[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]
RATING THE RATING AGENCIES: THE STATE
OF TRANSPARENCY AND COMPETITION
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
CAPITAL MARKETS, INSURANCE, AND
GOVERNMENT SPONSORED ENTERPRISES
OF THE
COMMITTEE ON
FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTH CONGRESS
FIRST SESSION
__________
APRIL 2, 2003
__________
Printed for the use of the Committee on Financial Services
Serial No. 108-18
U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 2003
89-083 PDF
For Sale by the Superintendent of Documents, U.S. Government Printing Office
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HOUSE COMMITTEE ON FINANCIAL SERVICES
MICHAEL G. OXLEY, Ohio, Chairman
JAMES A. LEACH, Iowa BARNEY FRANK, Massachusetts
DOUG BEREUTER, Nebraska PAUL E. KANJORSKI, Pennsylvania
RICHARD H. BAKER, Louisiana MAXINE WATERS, California
SPENCER BACHUS, Alabama CAROLYN B. MALONEY, New York
MICHAEL N. CASTLE, Delaware LUIS V. GUTIERREZ, Illinois
PETER T. KING, New York NYDIA M. VELAZQUEZ, New York
EDWARD R. ROYCE, California MELVIN L. WATT, North Carolina
FRANK D. LUCAS, Oklahoma GARY L. ACKERMAN, New York
ROBERT W. NEY, Ohio DARLENE HOOLEY, Oregon
SUE W. KELLY, New York, Vice JULIA CARSON, Indiana
Chairman BRAD SHERMAN, California
RON PAUL, Texas GREGORY W. MEEKS, New York
PAUL E. GILLMOR, Ohio BARBARA LEE, California
JIM RYUN, Kansas JAY INSLEE, Washington
STEVEN C. LaTOURETTE, Ohio DENNIS MOORE, Kansas
DONALD A. MANZULLO, Illinois CHARLES A. GONZALEZ, Texas
WALTER B. JONES, Jr., North MICHAEL E. CAPUANO, Massachusetts
Carolina HAROLD E. FORD, Jr., Tennessee
DOUG OSE, California RUBEN HINOJOSA, Texas
JUDY BIGGERT, Illinois KEN LUCAS, Kentucky
MARK GREEN, Wisconsin JOSEPH CROWLEY, New York
PATRICK J. TOOMEY, Pennsylvania WM. LACY CLAY, Missouri
CHRISTOPHER SHAYS, Connecticut STEVE ISRAEL, New York
JOHN B. SHADEGG, Arizona MIKE ROSS, Arkansas
VITO FOSELLA, New York CAROLYN McCARTHY, New York
GARY G. MILLER, California JOE BACA, California
MELISSA A. HART, Pennsylvania JIM MATHESON, Utah
SHELLEY MOORE CAPITO, West Virginia STEPHEN F. LYNCH, Massachusetts
PATRICK J. TIBERI, Ohio BRAD MILLER, North Carolina
MARK R. KENNEDY, Minnesota RAHM EMANUEL, Illinois
TOM FEENEY, Florida DAVID SCOTT, Georgia
JEB HENSARLING, Texas ARTUR DAVIS, Alabama
SCOTT GARRETT, New Jersey
TIM MURPHY, Pennsylvania BERNARD SANDERS, Vermont
GINNY BROWN-WAITE, Florida
J. GRESHAM BARRETT, South Carolina
KATHERINE HARRIS, Florida
RICK RENZI, Arizona
Robert U. Foster, III, Staff Director
Subcommittee on Capital Markets, Insurance, and
Government Sponsored Enterprises
RICHARD H. BAKER, Louisiana, Chairman
DOUG OSE, California, Vice Chairman PAUL E. KANJORSKI, Pennsylvania
CHRISTOPHER SHAYS, Connecticut GARY L. ACKERMAN, New York
PAUL E. GILLMOR, Ohio DARLENE HOOLEY, Oregon
SPENCER BACHUS, Alabama BRAD SHERMAN, California
MICHAEL N. CASTLE, Delaware GREGORY W. MEEKS, New York
PETER T. KING, New York JAY INSLEE, Washington
FRANK D. LUCAS, Oklahoma DENNIS MOORE, Kansas
EDWARD R. ROYCE, California CHARLES A. GONZALEZ, Texas
DONALD A. MANZULLO, Illinois MICHAEL E. CAPUANO, Massachusetts
SUE W. KELLY, New York HAROLD E. FORD, Jr., Tennessee
ROBERT W. NEY, Ohio RUBEN HINOJOSA, Texas
JOHN B. SHADEGG, Arizona KEN LUCAS, Kentucky
JIM RYUN, Kansas JOSEPH CROWLEY, New York
VITO FOSSELLA, New York STEVE ISRAEL, New York
JUDY BIGGERT, Illinois MIKE ROSS, Arkansas
MARK GREEN, Wisconsin WM. LACY CLAY, Missouri
GARY G. MILLER, California CAROLYN McCARTHY, New York
PATRICK J. TOOMEY, Pennsylvania JOE BACA, California
SHELLEY MOORE CAPITO, West Virginia JIM MATHESON, Utah
MELISSA A. HART, Pennsylvania STEPHEN F. LYNCH, Massachusetts
MARK R. KENNEDY, Minnesota BRAD MILLER, North Carolina
PATRICK J. TIBERI, Ohio RAHM EMANUEL, Illinois
GINNY BROWN-WAITE, Florida DAVID SCOTT, Georgia
KATHERINE HARRIS, Florida
RICK RENZI, Arizona
C O N T E N T S
----------
Page
Hearing held on:
April 2, 2003................................................ 1
Appendix:
April 2, 2003................................................ 63
WITNESSES
Wednesday, April 2, 2003
Cunningham, Deborah A., Senior Vice President, Federated
Investors...................................................... 30
Egan, Sean J., Managing Director, Egan-Jones Ratings Co.......... 28
Joynt, Stephen W., President and Chief Executive Officer, Fitch,
Inc............................................................ 36
Kaitz, James A., President and Chief Executive Officer,
Association for Financial Professionals........................ 38
McDaniel, Raymond W., President, Moody's Investors Service, Inc.. 39
Nazareth, Annette, Director, Division of Market Regulation,
Securities and Exchange Commission............................. 7
Root, Greg, Executive Vice President, Dominion Bond Rating
Service........................................................ 32
White, Lawrence J., Professor of Economics, Stern School of
Business, New York University.................................. 34
APPENDIX
Prepared statements:
Oxley, Hon. Michael G........................................ 64
Clay, Hon. Wm. Lacy.......................................... 65
Emanuel, Hon. Rahm........................................... 66
Gillmor, Hon. Paul E......................................... 67
Kanjorski, Hon. Paul E....................................... 69
Cunningham, Deborah A........................................ 71
Egan, Sean J................................................. 75
Joynt, Stephen W............................................. 87
Kaitz, James A............................................... 95
McDaniel, Raymond W.......................................... 123
Nazareth, Annette............................................ 128
Root, Greg................................................... 137
White, Lawrence J............................................ 144
Additional Material Submitted for the Record
Egan, Sean:
Written response to questions from Hon. Michael G. Oxley..... 161
McDaniel, Raymond W.:
Default and Recovery Rates of Corporate Bond Issuers......... 164
Fidelity Investments, prepared statement......................... 214
Standard & Poor's Credit Market Services, prepared statement..... 219
RATING THE RATING AGENCIES: THE STATE
OF TRANSPARENCY AND COMPETITION
----------
Wednesday, April 2, 2003
U.S. House of Representatives,
Subcommittee on Capital Markets, Insurance,
And Government Sponsored Enterprises
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to call, at 10:02 a.m., in
Room 2128, Rayburn House Office Building, Hon. Richard Baker
[chairman of the subcommittee] presiding.
Present: Representatives Ose, Shays, Oxley (ex-officio),
Ney, Ryun, Capito, Hart, Tiberi, Brown-Waite, Feeney,
Kanjorski, Hooley, Sherman, Inslee, Capuano, Hinojosa, Lucas,
Clay, McCarthy, Baca, Matheson, Miller, Emanuel and Scott.
Chairman Baker. [Presiding.] I would like to call this
meeting of the Subcommittee on Capital Markets to order this
morning.
We are here today to celebrate the birthday of my ranking
member, Mr. Paul Kanjorski.
[Laughter.]
And secondarily, to take up another small matter relating
to the performance of our rating agencies, the regulation and
oversight of those agencies by the SEC.
The hearing today actually represents the next logical step
in the committee's work and in examining all sectors in the
performance of our capital markets.
Most recently the committee received comment concerning
mutual fund performance and are awaiting the response from the
SEC on matters of particular interest before our next hearing.
But today, it is the issue of the nationally recognized
statistical rating organization known as the NRSROs. And there
are only at this moment four such organizations currently
recognized in that capacity.
It is my hope that we can examine in some detail the manner
by which these organizations are designated, the adequacy of
our current regulatory oversight methodologies and the basis
for which such organization is either to be given approval or
the methodology for revocation of such authority.
It is also important, I think, to understand how the system
works. As committee members will recall, in our examination of
the analyst investment banking world, many were surprised to
learn of the relationships and the revenues generated between
the various parties in transactions relating to analytical
opinions. It appears that the NRSROs do receive a significant
amount of revenue from the parties they are assigned for public
purposes to rate.
Then there is the real issue of bottom line performance.
NRSROs do have access to more information than any other market
participant other than the officials or the corporation which
they are examining. Shouldn't we expect as a result their
performance to exceed that of any other analyst or observer of
corporate conduct?
These are all questions of great significance and concern.
It has been sometime since the Congress has reviewed the NRSRO
system in any detail. And it is my expectation that today's
hearing will provide us with a broad scope of information, very
helpful in understanding whether any further actions may be
warranted or not.
And I certainly welcome all of those who have agreed to
participate here this morning.
Mr. Birthday Boy?
[Laughter.]
Mr. Kanjorski. Thank you very much, Mr. Chairman.
Mr. Chairman, for nearly a century, rating agencies like
Moody's, Standard & Poor's and Fitch have published their views
about the creditworthiness of issuers of debt securities. The
importance of these opinions has grown significantly in recent
decades as a result of increases in the number of issues and
issuers, the globalization of our financial markets, and the
introduction of complex financial products like asset-backed
securities and credit derivatives.
I believe that strong regulation helps to protect the
interests of American investors, but regulation in itself may
fail to accomplish this goal, and the private market may not
necessarily be responsible for the burdens. So somewhere in
there, we have to ascertain whether there is a responsibility
of the SEC and the Congress to reexamine the need for
regulatory activity on behalf of or regarding the credit-rating
agencies.
Accordingly, I am pleased we have worked diligently over
the last year to augment the resources available to the
Securities and Exchange Commission and enacted sweeping reforms
of auditing and accounting practices, restored accountability
to investment backing and analyst research, and improved the
conduct of business executives and corporate boards.
Although rating agencies received some scrutiny after the
recent spate of corporate scandals, we have not yet mandated
any substantive change in their practices.
