 360 days after the
Within 270 days after the
regulations
date of enactment, the SEC
date of enactment, the SEC
shall review its existing rules
shall review its existing rules
and regulations that employ
and regulations that employ
the term “nationally
the term “nationally
recognized statistical rating
recognized statistical rating
organization” or “NRSRO”
organization” or “NRSRO”
and promulgate new or
and amend or revise such
revised rules and regulations
rules in accordance with the
as it deems necessary for
goals of this law as it deems
either the public interest or
necessary for either the public
the protection of investors.
interest or the protection of
(Section 4)
investors. (Section 4)
Conforming amendments
Provides for conforming
Provides for conforming
amendments to several
amendments to several
Federal statutes, including the
Federal statutes, including the
Securities Exchange Act of
Securities Exchange Act of
1934, the Investment
1934, the Investment
Company Act of 1940, the
Company Act of 1940, the
Investment Advisers Act of
Investment Advisers Act of
1940, and the Housing and
1940, and the Housing and
Community Development Act
Community Development Act
of 1992.
of 1992.
a. In the qualitative approach information is gleaned from analysts’ trips to the rated firm. In the
quantitative approach information is gleaned from the rated firm’s publicly available financial
statements.