At hearings before our committee last year, however, one
witness noted that rating agencies played a significant role in
Enron's failure. Additionally, a recent Senate investigative
report found that the monitoring and review of Enron's
finances, quote, fell far below the careful efforts one would
have expected from organizations whose ratings hold so much
importance, unquote.
I wholeheartedly agree. Outside of Arthur Andersen, the
rating agencies probably had the greatest access to
comprehensive non-public information about Enron's complicated
financial arrangements, and they exhibited a disappointing lack
of diligence in their coverage of the company.
Furthermore, the rating agencies have missed a number of
other large-scale financial debacles over the last several
decades. They failed to sound appropriate alarms before New
York City's debt crisis in 1975 and the Washington Public Power
Supply System's default in 1983. They have also floundered
before when First Executive Life collapsed in early 1990s and
during Orange County's bankruptcy of 1994. The failure of
rating agencies to lower the ratings in these cases ultimately
resulted in the loss of billions of dollars of American
investors who little understood the true credit risks.
As a result of the concerns about the role that the rating
agencies played in recent downfalls of Enron, WorldCom and
other companies, we called upon the Securities and Exchange
Commission to study these issues and report back to us. In
reviewing this report, it has become clear to me that while our
capital markets and the rating agencies have evolved
considerably in recent decades, the Commission's oversight and
regulations in this area have changed little.
Moreover, it disturbs me that the Commission has studied
these issues for more than a decade without reaching any firm
conclusion. In 1992, for example, then SEC Commissioner Richard
Roberts first noted that rating agencies, despite their
importance and influence, remained the only participants in the
securities markets without any real regulation.
In 1994, the Commission also solicited public comment on
the appropriate role of ratings in our federal securities laws
and the need to establish formal procedures for recognizing and
monitoring the activities of the nationally recognized
statistical rating organizations.
This release led in 1997 to a rule proposal that the
Commission never finalized. In releasing its latest rating
agency report to the Congress, the Commission stated that it
would issue within 60 days a concept paper asking questions
about rating agency regulation. Sixty days have now passed.
It is therefore my expectation that the SEC will publish
its concept release as quickly as possible and that it will
move with due diligence to finally resolve this issue and
publish regulations regarding agencies.
As we proceed today, it is also my hope that we will
carefully examine the many issues raised in the recent SEC
report on rating agencies. We must discern how the Commission
should oversee rating agencies in a systematic way. We should
also explore the conflicts of interest that rating agencies
encounter like their reliance on payment by issuers, and their
provision of consulting services to issuers. Last year,
accountants came under fire for similar problems. We should
additionally discuss the competitiveness of the credit rating
industry. In particular, many critics have raised concerns
about the ability of participants to enter the market.
Furthermore, I think that we should evaluate the ability of
investors to understand credit ratings. In studying the
recommendations of investment analysts two years ago, we heard
stories about ``buy'' meaning ``hold'' and ``hold'' meaning
``sell.'' With respect to credit ratings, investors may well
understand that triple A is an excellent credit risk with
little probability of default and that triple B+ means an
acceptable credit risk with some chance of default. But they
may not know that B-, a passing grade on their child's report
card, signifies junk bond status. Average American investors
need help in deciphering this convoluted code.
In closing, Mr. Chairman, I expect the Commission to take
prompt and prudent action on rating-agency regulatory issues. I
also look forward to working with you on these matters as we
move forward deliberatively.
Chairman Baker. I thank the gentleman.
[The prepared statement of Hon. Paul E. Kanjorski can be
found on page 69 in the appendix.]
Chairman Baker. Chairman Oxley?
Mr. Oxley. Thank you, Mr. Chairman.
And I want to thank you and commend you and thank you for
holding this important hearing to study the role and function
of credit rating agencies in the securities markets.
Over the past two years, this committee has lead the way on
investor protection beginning with an examination of Wall
Street analysts and continuing with a review of accountants,
corporate officers and boards, investment banks, mutual funds
and corporate governance practices generally.
Our inquiries resulted in the Sarbanes-Oxley Act and other
regulatory reforms and now we turn to credit rating agencies.
Sarbanes-Oxley required the SEC to submit to the committee
report on rating agencies and that report was issued in
January. I am pleased that the SEC's top market regulator is
here this morning to discuss its content.
Ms. Nazareth, welcome to the committee. We are glad to have
you back with your valued experience at the SEC.
I know that members of this committee have questions about
the Commission's oversight for this industry. Some commentators
have called for greater transparency in the rating process and
have raised questions about potential conflicts of interest
that arise because agencies collect fees from and sell other
services to the companies that they rate.
We have seen to many instance where greater transparency
has led to better functioning markets and more informed
investors.
The similarities between the potential conflicts of
interest presented in this area and those that were addressed
in the area of accounting firms in Sarbanes-Oxley are
impossible to ignore. I look forward to our panel's views on
the need for more disclosure and clarity in the rating process.
Beyond the potential conflicts and the lack of transparency,
some of questioned the real liability of the ratings
themselves, particularly in light of the rating agencies
failure to warn investors about the impending bankruptcies at
Enron, WorldCom, Global Crossing and other major companies.
There are also concerns regarding the openness of the
industry and whether anti-competitive barriers to entry exist
for ratings firms seeking recognition by the SEC. We are all
familiar with the accounting scandals which turned the big five
into the final four and resulting concerns that have been
raised.
Somehow the fact that until very recently, there were only
three SEC-recognized credit ratings agencies does not seem to
garner the same level of scrutiny. The Commission has
recognized only one new firm in well over a decade.
I am concerned that the Commission may have allowed an
oligopoly to exist. And I hope and expect to hear from the SEC
on how they plan to clarify and improve the application for
firms striving to qualify as recognized rating agencies.
Thank you, Chairman Baker, for holding this hearing.
Focusing attention on the role of rating agencies and examining
the current levels of disclosure, competition, accuracy and
regulatory oversight in the industry will surely benefit
investors and the market.
And I yield back.
[The prepared statement of Hon. Michael G. Oxley can be
found on page 64 in the appendix.]
Chairman Baker. Thank you, Mr. Chairman.
Mr. Miller? No opening statement?
Mr. Emanuel?
Mr. Emanuel. Thank you very much.
Obviously a number of questions, Mr. Chairman, that we need
to hear have already been raised. So rather than repeat them, I
think like every member of this body and of this committee and
subcommittee, we have state funds, teachers' funds, police
funds, all who lost money in WorldCom and Enron.
And although the Sarbanes-Oxley bill correctly started to
realign the walls that exist in the accounting industry, the
investment banking, commercial banking, the credit agencies to
date have been immune from that oversight. And we need to
obviously take a look at what those agencies do, whether there
is a conflict of interest that exists, whether there is in fact
more of the debt market they should cover rather than limit it.
So I submit my full remarks to the committee. And then look
forward to the testimony and the question and answer period.
Thank you.
[The prepared statement of Hon. Rahm Emanuel can be found
on page 66 in the appendix.]
Chairman Baker. Mr. Shays?
Mr. Shays. Thank you, Mr. Chairman.
I thank you for conducting this hearing. And just to say to
you that when we had the hearing on Enron there was not one
profession that looked good. The managers did not manage. The
directors did not direct. The employees did not speak out, not
withstanding Ms. Watkins who spoke out internally. The lawyers
were on a gravy train. The accountants did not do their job of
auditing. But what to me was most alarming was how the rating
agencies just broke down.
And it seemed very clear to me that they broke down in
measure because they also were part of the renumeration this
incredible amount of opportunity to make money at the public's,
I think, unfortunate expense.
So delighted we are having this hearing, and I hope that we
hear some very convincing information from the regulators as to
how we are dealing with this issue.
Chairman Baker. Thank you, sir.
Other Members wanting opening statements?
Mr. Scott?
Mr. Scott. Thank you very much, Mr. Chairman. I too want to
thank you Chairman Baker and Ranking Member Kanjorski for
holding this important hearing today regarding the Securities
and Exchange Commission's oversight of the credit rating
agencies. I certainly want to thank the distinguished panel of
witnesses today for your testimony.
This is indeed a very, very important hearing. As we know
last year the Senate Governmental Affairs Committee held a
hearing on Enron's scandal and questioned why Enron's credit
rating was high until just before the company filed for
bankruptcy.
Due to the development of complex financial products and
the globalization of the financial markets, credit ratings have
been given increased importance. The credit ratings effect the
security markets in many ways. But the SEC has not performed
any significant oversight over rating agencies.
And perhaps this lack of oversight has led to what the
Senate Governmental Affairs Committee in their hearing, to be
incredulous that they had that good credit risk until just
before the bankruptcy.
I think there are several areas we certainly need to focus
on--information flow, potential conflicts of interest, alleged
anti-competitive or unfair practices, reducing potential
regulatory barriers to entry and ongoing oversight.
And there are some questions that I certainly would want to
get some answers to. For example, I would like to know whether
there is general agreement about whether greater regulatory
oversight of credit agencies is indeed warranted.
The Senate Governmental Affairs Committee staff report
recommended that the SEC monitor credit agency compliance with
performance and training standards. I mean, is it time for that
change?
Again, a very important hearing. I look forward to hearing
from the panel and the recommendations for the SEC review of
the credit agencies.
Thank you Mr. Chairman.
Chairman Baker. Thank you, Mr. Scott.
Mr. Tiberi? No opening statement?
Mr. Ryun? Mr. Ryun has excused himself.
Mr. Matheson?
Mr. Sherman?
Mr. Sherman. As we explore the financial world, we find a
world where the referees are paid by one of the teams. We find
this among auditors and around credit creating agencies or bond
rating agencies.
What insulated bond rating agencies from the same pressures
that accountants faced was first an absence of competition. The
vast majority of bonds being rated by the two major agencies.
So even if you call them as you see them, they still have to
hire you for the next game.
But the absence of competition is not an enshrined value of
American free enterprise. And it probably is a good thing that
we are going to get some more competition in this area.
If the competition is to serve investors either by reducing
the fees charged to corporations or to provide better insight
that is good. My fear is that competition will be best
expressed in the sense of who will give you a better a grade.
If you were to--if a rating agency were to cut its fees by
half, it would be nothing in terms of value to the corporation
as if it were increase its grade by the slightest denomination
available.
I will look forward to learning in these hearings what we
are doing to providing a disclosure of all of the relationships
between the rating agencies and the issuer in terms of is there
consulting services being provided? What services and what
cost? And what are the fees being charged for the basic rating
services?
The thing that would concern me the most as a bond buyer is
if I ever saw that a corporation was paying more than the
standard fee to the entity providing its grade.
One advantage we have in bonds is that most of the
decisions are being made by highly sophisticated bond
purchasers and that the individual investor plays a smaller
role. But even there often it is a fund that invests in bonds
and then competes for the highest rate of return saying, ``All
of our bonds are at least single A or double A.
And so even bond managers should they fear that a rating
agency's results may not be strong, the pressure on them is to
buy the highest yield with the best grade whether they like
that grade or not.
So I look forward to seeing what we can do to prevent the
increase in competition from being a competition for who will
provide the best grade and to provide investors with the best
way for them to decide whether it is a grade they can trust.
Thank you.
Chairman Baker. Thank you, Mr. Sherman.
If there are no members seeking recognition, then at this
time I would like to welcome our first panelist this morning,
Ms. Annette Nazareth, who appears here in her capacity as the
Director of the Division of Market Regulation for the
Securities and Exchange Commission.
Welcome, Ms. Nazareth. And I do not know if your mike is
on. Try that little button.
Ms. Nazareth. Can you hear me now?
Chairman Baker. Very well.
STATEMENT OF ANNETTE NAZARETH, DIRECTOR, DIVISION OF MARKET
REGULATION, SECURITIES AND EXCHANGE COMMISSION
Ms. Nazareth. Thank you, Chairman Baker, Ranking Member
Kanjorski and Members of the Subcommittee.
On behalf of the Securities and Exchange Commission, I
appreciate the opportunity to testify today before you
regarding credit rating agencies and their role and function in
the operation of the securities markets.
As you know, this past January, the Commission submitted to
Congress a detailed report on credit rating agencies in
response to the congressional directive contained in the
Sarbanes-Oxley Act of 2002.
In my testimony this morning, I would like to highlight for
you some of the key points in the Commission's report and give
you a sense of some of the areas we intend to explore in more
depth.
During the past 30 years, regulators, including the
Commission, have increasingly used credit ratings to help
monitor the risk of investments held by regulated entities and
to provide an appropriate disclosure framework for securities
of differing risks.
Since 1975, the Commission has relied on ratings by market-
recognized credible rating agencies for distinguishing among
grades of creditworthiness in various regulations under the
federal securities laws.
These nationally recognized statistical rating
organizations or NRSROs, are recognized as such by Commission
staff through a no-action letter process.
Recently, the Commission has pursued several approaches,
both formal and informal to conduct a thorough and meaningful
study of the use of credit ratings in the federal securities
laws, the process of determining which credit ratings should be
used for regulatory purposes, and the level of oversight to
apply to recognized rating agencies.
Commission efforts included informal discussions with
credit rating agencies and market participants, formal
examinations of each of the NRSROs, and public hearings that
offered a broad cross-section of market participants the
opportunity to communicate their views on credit rating
agencies and their role in the capital markets.
These Commission initiatives coincided with the requirement
of the Sarbanes-Oxley Act that the Commission conduct a study
of credit rating agencies and submit a report of that study to
Congress.
Our report identified a number of important substantive
issues relating to credit rating agencies that the Commission
would be exploring in more depth. And the Commission plans to
issue a concept release that would seek public comment on these
matters in the very near future.
Among other things, the concept release would ask a wide
range of questions regarding possible approaches the Commission
could develop to address various concerns regarding credit
rating agencies.
I will devote the remainder of my testimony to a synopsis
of some of these complex issues.
One important group of issues the Commission staff has been
reviewing relates to the information flow surrounding the
credit rating process.
First, we are exploring the current amount of disclosure
that rating agencies provide regarding their ratings decisions.
At the Commission's credit rating agency hearings
representatives of the users of securities ratings,
particularly the buy side firms, stressed the importance of
transparency in the rating process.
In their view the marketplace needs to more fully
understand the reasoning behind the ratings decision and the
types of information relied upon by the rating agencies in
their analysis.
Better information about ratings decisions they assert
would reduce the uncertainty and accompanying market volatility
that frequently surrounds a ratings change.
Second, the Commission staff is reviewing the implications
of direct contacts between rating analysts and subscribers.
Some have expressed concern regarding the special access
subscribers have to rating agency information and personnel.
And questions have been raised as to whether this direct access
creates the potential for inappropriate selective disclosure of
information.
Finally, the Commission staff is assessing the extent and
quality of disclosure by issuers. At the Commission's credit
rating agency hearings several specific areas for improved
issuer disclosure were mentioned, including the need for
additional detail regarding an issuer's short term credit
facilities and, particularly in light of the Enron experience,
better disclosure of the existence and nature of ratings
triggers in contracts that are material to an issuer.
Another set of issues the Commission staff has been
examining is the potential conflicts of interest faced by
credit rating agencies.
First, the Commission staff is reviewing potential
conflicts of interest that could arise when issuers pay for
ratings. Arguably, the dependence of rating agencies on
revenues from the companies they rate could induce them to rate
issues more liberally and temper their diligence in probing for
negative information.
Rating agencies on the other hand assert that their
processes, procedures and market competition sufficiently
address these concerns.
Second, the Commission staff is assessing the potential for
conflicts of interest to arise when rating agencies develop
ancillary fee-based businesses. The large credit rating
agencies recently have begun to develop ancillary businesses
such as ratings assessment services and risk management and
consulting services to compliment their core ratings business.
Concerns have been expressed, for example, that credit
rating decisions might be impacted by whether or not the issuer
purchases additional services offered by the credit rating
agency.
The Commission staff also has been exploring the extent to
which allegations of anti-competitive or unfair practices by
large credit rating agencies have merit.
In the course of the Commission's study, there were a few
allegations that the largest credit rating agencies have abused
their dominant position by engaging in certain aggressive
competitive practices.
Some allege, for example, that rating agencies may have
used what critics term strong-arm tactics to induce payment for
a rating that an issuer did not request.
A fourth set of issues under review by the Commission staff
is whether the Commission's historical approach to the NRSRO
designation has created potential regulatory barriers to entry
into the credit rating business.
For many years, market participants have voiced concerns
about the concentration of credit rating agencies in the U.S.
securities markets and whether inordinate barriers to entry
exist.
Most agree that significant natural barriers exist,
particularly given the long standing dominance of the credit
rating business by a few firms, essentially the NRSROs, as well
as the fact that the marketplace may not demand ratings from
more than two or three rating agencies.
There also has been substantial debate regarding the extent
to which any natural barriers to entry are augmented by the
regulatory use of the NRSRO concept and the process of
Commission recognition of NRSROs.
One obvious way to avoid potential regulatory barriers to
entry is to eliminate the regulatory use of the NRSRO concept.
And the Commission staff is exploring this possibility.
The Commission staff also is reviewing steps short of
eliminating the NRSRO concept that would reduce potential
regulatory barriers including possible clarifications of the
current process and criteria for regulatory recognition of
rating agencies. Instituting timing goals for the evaluation of
applications for regulatory recognition, and considering
whether rating agencies that cover a limited sector of the debt
market or confine their activity to a limited geographical area
could be recognized for regulatory purposes.
Finally, the Commission staff is assessing whether more
direct ongoing oversight of rating agencies is warranted and
possible and if so, the appropriate means of doing so.
This oversight could include, among other things, record
keeping requirements designed for the credit rating business
and a program of regular Commission inspections and
examinations.
As part of this analysis, we are examining the scope of the
Commission's present oversight as well as the potential impact
on the credit rating market of any action the Commission may
take.
In addition, I should note that the rating agencies have
asserted that their ratings activities are at least to some
extent protected by the First Amendment.
Another aspect of possible ongoing Commission oversight is
whether rating agencies should and can be required to
incorporate general standards of diligence in performing their
rating analysis and develop standards for training and
qualification of credit rating analysts.
In the aftermath of the Enron situation and the recent
corporate failures, some have criticized the performance of the
credit rating agencies and questioned whether they are
conducting sufficiently thorough analysis of issuers,
particularly given their special position in the marketplace.
Concerns have also been raised regarding the training and
qualifications of credit rating agency analysts. Whether and
how such standards might be incorporated into the Commission's
oversight of credit rating agencies likely will be explored
more deeply in the forthcoming concept release.
As you can see, credit rating agencies raise a wide range
of complex regulatory and policy issues. I expect you will get
a sense of some of the diverse perspectives on these matters
from the witnesses who will be testifying later this morning.
The Commission has made substantial progress in its review
of credit rating agencies as I hope is evident from our recent
report to Congress. And I expect our analysis to be focused
further based on comments received in response to the planned
concept release.
Thank you for the opportunity to testify.
[The prepared statement of Annette Nazareth can be found on
page 128 in the appendix.]
Chairman Baker. Thank you very much. I do appreciate, Ms.
Nazareth, not only your work but the apparent openness having
read your written testimony, of the SEC to consider a number of
alternative directions to take with regard to current market
performance.
Is there at the current time a written set of standards if
one complies with, would lead to a designation as an NRSRO that
could be printed in a form and handed to someone? And if you
meet these guidelines, you can be assured of approval?
Ms. Nazareth. The process is not that formal at this time.
I believe that in general the standards for national
recognition are understood to the extent that the 1997 proposal
basically talked about codifying what was the staff's approach
to national recognition.
But certainly what the Commission has been talking about
more recently is taking those general standards and were it to
decide to continue to use the NRSRO designation to apply more
objective criteria and further list criteria to obtain the
NRSRO designation.
Chairman Baker. In response to the 1997 rule proposal, in
which the SEC had a considerable number of suggestions, the
response from the NRSRO group was that the SEC concerns were
addressed by their existing policies, meaning the SEC's,
procedures and competition.
Now if there are only four of them, and there were three at
the time, doesn't it seem that the competitive argument was at
best a little disingenuous? How does one allege that a
government granted authority to do a public function and you
only have three of you in the country, leads one to conclude
that that is a competitive environment? But yet they were
saying this strong competition is what keeps us on our toes.
Ms. Nazareth. I understand the position that you are
taking. You know, there is a question as to whether or not
there really is sort of a natural oligopoly in this business.
And----
Chairman Baker. I think that is a great answer.
Ms. Nazareth. Yes, I think our concern is we certainly do
not want to be in a position where we are adding to any
impediments to entry into the business through the regulatory
process.
Chairman Baker. Let me jump to the next level because my
time is going to expire here. And we do have members with a lot
of interest.
Let's assume for the moment that I have been designated.
What is the normal regulatory oversight process that exists
today from your perspectives to my conduct? What is it that I
could expect? Do I have an SEC audit? Are there analysts coming
through and looking at how I perform my day-to-day? Do you have
to present a business plan? What is the formal relationship
between this public regulatory authority and the SEC?
Ms. Nazareth. The SEC's oversight on an ongoing basis is
very limited. These entities are registered as investment
advisers, but the Adviser's Act does not really specifically
contemplate much of this type of business.
So there is not sort of a regular examination process or--
--
Chairman Baker. Well, let's assume for the moment that
tomorrow we read where one of the four is engaging in their
inappropriate conduct, there is a capital adequacy question,
whatever the reason. But it is a national in scope issue.
Is there a process by which the designation can be
withdrawn?
Ms. Nazareth. The designation has never been withdrawn, but
certainly it could be withdrawn. I mean, there is not a formal
process, but there is a process in general for no action
letters that they could be withdrawn.
Chairman Baker. Well, you can hopefully understand that the
concern is that we do not have clinical standards by which
someone gets approved. There is not a formal set of standards
for continual oversight, and there is not a published
methodology for withdrawing the designation once granted.
Would it at least be advisable to consider having this
process subject to the Administration Procedures Act where that
requires certain printed notices to the public, public hearings
where interested parties could come and make comment?
At least opening it up to that extent where market
participants at the very least and the general public on a
large scope would have an ability to express the views of the
market to the SEC because one of the principles on which the
SEC basis its judgment is national recognition and market
acceptance of whoever it is that is to be designated.
It seems to be difficult to obtain without a formally
structured process to get that information. Is that something
would or would not be advisable?
Ms. Nazareth. It is certainly something that is along the
lines of what a number of participants at the credit rating
agency hearings that we had, had raised as well. Greater
transparency with respect to the process as well as
solicitation of more data from the public at large about the
national recognition. So that is certainly something that the
Commission could consider.
Chairman Baker. And let me again, I do not want to end on a
negative note. I appreciate your appearance and recognize that
this is not a circumstance that has occurred in the last six
months. This is an environment, which frankly has existed the
first designation. And this is just the appropriate for a
review of all aspects of market conduct. And I certainly have
more questions, but my time has long expired.
Mr. Kanjorski?
Mr. Kanjorski. Thank you, Mr. Chairman.
Ms. Nazareth, your testimony raises some questions about
the rating agencies. I am more interested in what is your
personal valuation or opinion of the rating agencies? Because
you know, there is no reason to go along to set standards and
an awful lot of paperwork and a lot of hoops and things to jump
through just to make us look like we are closing the door after
the horse got out of the barn.
The question really should go: In your opinion, do the
agencies open up the door to allow the horse to get out of the
barn?
Ms. Nazareth. Well, I do not know who much weight my
personal opinion should have on this particularly since I am
not familiar with all of the factors, you know, surrounding
this. But I can say that, in general what makes this area so
difficult and the reason that we never seem to come to closure
on how to address these issues is that, fundamentally what is
occurring here is financial analysis.
Mr. Kanjorski. Yes.
Ms. Nazareth. Which is why we certainly need to be sure it
is being done in a manner that has integrity and that is free
to the fullest extent of conflicts----
Mr. Kanjorski. Well, are there any questions concerning----
Ms. Nazareth. ----but you do not know whether or in general
it is an opinion.
Mr. Kanjorski. Well, you mean after all of this time of
studying it and the requests that we made under the Sarbanes-
Oxley Act, the Commission still has not made a judgment?
I think it is about time somebody steps up to resolve the
problem, rather than spending a lot of time studying it. Look,
we have had some startling failures--Enron, WorldCom--and all
of us are trying to prove that we did not have anything to do
with it. Certainly the Congress is not responsible for it.
And the Commission probably is saying, ``Well, we are not
responsible for it.'' And the rating agencies I would assume
are saying, ``Well, we are not responsible for it either.''
I do not think that we should concentrate necessarily on
finding fault. Those are days gone by. But, do you see any way
that we are going to improve analysis, limit conflicts of
interest, or restore integrity if we do put into effect some
regulatory control over these rating agencies?
Ms. Nazareth. Well, what the Commission is going to examine
in the concept release is whether or not additional regulatory
oversight would be appropriate and whether, you know, it might
help in this area. I think----
Mr. Kanjorski. I thought that was what the concept release
that we are waiting to receive would do.
Ms. Nazareth. That is right, in the concept release. That
is----
Mr. Kanjorski. When is that going to happen? I mean, maybe
we should have postponed this hearing until we obtain the
concept release.
Ms. Nazareth. Well, we suggested that. No, the concept
release will be coming out shortly. There are drafts
circulating internally now.
Mr. Kanjorski. Can you give us a peek preview as to what
you are talking about?
Ms. Nazareth. Well, I think where it currently stands, and
again I cannot say where the Commission will come out, but it
could potentially be very broad in its scope in raising as
Chairman Baker had mentioned, you know, all manner of issues--
--
Mr. Kanjorski. I understand all of that, and you know, I
think we do not get to that level unless we find that rating
agencies have either failed or scored very poorly.
I guess what I am simply asking you is as a teacher, grade
them, A, B, C, D, or F.
Ms. Nazareth. You know, I think in general the credit
rating agencies have done remarkably well. I think the problem
is that you have some colossal failures, and we can--and it is
interesting what you have----
Mr. Kanjorski. Would you attribute any of these failures of
Enron, WorldCom or any of these other organizations to either
the conflict of interest that the agencies may or may not have
been in, or their failure of analysis, or their failure of due
diligence?
Do you see a problem? I mean, there was not any question
when we examined the accountants. There was a very definite
link between the accountants who were getting involved in
carrying out the fraud. I mean that was very clear as far as
testimony.
Are these people directly involved in any of this or is it
a failure of one out what 17,000 publicly traded corporations
and they have missed three or four of them. Is that all?
Ms. Nazareth. You know, I am personally not aware of all of
the facts. I can tell you that the rating agencies certainly
take the view that they were defrauded in the same manner as
the rest of the investing public was.
Mr. Kanjorski. Well, then, shouldn't we----
Ms. Nazareth. On the other hand, they may have been privy
to more information than others were. So I really do not know.
Mr. Kanjorski. Well, I am wondering, rather than
concentrate a lot of our time on process and particularly new
regulations of an existing business that is doing fairly well,
I mean, until preparing for this hearing, over the years, I
have always had a great deal of respect for the rating
agencies. I have always thought that they have done a pretty
good job. The failures also are minute when you really look at
them over the scheme of how many papers they are rating.
Should we have more transparency on the corporate side? Is
it that? There was some mention here on Enron--that they could
not pierce the veil of some of these off-shore things because
they just did not know about it. Should we be up here arguing
for total disclosure of everything a corporation does and then
put some rule into effect that the agencies have to be an arm
of the government in some way directly or indirectly, to
examine that?
Should the SEC be out there even examining that? I mean, it
sort of seems unfair for me to suggest that we are all up here
trying to burden this system all over again. Boy, as a Democrat
I should not be talking this way.
[Laughter.]
Democrats are supposed to be for more regulation, but you
know, I do not want to be a party to adding expense to the
securities market, driving the credit situations into a
jeopardized position because of actions we take that are not
really going to accomplish the one thing I am interested in.
Maybe I should say it: How many unsophisticated investors
are the ones that are reading these ratings or is it a fact
that the people that read these ratings and understand these
ratings are because they are expert in the field? And what we
are trying to do is prepare something that mom and pop can
decide over a kitchen table discussion, but when it in fact
they do not decide on bond ratings or other ratings made by
these agencies?
Ms. Nazareth. Well, the ratings are used primarily by the
sophisticated financial users. And the reason that we consider
it important is because it does have great influence on the
financial markets and people's ability to raise funds and the
like. It is important to----
Mr. Kanjorski. Let me come to a conclusion----
Ms. Nazareth. ----the----
Mr. Kanjorski. ----I know my time is almost gone. Can you
attribute any of the financial failures that have occurred over
the last year in the American economy to a large extent, not a
total extent, but to a large extent or as to the extent of the
accountant problem that we have to the rating agencies?
Do see them as the----
Ms. Nazareth. I personally do not see that level of----
Mr. Kanjorski. So we are at a much lower position and----
Ms. Nazareth. I would assume so.
Mr. Kanjorski. ----therefore our regulations or statutory
authority for regulations should be more constricted? Is that--
--
Ms. Nazareth. Again, what we have to analyze is what will
additional regulation bring to the process? The Commission is
not only going to have to decide if it engages in more
regulation, but what additional benefits would that regulation
bring? And two, are there limits to the Commission's current
authority? And would the Commission need----
Mr. Kanjorski. Now----
Ms. Nazareth. ----additional authority from Congress to do
that?
Mr. Kanjorski. In some of our opening statements, we
referred to this conflict of interest problem. It is
potentially an alleged conflict of interest because we do not
know whether there is one where payments are coming from the
issuers and/or paying to the rating agencies that may cloud
their judgment.
Have you ever seen anything like that happen? I mean, are
we dealing here with conflicts of interest that are rampant or
even evident in some of these failures? Or is that just a
misstatement of fact and we should apologize to the rating
companies.
Ms. Nazareth. I think there are always potential conflicts
of interest----
Mr. Kanjorski. Have you seen any? I know there is a
potential conflict of interest in every step we take in life.
Ms. Nazareth. That is right.
Mr. Kanjorski. But have we seen any conflict problem or do
we know of any or have any evidence that they have had any
impact on any of these failures?
Ms. Nazareth. I am not aware of their being systemic
conflict problems.
Mr. Kanjorski. Thank you.
Chairman Baker. Mr. Oxley?
Mr. Oxley. Thank you.
Mr. Chairman, in the absence of marketplace competition,
the SEC really is the only agency that determines the
qualifications of a ratings agency in place of the normal
checks and balances a marketplace has. And in the case of other
oligopoly or monopolies regulated by the SEC, there are
regulations, public interest obligations and the like that tend
to provide some balance. But in the case of the rates charged
by the agencies, the SEC really has no authority over those
rates. Is that correct?
Ms. Nazareth. That is right.
Mr. Oxley. And what would prevent the--any of the agencies
from exercising monopoly power or pricing for their services?
Ms. Nazareth. Well, there are a few of them obviously, and
I would think that market forces have, you know, prevented that
from happening because there is some limited competition there.
And I would also assume that were there inappropriate tactics
being exercised by these agencies, we would have heard about
it.
But----
Mr. Oxley. So you think there is some marketplace----
Ms. Nazareth. I think there is some marketplace
competition. Usually the number of ratings required for an
issue is one or two ratings. And they do have some choice here.
Mr. Oxley. I know that there are--at least I have been told
that there is one agency that is considering tripling its price
even though they apparently are adding no value, extra value.
If that were the case and they were indeed to triple their
price, what would be the--what would be the outcome? What would
be the view of the SEC in that situation?
Ms. Nazareth. Normally we would not exercise authority over
the prices that these entities would charge. We do not do that
with the broker dealers either.
Mr. Oxley. Well, and I am not here to advocate the
government regulation of pricing. Far be it for a conservative
Republican to advocate that. But obviously our goal is to--our
goal is to try to get more competition, more entries into the
market. And you have obviously heard from Chairman Baker,
Ranking Member Kanjorski and myself, that that clearly is I
think what we are aiming at.
And so to that extent we want to work with the SEC to
encourage market entry. It may very well be potential growth
industry given the past history of ratings agencies and some of
the problems that developed with failure to recognize some of
the major business failures that we had over the last several
months. And clearly that is what we are aiming at.
We appreciate your constant efforts in that--and I know you
have been at the Commission for a number of years and have
always had the best interests of the public at heart. And this
is no exception. And we are looking forward to your leadership,
working with us to provide a more competitive marketplace in
this area.
And I thank you and I yield back.
Ms. Nazareth. Thank you.
Chairman Baker. Thank you, Mr. Chairman.
Mr. Miller, do you have a question?
Mr. Miller. I do, a few. They are along the lines of Mr.
Sherman's opening statement. We have heard both concerns for
conflicts of interest and a lack of competition. And I know
that reliability has to be one basis of competition for these
agencies, at least sequentially because no issuer is going to
want any agent--if every issuer is going to want a rating that
is accepted in the marketplace as reliable.
But what will be the basis of the competition? Is it going
to be price only to the issuer, what the agency would charge if
there were more agencies? And are we going to have to worry
about the more of what we saw with the accounting firms
becoming willing partners in Enron, WorldCom, et cetera?
Ms. Nazareth. What our focus has been all along is that the
marketplace ultimately would decide through their use of these
rating that the issuers of these ratings were credible and were
issuing the ratings in an appropriate way without conflict and
side agreements with the issuers.
So basically, we have used that process to try to recognize
or mimic how the marketplace viewed what these agencies were
doing.
Mr. Miller. What we want these agencies to be is detached.
We want detachment from the agencies. That is--isn't that
right?
Ms. Nazareth. Yes.
Mr. Miller. Is it--if there is a proliferation of these
agencies, and I know that there are natural barriers to entry,
there is not going to be 400 agencies. But is--is there not
going to be some push for more favorable ratings as Mr. Sherman
suggested in his opening remarks? Is that not a concern?
Ms. Nazareth. Well, certainly from our limited
perspective--you know, originally we started using this
national recognition process because we wanted to ensure that
our regulated entities that were using these ratings for
regulatory purposes were not in fact doing what you are
suggesting, which is sort of buying a rating, you know.
Because the ratings were used to determine things like
capital requirements for the broker dealers and the like. And
you did not want to have a situation where there was any issue
that the credibility of the rating was called into question.
And so there is a concern there if we are going to continue
to use this designation because we have become somewhat
attached to it for regulatory purposes, we really do have to
ensure that all of the appropriate procedures are in place so
that you do not have what you are suggesting which is a race to
the bottom based on people coming in and competing on basis
other than the credibility of their ratings.
Mr. Miller. The suggestion is that having essentially three
firms is oligolistic.
Ms. Nazareth. Yes.
Mr. Miller. What would be the appropriate size of the
market?
Ms. Nazareth. I do not know what the perfect size of the
market would be but I do note that in Europe where they do not
have this designation process, they likewise have a somewhat
limited number of major firms that are operating in the
marketplace.
I think we had a staff person from the Financial Services
Authority in London testify at our hearing, who said that they
generally have I think south of 10. So I do not think we are
talking about a situation here where there are hundreds of new
entrants trying to come into this marketplace.
Mr. Miller. Okay. Has Europe had any of the kind of
problems that we have had or that we fear or agencies missing
it?
Ms. Nazareth. Well, I think that they feel that they have
had a very comparable experience. And they are very much
looking to what we are doing in this area. There is a lot of
interest in Europe as there has been here to looking into
further regulation of the credit rating agencies. So they are
very much looking to us for the analysis that we undertake in
this regard.
Mr. Miller. Okay. Thank you.
Chairman Baker. I thank the gentleman.
Mr. Shays?
Mr. Shays. I would like to ask you what your reaction was
when the whole debacle of Enron unfolded. I would like you to
tell me what you thought and why you thought what you thought.
Ms. Nazareth. I cannot really speak for the agency in that
regard. So I am not sure it is appropriate or how helpful it
would be to just say what my own personal views are. I do not
think in this regard I am necessarily----
Mr. Shays. Well, you were in office at the time, correct?
Ms. Nazareth. Yes.
Mr. Shays. Well, then describe----
Ms. Nazareth. Well, we----
Mr. Shays. Describe to me what you felt as a Commissioner.
Ms. Nazareth. And----
Mr. Shays. And what that, you know, made you think you
might need to do.
Ms. Nazareth. I think----
Mr. Shays. I do not think it is a difficult question.
Ms. Nazareth. We do not oversee the activities of these
credit rating agencies. There may be people in other areas of
the Commission involved in Enron enforcement action who have be
privy to more detailed information.
But in the Division of Market Regulation, we are not privy
to the specific information that the credit rating agencies
reviewed with respect to the Enron situation.
I think--there is no question that looking at the
situation, there are two distinct possibilities. One is that,
as I said earlier, the fraud that was perpetrated on the public
was likewise perpetrated on the credit rating agencies, and
that they were given answers that were not truthful with
respect to questions that they raised.
The other possibility is that because of their unique role
there may have been information that had they probed further
might have caused them to realize that things basically did not
add up.
What would be my personal question is--on which side of the
line did it fall? But I personally am not aware of which was
the case.
Mr. Shays. The--you know, all of us when we had to examine
that, I do not think that--since I do not believe there was a
professional that did their job or looked good, any one of us
in any profession would--I would think have instinctively have
said, ``My gosh, what role should or could we have played?''
And so we as legislators had to look at, you know, whether
our oversight was proper and whether we needed to take action.
I do not think it would be surprising for me to expect that
your agency ultimately while you do not regulate a rating
agency, you are the that has given them authenticity, correct?
Ms. Nazareth. Certainly we have some involvement because of
this designation process.
Mr. Shays. So if you believe that maybe the rating agencies
did not do their job, do not you have the ability to--in other
words, de-designate them?
Ms. Nazareth. Well, that is one issue. I do not think that
we have considered in this instance that they were subject to
designation but I think that----
Mr. Shays. Why not, why not?
Ms. Nazareth. Because in general, I think, as we said
earlier, ultimately--if we believed that there was a systemic
issue, clearly that is something that the Commission or the
staff should consider. I think if you look--there have been
some, there is no question about it, colossal failures.
And we have discussed many of them here today, WHOPPS,
Orange County, New York City, but you know the track record in
general. It is public--they publish it. It is quite admiral in
terms of the track record and in terms of predicting the
repayments on debt securities. And I think nobody is a
guarantor in this area. This is an area of you know, financial
analysis and opinion.
So----
Mr. Shays. Do you believe that the rating agencies
adequately serve the public in continuing to rate Enron's
investment grade four days before bankruptcy rating the
California utilities A-2 weeks before it default, in rating
WorldCom investment grades three months before bankruptcy and
rating Global Crossing investment grade four months before
defaulting on loans?
Ms. Nazareth. What was your question--did they serve the
pubic?
Mr. Shays. Yes.
Ms. Nazareth. I do not think it was their finest hour.
Mr. Shays. Would you say that is an understatement?
Ms. Nazareth. In this case, I said I am not sure the
reasons for their inability to detect the problems, but
certainly the result was extremely problematic. And we all know
what the affects of that were.
Mr. Shays. I would just say Mr. Chairman, that the
challenge I am having is that I think you wrote a very thorough
statement of all the things you are reviewing, but I do not
feel any passion in your voice. I do not feel any sense of
responsibility in your position. And it makes me tremendously
concerned.
I thought I was giving you a softball that you could have
knocked out of the park. I thought I was basically giving you
the opportunity to say, ``I was horrified. It caused us to look
at what we are doing and how we might make a better
contribution. It got us thinking of recommendations we might
make to the legislative body on ways that we could protect the
public interest to make sure things were done better.''
I get the feeling that basically you all are pretty much
asleep. That is the feeling I get from the way you responded to
me.
Chairman Baker. Your question is, ``Did you know that all
of those things?'' That is your question. I was just framing it
for you as a question instead of a statement.
Mr. Shays. I would like you to do it. That is your
question.
[Laughter.]
Chairman Baker. Thank you, Mr. Shays.
If I may, Mr. Scott, you are next.
Mr. Scott. Thank you very much. Ms. Nazareth let me ask you
this, could you explain to me why three credit rating agencies
are exempt from the SEC rules on corporate disclosure?
Ms. Nazareth. I am glad you asked that question, because
there is some misunderstanding about how reg FD works. All
credit rating agencies that publicly disseminate their views,
whether or not they are NRSROs--have an exemption from reg FD.
At the time that reg FD was promulgated I think the belief
was and continues to be that you want credit ratings to be as
knowing and be based on as much information as possible. And to
the extent that there is some information that issuers might
feel free to share with the rating agency, that could be
factored into the rating and therefore, have the rating be to
some extent more accurate and timely, that that was an
appropriate exception, particularly since the rating then is
widely disseminated.
So it was within keeping of the spirit of reg FD whether or
not the full basis on which the rating was promulgated was
known. The fact of the matter is that there would be wide
dissemination of a rating that included this information. And
that therefore you would have a better more fulsome rating than
you would have had without it.
That was the logic.
Mr. Scott. But as you look at it, do not you think that
this lack of disclosure has a harmful effect on the decision
making process?
Ms. Nazareth. It's not a lack of--it is a question of
whether or not something is not required to be disclosed at the
time. If you recall, reg FD said if the issuer were determined
to disclose something you had that was material that you had to
widely disseminate to every one. It could not be selective
discloser.
In this case again, if it is something that the issuer is
not obligated at that moment in time to publicly disseminate,
but feels that it would be important for the credit rating
agency to know, reg FD would not be an impediment to sharing
that information.
It does not require that he share it. If he does share it,
it is not a violation of the regulation.
Mr. Scott. These credit rating agencies are sort of like an
exclusive club. I mean, they cannot get a foothold in the
industry, in the business without the SEC's approval. Is that
right?
Ms. Nazareth. Well, I think credit rating agencies in
general, you know, there are many of them and they can--and
many of them are quite successful. I think the issue is the
designation as a nationally recognized statistical rating
organization which is more selective.
Mr. Scott. Can't get that without the SEC approval?
Ms. Nazareth. Yes.
Mr. Scott. Well, why have there not been any new rating
agencies designed in the last 10 years? Do you see that as a
problem?
Ms. Nazareth. I guess I have to put it in the context of
how many have applied as well.
Again, we think there are some natural barriers to entry
here. There have not been that many applications. As you may
know, at one point we were up to seven and because of
consolidation in the industry, those seven who had been
designated went down to three.
And I would say in the last ten years we probably had about
four or five additional rating agencies who had applied who did
not receive the designation. We have currently three or four
that are pending.
So we are not talking about scores of people who have come
in who we have turned down. There has been a limited number,
obviously some of them have received the designation and I
think we took action in 1999, on Thompson Bank Watch, which had
had a limited designation. And so we expanded their NRSRO
designation to cover a wider variety or products in 1999. And
then as you know, recently we had Dominion approved. So we are
now up to four.
Mr. Scott. Are there artificial barriers?
Ms. Nazareth. Well, that is what we want to be sure that we
are not creating. I think we are trying to ensure that there is
some discipline on this process because we use the designation
for regulatory purposes. But I think the Commission is very
interested in ensuring that they are not creating artificial
barriers that exacerbate any competitive issues.
Mr. Scott. So there are barriers, but you would say they
are more natural market forces?
Ms. Nazareth. Well, there certainly are a lot of natural
market barriers.
The question is, are there things that the Commission could
do to ensure that their regulatory process does not make it
worse.
Chairman Baker. Mr. Scott, your time is winding up. If you
could make this your last one, sir.
Mr. Scott. Well, I just would like to say that I think that
there is a challenge here for the SEC to move forthrightly to
make for better competitiveness as an--just--is there--is there
general agreement on whether greater regulatory oversight of
these credit agencies is warranted? Is it pretty much agreed?
Ms. Nazareth. No. I think that the Commission has an open
mind about it and is seeking comment on that through the
concept release--which explains my lack of passion in my
testimony. I think that the Commission is truly open minded
about what inputs it gets back in the context of the concept
release.
And I think we will also carefully look at the authority
issues and determine if additional regulation is warranted, in
which case we may also seek further authority from Congress.
Mr. Scott. Thank you Ms. Nazareth.
Chairman Baker. Thank you Mr. Scott.
Mr. Capuano?
Mr. Capuano. Thank you, Mr. Chairman.
Ms. Nazareth, do not confuse me with Mr. Shays. I have no
softballs to throw at you.
Ms. Nazareth. Oh, great.
Mr. Capuano. I have to tell you that I came to this hearing
today because I wanted to make sure that I was on record as
telling the SEC that think you have done a minimal job at best
in reaction to this crisis that has been facing us now for
almost two years. If it was not for the state attorney general
in New York, I think that you would have done even less than
you have done.
So I am not a happy camper. I do not that the investing
confidence has come back. I do think that today's situation or
today's hearing relative to rating agencies is just another
part of it.
But it amazes me, absolutely amazes me that average people
can see the potential conflict in the private end in what the
agencies do. Every single one of them, just like auditors, are
afraid that the people they are rating are going to go to
another rating agency if they rate them too harshly. How is
that not seeable? How is that not clearly understood?
And when you have that situation, I think there is no
answer other than relatively strict regulation or at least
oversight from somebody. And the only somebody is the SEC.
That is who the public looks to. They look to the SEC.
And for the SEC to sit back and say, ``Well, we are not
sure. We have been thinking about this for--well, since 1994.
We are going to continue to think about it. We have a lot of
questions.''
To me is, well, why bother. Why bother? Forget your concern
or anybody's concerns for the general public's faith in the
system. The credit rating agencies, just like the auditors,
have a financial push to not anger their clients.
Very simple. Having been involved with credit rating
agencies in the past, their desire to delve deeply into the
numbers underwhelmed me every time I ever dealt with them.
Cookie cutter stuff, did not fit into the cookie cutter,
fine if it did, fine. Very little--very few questions. And here
is the rating.
And you know as well as I do that the average investor,
that includes the small investor who might just wonder what
their mutual fund is doing, they may not read the credit report
but they certainly will know that it is an A or double AA or a
triple BBB or whatever it is going to be. They know that.
And the individual companies themselves use those ratings
as advertising. You know that. ``Oh, we got an A. We got a B.''
That is what it is all about. And to worry about or to
take, I do not know, I think I read somewhere since 1994, if
you want to certify a group, do it and make it count. If you do
not, then do not.''
These people are walking around and that does not mean that
everybody is doing a bad job. I do not mean to imply that. But
the ones who do not do their job, clearly there have been many,
but the ones who do not do their job are walking around with
their CC certification which tells the investing public, ``It
is fine.''
How is it that you do not see a problem with that? How is
that there is still debate in the SEC to do something? How is
that possible at this point in time after the crisis that we
continue to suffer from?
Ms. Nazareth. I do not think that there is any question
that the Commission considers it a very important issue. I
think--you actually stated it quite clearly. I think where we
are is that given that we do give this NRSRO designation--we
either have to be in or out.
We either have to stop giving the designation and basically
say we have no oversight responsibility over these entities.
And clearly the statute does not specifically say that we are
supposed to be overseeing credit rating agencies, or if we are
going to continue to designate these entities, there has to be
certainly more transparency to the process. And it will raise
further issues of what additional oversight is necessary.
I think we are in a difficult position right now because
once you designate an entity, I think it does leave the
impression that there is more being done on any ongoing basis.
And I think that is the challenge that the Commission has and
we are hoping that in the next few months once they basically
analyze more current feedback that they get from the soon-to-
be-released concept release, that they will make a
determination.
Mr. Capuano. The last time they asked for feedback and they
analyzed it, they basically decided to do nothing. Do I have
any faith whatsoever--should I have any faith that something
will be done, anything will be done?
Ms. Nazareth. I would think so. I also think that the
concept release of the time was probably somewhat more limited
than the issues that we are looking at now.
So, I think there is much more focus on the issue how.
But suffice it to say, as others have said here, that it is
a very complicated issue. But----
Mr. Capuano. I understand that it is a complicated issue.
Everything is complicated in life. I understand that, but at
the same time for me, I do not care. The SEC gets paid and now
hopefully gets paid more than they used to----
Ms. Nazareth. We thank you for that.
Mr. Capuano. Well, happy to do that. I think it was
worthwhile. But it gets paid to deal with complicated issues.
Ms. Nazareth. Uh, huh.
Mr. Capuano. My mother relies on your goodwill and your
positive action to do your best within reason obviously, to
make sure that her investment is reasonably safe. We need some
speed here.
I need some speed here.
Ms. Nazareth. Right.
Chairman Baker. Speaking of speed, Mr. Capuano, your time
has expired but----
Mr. Capuano. Thank you.
Chairman Baker. Thank you, Mr. Capuano.
I would like to suggest for members, because everybody has
a sincere interest in this, as opposed to going to a second
round with five minutes for everybody, that everybody who
chooses can ask--well, we have members who have not yet--do you
have questions?
Okay. Mr. Ney?
Let me recognize Mr. Ney for his five minutes, and then we
will go to a second round with each member having the option to
ask two more questions just to make sure we have vetted
everything.
Mr. Ney?
Mr. Ney. Thank you, Mr. Chairman. One question I wanted to
ask is about the rating firms. You know, the rating firms are
essentially private research firms. They have been granted a
government benefit in the form of a monopoly power they enjoy
as a result of receiving an NRSRO status from the Commission's
staff.
Why should they also get special access to information that
reg full disclosure restricts from the public?
Ms. Nazareth. They do not have a unique benefit under
regulation FD. All credit rating agencies whether or not they
are designed as an NRSRO have an exception under reg FD.
Mr. Ney. So they do not have special access to information?
Ms. Nazareth. They do not. They do not. NRSROs alone do not
have special access.
Mr. Ney. Okay. The other question, Mr. Chairman, I had is
Standard & Poor and Moody's control about 80 percent of the
credit ratings market. In light of the fact that a rating from
two different firms is typically needed for issuing new debt,
the two firms do not actually compete against each other.
Even though S&P and Moody'ss have failed repeatedly to warn
investors, their revenues have not suffered because there are
few alternatives.
What do you think could be done to counter what I consider
unhealthy conditions?
Ms. Nazareth. Well, I think there is some issue as to
whether or not there are natural barriers to entry, but one of
the things that the Commission is interested in ensuring is
that it is not sort of adding to the competitive problems
through its regulations. So that is something that is the
subject of great Commission focus right now and will be
hopefully addressed through the concept release, the questions.
Mr. Ney. So this subject is under internal discussion----
Ms. Nazareth. It is under internal discussion, yes.
Mr. Ney. Is there a timeframe or guesstimate or----
Ms. Nazareth. Well, we are hoping that the concept release
will be issued within the next few weeks and then from there,
we will take the data and the Commission will determine what
further steps it wishes to take.
Mr. Ney. Thank you.
Thank you.
Chairman Baker. Thank you, Mr. Ney. And starting our second
round now, we would recognize any member for a couple of
additional questions. I just want again reiterate my
appreciation for your appearance.
I have two questions that are not troubling, but of
interest. S&P for example, is a publicly owned corporation that
has its stock traded in the public market.
Who rates them?
Ms. Nazareth. Who rates S&P? I do not know.
[Laughter.]
Chairman Baker. Because it would seem that if--if we have
only four them and they are all publicly traded stock----
Ms. Nazareth. Right.
Chairman Baker. And you in normal conduct of business, you
have to get access to capital, if you are going to get access
to capital, you have to have a rating. It has to be by a
nationally recognized rating organization.
Secondly, it is I think generally known that there are
officials of the credit rating corporations, to make it clear,
there are businesses making business judgments for their own
shareholders who serve in either a board or administrative or
executive capacity who also serve on the boards of the
companies they rate.
Now that to me is an extraordinary--a difficult matter.
Has the SEC looked at that relationship or an executive in
a rating agency serving on a--as a board member of a company
which they are not rating?
Ms. Nazareth. No, we have not. If that is the case, I think
that is a good area of pursuit. We have more to suggest but we
will get to those later.
That is my two questions.
Mr. Miller?
Mr. Miller. A quick couple of questions. All of our
concerns about conflict of interest, about the lack of
detachment by these agencies does seem to date from the
agencies from being paid principally by investors being paid
principally by issuers.
Is it possible to go back? Can the market work? Can we get
that genie back in the bottle?
Ms. Nazareth. You know, the rating agencies themselves may
be able to speak more directly to that. I think the reason it
switched originally was because it is very difficult in a world
where information is sort of freely disseminated through
technology to be able to make their money through subscriptions
because these ratings become widely known, and you know, there
is sort of a free-rider effect.
So this was really their alternative to that problem. And
certainly the rating agencies can address, how they think the
potential conflicts are mitigated. Largely it is done, I think,
both through their view that their franchise value is based
substantially on the integrity of their ratings.
That is certainly one thing they argue. But also they rate
so many issuers that their income is not reliant to any
significant extent on any one issuer so that they do not feel
that they are unduly influenced by an issuer leaving because
there is no concentration.
Mr. Miller. Second question. Mr. Shays pointed out the
number of times that changes in ratings did not appear until
immediately before bankruptcy. That also may be because the
change of rating precipitated bankruptcy.
One of the things that seems to be most troubling about the
amount of power that these agencies have and the lack of--and
relative lack of regulation either by the marketplace or by
government or anybody is those triggers. Do you think that
those are a necessary part of the marketplace having
accelerated payments on debt because of changes in ratings?
Ms. Nazareth. I think that is a great question. I think
certainly one of the lessons learned from some of these
situations is that we need a greater understanding of the
ratings triggers. I think from what I understand the credit
rating agencies themselves do a more rigorous job now of
understanding where all of the ratings triggers are and what
impact the change in rating would have.
And I also think that it is something the Commission will
consider in terms of adding more disclosure information as
well, because it obviously has a material effect. There is in
some sense a spiraling effect when things go bad if you have
these triggers that as you say, precipitates a bigger crisis.
Chairman Baker. Thank you, Mr. Miller.
Mr. Shays?
Thank you Mr. Chairman.
Mr. Chairman, I am going to make two observations. One is
that when I have an employee, I want an employee who is
anticipating problems and looking for solutions.
And so Ms. Nazareth, I understand you are not a
Commissioner, but this is your area. And I want to go on record
as saying that I believe your lack of energy points out that a
fire needs to be lit underneath you.
Tell me why I should take more comfort in the four rating
agencies that basically have your ``no action'' stamp of
approval than I should on the ones that do not?
In other words, it strikes me that there are some rating
agencies that do not have the status of your stamp of approval
that really have done a better job. Why should I be comfortable
when I look at what two of these firms have done, they have 80
percent of the business and they do not compete with each
other.
Why should I take comfort in what they have done?
Ms. Nazareth. We are not by virtue of designating these
entities saying that any of these other ratings services cannot
be used. What we are saying is that we had tried very narrowly
for purposes of our regulations to determine that we had
agencies that were nationally recognized and as Mr. Miller
suggested, who were significant enough and whose ratings
presumably would not be influenced by other factors, like other
competitive factors, to have credible ratings.
Obviously, you have raised a number of important issues
that the Commission will consider. I take issue with your
characterization unfortunately of a lack of zeal. I think that
you are perhaps misinterpreting a cautiousness on my part
because I am in fact representing the views of a number who may
not at this moment in time have completly formulated their
views on what the Commission is going to do.
But I can assure you that the Commission is examining this
issue with a tremendous passion and that there is a huge amount
of effort going on at the Commission to come to the right
answer on this.
And again, if we feel that more is needed to be done, we
may in fact be back here asking Congress for additional
authority to do more in this area.
Mr. Shays. Well, the fact that you would ``if I feel more
that needs to be done,'' we all know that more needs to be
done. It is the question of what needs to be done.
My second question, living with the format of the question,
is to ask why should I draw comfort that there are no formal
requirements to have your stamp of approval and it is not
transparent?
Why should I draw any comfort from that at all?
Ms. Nazareth. I am not suggesting that you draw comfort
from that. It is quite clear that if the Commission continues
to use this designation, there will be much greater
transparency around that process. I have no doubt about that at
all.
Mr. Shays. And so the proposed rule of 97, maybe we will
finally be acted on?
Ms. Nazareth. Or some other form of it, yes.
Mr. Shays. Interesting that it is a proposed rule in 1997,
isn't it?
Ms. Nazareth. Yes.
Chairman Baker. Thank you, Mr. Shays.
Mr. Kanjorski?
Mr. Kanjorski. Who is going to win the World Series?
[Laughter.]
Thank you very much, Mr. Chairman.
Ms. Nazareth. Happy birthday.
Mr. Kanjorski. Thank you.
Chairman Baker. Thank you, Mr. Kanjorski.
Ms. Capito?
Mr. Shays. Can I make an observation?
I like Mr. Kanjorski, when it is not his birthday. He is
just too nice today.
[Laughter.]
Totally out of character for the record.
[Laughter.]
Mr. Kanjorski. One day here----
Chairman Baker. Officially no comment?
Ms. Capito?
Mr. Ney?
Ms. Hart?
Mr. Scott?
Mr. Scott. Yes, I would like to--let me ask you in terms of
regulatory oversight, do you think that the Securities and
Exchange Commission should monitor credit agency compliance
with performance and training standards?
Ms. Nazareth. That is something that is under very serious
consideration by the Commission. I know that was something that
was recommended in one of the congressional reports. And it is
one of the items that is going to be explored in the concept
release.
Mr. Scott. What about you? What do you think? Do you think
this should be done?
Ms. Nazareth. I think if we continue to use this
designation we cannot be sort of half in. If we are going to do
that, then we are going to have to do more rigorous oversight.
Exactly what form that will take I do not know and whether or
not we need to come for additional authority is also an open
question.
Mr. Scott. Okay.
Ms. Nazareth. But it is for the Commission to decide. I do
not have a vote.
Mr. Scott. Let me ask you this question about conflict of
interest.
Chairman Baker. And that will have to be your last, Mr.
Scott so we can wrap up. Thank you Mr. Scott.
Mr. Scott. What do you think should be done about potential
conflicts of interest that arise when insurers pay for ratings
and when rating agencies develop additional fee based services?
Ms. Nazareth. That definitely raises questions for us. As
you may know, at this point, the additional fee-based services
that the credit rating agencies, that those businesses are
involved in, are rather small. But certainly, intellectually,
it raises all the same issues that we saw with the accounting
industry. So that is another issue that the Commission is
looking at very closely.
Mr. Scott. Thank you, Ms. Nazareth.
Chairman Baker. Thank you Mr. Scott.
Let me express my appreciation on behalf of the committee
for your willingness to participate at such length. Your
appearance here has been a great help to the committee, and we
look forward to working with you on the results of the concept
study. And appreciate the efforts of the agency .
Thank you very much.
Ms. Nazareth. Thank you.
Chairman Baker. At this time I would like to call up our--
members of our second panel, please. I want to welcome each of
you here this morning to participate in this informational
hearing for the subcommittee.
To the extent possible, I would ask that each witness try
to summarize their testimony. All of your formal statements
will be made part of the official record. It is my observation,
given the interest of members, that the follow-on discussion
between the committee members and each of you will probably be
of great interest to us. And given the number of folks we have
to hear from this morning, please try to constrain your remarks
to no longer than five minutes.
To that end, I would like to begin by calling on the
managing director of Egan-Jones Ratings Company, Mr. Sean J.
Egan.
Welcome, sir.
STATEMENT OF SEAN J. EGAN, MANAGING DIRECTOR, EGAN-JONES
RATINGS CO.
Mr. Egan. Thank you.
My name is Sean Egan. I am managing director of Egan-Jones
Ratings, a credit ratings firm. By way of background, I am the
co-founder, and we were established for providing timely,
accurate ratings to institutional investors.
We are dissimilar to the rating firms that are currently
recognized by the SEC, the NRSROs, in that we are not paid by
the issuers of ratings. We think there is a fundamental
conflict of interest, and we do not think that it is
surmountable.
We are paid by approximately 300 institutional investors
and broker-dealers. Unlike the current NRSROs, we provided
warning to investors on the major debacles, such as Enron,
WorldCom, Global Crossing, Genuity.
We are based in the Philadelphia, Pennsylvania, area, but
we have employees that are in other offices.
We believe that the rating industry is flawed in a couple
of fundamental ways. One is that there is little competition.
This is not an oligopoly. People refer to it as an oligopoly;
it is not. What it is is a partner monopoly. That is, that you
have two firms, S&P and Moody's, having between 80 and 85
percent of the revenues in this business, and neither of them
compete against each other because you need two ratings,
typically, for a bond underwriting.
So, if S&P is awarded a designation for rating a particular
issue, Moody's is soon to follow. It is not as if they are
competing against each other, unlike the accounting firms. In
fact, they are side by side.
The second problem, of course, is that there is a conflict
of interest. The major rating firms, S&P and Moody's, used to
be paid by the users of credit ratings, but that changed
approximately in the mid-1970s, whereby they received the bulk
of their rating, their fees, now from the issuers.
Some people refer to this as a natural oligopoly. We
disagree. It is not a natural oligopoly in any other way than,
let's say, the financial analysis industry, or the money
management industry; you do not have two firms controlling 80
to 85 percent of the industry. Likewise, in the equity research
area you do not have two firms controlling 80 to 85 percent. It
is simply not a natural oligopoly. There have been barriers
that have been set up for getting this NRSRO designation.
Because of the unhealthy state of the credit rating
industry, investors have lost hundreds of billions of dollars,
pensioners have lost their pensions, and workers have lost
their futures.
Now, the current NRSROs will put up what we call five
defenses for why they should be the only NRSROs recognized, and
I will run through these very quickly. I have four in my
written testimony, but we added a fifth.
One is issuer misdeeds. That is that the issuers did not
tell us that they had fraudulent financial statements. Our
feeling is that any decent credit rating firm should be able to
figure it out. There is always fraud. It always happens. When
Bernie Ebbers has a $400 million loan from the company, that
should be a fairly good signal that something is wrong.
The second defense that the S&P and Moody's put up for why
they missed it is that they have little incentive. We call that
the Jack Grubman defense, and you heard a little bit about that
this morning from Annette.
Our feeling is that, just like Jack Grubman and Henry
Blodget of Merrill Lynch constitute a small part of their
respective firms' revenue base, they still misled investors, to
their benefit. So we do not believe that the little incentive
argument holds much water.
A third comment you will hear for the defense of the
current situation is that ``our reputation is key.'' We refer
to this as the Arthur Andersen defense, that, ``There is no way
we would let a rating company be misrated''--this is what they
will say--``because our reputation is too important.'' Well, we
think that is trumped by the compensation issue.
This fourth defense that they will use is the committee
approach. That is, that, ``We rate things via committee and
that way no one particular person can affect things.'' We refer
to this as the lemming defense, that it is very clear that
there is just one analyst that is looking at the company, it is
very clear what the hierarchy is, and it is very difficult to
buck that.
The last defense that will be used for not changing this
industry is what we call the ``great, great grandfather
defense,'' and that is that a firm needs to be established
around World War I, which is when S&P and Moody's were
established, to have any sort of presence in this industry. We
disagree with this.
We have a number of recommendations. I do not want to get
into them now. What we would encourage the SEC to do is to
broaden their definition of what is appropriate for an NRSRO.
They list national recognition in the United States as being
the primary criterion for recognition.
We commissioned a survey. We contacted the SEC before that
survey, during that survey and afterwards, and that survey
basically indicated that we had more than four times the
recognition of any other non-NRSRO firm. We provided that to
the SEC, we asked for a meeting, they refused to have a meeting
with us.
We were somewhat surprised when DBRS was given the
designation. We had more than four times the recognition of
them. We asked the SEC what exactly we needed to get this
designation and they said they simply could not tell us and
they are still studying it.
So if you have any additional questions, I will be happy to
answer them later.
[The prepared statement of Sean J. Egan can be found on
page 75 in the appendix.]
Chairman Baker. Thank you very much, Mr. Egan.
Our next witness is the Senior Vice President of Federated
Investors, Ms. Deborah A. Cunningham.
Welcome, Ms. Cunningham.
STATEMENT OF DEBORAH A. CUNNINGHAM, SENIOR VICE PRESIDENT,
FEDERATED INVESTORS
Ms. Cunningham. Thank you, Chairman Baker.
I am in charge of the taxable money market group at
Federated investors, which is a mutual fund company based in
Pennsylvania, and it is in that context that I offer my remarks
to you here today.
The group that I am in charge of at Federated is required
from a regulatory standard to utilize the ratings from the
various NRSROs, and this is set forth by Rule 297 from the
Investment Company Act of 1940, which requires money market
funds to utilize NRSROs as information in the minimal credit
risk determination that we make. It is one piece of the puzzle
that is used in the determination of creditworthiness that our
analysts use, but we are required to do so.
The securities that the funds that I manage purchase are
generally corporate notes from either financial-or industrial-
type corporations, as well as asset-backed securities. The
asset-backed securities that I purchase are required, again
from a regulatory standpoint, to have NRSRO ratings, while that
requirement is not mandatory for the corporate securities that
we purchase. On average, however, though, 99 percent of the
securities that I purchase in the funds that I manage are
indeed rated by at least one NRSRO.
On the positive side, I think that the content of the NRSRO
writeups that have been disseminated has improved drastically
over the last several years. The qualitative information, as
well the timeliness of those writeups is very good.
On the negative side, there have been instances in recent
times when I have reviewed information that shows data that is
more than 18 months out of date. So it is obviously not a
perfect scenario yet in this context.
The NRSRO reports are helpful from my analysts standpoint
because they are concise, they offer peer-group information,
show industry averages, industry comparisons. They also show a
large array of historical information, so you are able to look
at some trend analysis from this information that is
disseminated by the rating agencies.
In general, then, they have a summary that has positives
and negatives that effectively is the justification for the
rating that in fact that rating agency is giving to that
particular company.
The NRSROs are also providing clues for future financial
health of the particular entities that we are using by way of
their outlook and by way of their watch lists. The watch list
companies are basically those who are closer to having their
ratings change, either upward or downward, in the near future.
Occasionally, however, an issuer will be downgraded without
first having a negative outlook or first being listed on a
watch list as a potential downgrade, and this causes a lot of
havoc in the marketplace. It is a very disruptive procedure.
The reason for those sort of sudden surprise changes can be
necessarily a sudden surprise change in the information that is
being disseminated by the company or it can be
misrepresentation or a misunderstanding of the information that
had been previously disseminated.
Whichever the case is, I think an improvement that we would
like to see would be for any type of sudden, unexpected changes
by the NRSROs to be accompanied by a more detailed, transparent
statement as to why those changes occurred and what the future
outlook will be for other such changes.
Switching to asset-backed securities for a second, these
issuers are special purpose entities, they are not publicly
traded, publicly held companies, so the information that is
available in the marketplace for them is much, much lower than
it is for publicly traded corporates and financials.
The NRSROs do require a great amount of information to be
submitted in order for them to rate these special purpose
entity, asset-backed securities and they require that
information on a regular basis to monitor and upkeep that
rating.
Another suggestion that I would have for the NRSROs for
improvement would be to better disseminate a lot of this
information to the investing community so that we are not
always at odds trying to get that information directly from the
issuers.
Now let me address for a second the issue of fees. The fees
that are paid by fund companies, such as Federated Investors,
who manage money market funds and other types of bond funds,
are a substantial portion of the advisory fees that we charge
our customers for those funds.
Although these fees may indeed pale to what the issuers are
actually paying those NRSROs, I guess I believe that it is
incremental enough that the rating agencies are in fact looked
upon by us as being unbiased third-party experts.
In order to ensure this unbiased quality, I think all of
the contract negotiations that take place for fees from the
issuers to the rating agencies should be done away from the
analysts and the committee members that are actually
responsible for designating ratings for that particular
company. And I am not sure if that is the case today or not.
With regard to additional fee-based businesses, I guess I
take a different tack, and it is one that we are familiar with,
in that I have many of the funds that I manage rated by the
rating agencies themselves.
And in those instances some of the rating agencies dictate
that the securities that are held within those funds are also
rated by that same NRSRO. So this seems to be a little bit of a
bad business practice that I think could be amended in that, as
long as there is any rating on those securities within those
rated funds, this should suffice.
Let me recap by looking at the current NRSRO status. The
SEC most recently designated Dominion Bond Ratings as the
fourth NRSRO. At one point there was a high of seven NRSROs and
through consolidation that shrunk down to three.
I think this recognition of DBRS as the fourth agency is
one that is welcome. Investors are always looking for
additional information and additional opinions, and we are in
the process right now of negotiating with DBRS as to how we are
going to utilize their information.
I think that the addition, though, of these NRSROs should
be deliberate and it should be detailed by the Commission.
However, more transparency in that process is probably a good
idea.
[The prepared statement of Deborah A. Cunningham can be
found on page 71 in the appendix.]
Chairman Baker. Thank you very much, Ms. Cunningham.
Out next witness is the Executive Vice President of
Dominion Bond Rating Service, Mr. Greg Root.
Welcome, sir.
STATEMENT OF GREG ROOT, EXECUTIVE VICE PRESIDENT, DOMINION BOND
RATING SERVICE
Mr. Root. Thank you very much. I would like to thank you
and the subcommittee for giving us the opportunity to address
such an important issue today.
As we all know, ratings have become a key, integral part of
the financial markets, and therefore I think it is imperative
that there be a clear understanding of the role of rating
agencies, how they operate and how they compete.
Let me begin with just a brief overview of Dominion Bond
Rating. We are based in Toronto, founded in 1976 by Walter
Schroeder, who remains the company's president. And DBRS is
employee owned. We do not have public shareholders, we are not
affiliated with any other organization and we limit our
business to providing credit ratings and research.
DBRS is what we call a general rating agency in that we
analyze and rate a wide variety of institutions and provide
credit research on these as well.
We currently rate about 700 different entities, and we have
about another 250 companies, most of which are based here in
the U.S., that we are providing credit research on without
ratings.
DBRS has 65 employees and we have 45 analysts at this time.
Since our inception, DBRS has been widely recognized as a
provider of timely, in-depth, impartial credit analysis. Our
opinions are conveyed to the marketplace using a familiar,
easy-to-use letter grade rating scale. These ratings are
supported by extensive research, which include detailed reports
on individual companies, as well as comprehensive industry
studies.
This information is disseminated through various means,
including a proprietary subscription service, which is used by
more than 300 institutional investors, financial institutions
and government bodies.
DBRS credit ratings reflect the company's opinion as to the
likelihood of timely payment in full of principal and interest.
In arriving at these decisions, our team of analysts consider a
wide range of quantitative and qualitative factors that could
affect the future creditworthiness of the issuer or specific
instrument in question.
As part of the process, we maintain an ongoing dialogue
with the managements of the companies we rate. All ratings are
processed through a committee system and are reviewed
constantly. Ratings are changed whenever we are of the opinion
the relative creditworthiness has changed positively or
negatively.
Next I would like to say a few words about the role of
rating agencies in the capital markets. Again, over the past 30
years the SEC, other federal and state regulators and even
Congress have increasingly relied on credit ratings as a way to
monitor the risk of investments held by regulated entities. In
addition to these legislative and regulatory uses, NRSRO credit
ratings are widely used extensively in debt covenants and other
financial instruments between private parties.
I am pleased to say that the confidence the regulators and
the markets have shown in the rating agencies is not misplaced.
While ratings are certainly not guarantees of future
performance, studies show that there is a strong positive
correlation between ratings and default rates.
However, although DBRS is proud of the role rating agencies
play in the global securities markets, we are aware that there
are certain concerns that have been raised regarding our
industry, and I would like to touch on a few of these at this
time.
First is transparency. At the SEC's rating agency hearings
last fall we heard institutional investors express a desire for
a clear understanding of the reasoning behind rating decisions.
DBRS makes every effort to satisfy this desire by issuing full
detailed reports on the companies we rate. These reports openly
convey our views on both current ratings and on the direction
of ratings. We believe everyones' interests are best served
when the reasons behind ratings are widely known.
The second involves conflict of interest. DBRS has worked
diligently to minimize the potential for conflicts of interest
in the rating process. My written testimony goes into this
topic in my detail, but let me just say here that the success
of our business is primarily based on one key factor: our
reputation. If at any point investors doubted the independence
of our judgment, the demand for our services would decline. We
have no intention of letting that happen.
And the third is the competition and barriers to entry. As
the rating that has been most recently granted the NRSRO
designation, DBRS has somewhat of a unique perspective on this
issue. Because credit ratings play such an important role in
the capital markets, we believe that barriers to entry in this
field should be high.
That said, the real concern, as we see it, is not so much
that the barriers make it difficult for new competitors to
enter the field, but rather that there is no well-defined
process for designating NRSROs.
The no action letter process that the SEC currently use is,
in our opinion, ill suited for this task because the criteria
for designation are not sufficiently defined, the application
process is not standardized and adverse decisions on requests
for designation are not subject to appeal.
Based on our recent experience, DBRS believes that there
should be a clear definition of what constitutes an NRSRO and a
transparent process to enable qualified companies to apply for
this designation.
In conclusion, I believe that the credit rating system as
it exists today works quite well and has helped foster the
growth of the financial markets globally. In light of recent
events, it is appropriate that the issues being raised by the
subcommittee be thoroughly reviewed, and we very much
appreciate having the opportunity to be part of this process.
Thank you.
[The prepared statement of Greg Root can be found on page
137 in the appendix.]
Chairman Baker. Thank you, Mr. Root.
It would be my intent, we have announcement of two votes on
the floor that are now pending, we have about 10, 12 minutes
left before the first vote closes, so we could proceed with Dr.
White's testimony. The committee would then stay in recess for
15 minutes to go over and come back for the two votes and
hopefully not inconvenience you too greatly.
Dr. White is a Professor of Economies at Stern School of
Business, New York University.
Welcome, Doctor.
STATEMENT OF LAWRENCE J. WHITE, PROFESSOR OF ECONOMICS, STERN
SCHOOL OF BUSINESS, NEW YORK UNIVERSITY
Mr. White. Thank you, Mr. Chairman. I am very pleased to be
here and to have this opportunity to testify before the
subcommittee. My written testimony states my position in
greater depth.
The problem of the regulation of the NRSROs is what I have
described as ``the SEC's other problem.'' Of course the SEC's
efforts with respect to corporate governance and public
accounting is at center stage, but the NRSRO issues could well
be as important for the efficient operation of the U.S. capital
markets.
The SEC's current regulatory barriers to entry into the
NRSRO category are highly unsatisfactory, and the two potential
paths out of these difficulties are clear. Unfortunately, the
SEC's recent report was a great disappointment. It simply
raised the same old questions instead of pointing toward the
solutions.
The basic problem is as follows: Since 1931, financial
regulators have required their regulated institutions to pay
attention to the credit ratings of the bonds and obligations
that they hold. That regulation has grown greatly, especially
in the past three decades.
The issue of whose ratings should be paid attention to was
addressed only in 1975, when the SEC created the NRSRO
category. It immediately grandfathered into the category the
three major incumbents, and it then allowed only four
additional entrants over the next 17 years. But mergers and
consolidation among those entrants and between those entrants
and Fitch then reduced the total number back to the original
three by the end of the year 2000.
From 1992 until the end of February of this year, the SEC
allowed no new entrants. Only at the end of February, as we
have just heard, did DBRS enter this category.
So that is where we are: greatly expanded regulatory demand
that financial institutions use ratings, and limited supply of
SEC-designated approved rating firms, the NRSROs. It is no
wonder that we are here today discussing the problems of this
industry.
Now, it is important to remember: So long as regulators
delegate their safety judgments to ratings firms, there is
going to be a need to designate whose ratings should be heeded
by the regulated financial institutions. So long as we have
that process set up, this designation is unavoidable. But that
process forces the capital markets to pay attention primarily
to the designated entities, and there are unfortunate
consequences to this whole limitation process. One has to worry
whether new ideas, new innovations are going to enter the
marketplace in this kind of framework.
There are two basic paths that could be followed to get us
out of these difficulties. The first and best is to have the
financial regulators withdraw those safety delegations and to
make the safety judgments themselves. I say this as a former
bank regulator myself. For almost three years I served on the
Federal Home Loan Bank Board. I had a number of sessions in
just this hearing room, Mr. Chairman, some of them enjoyable,
some of them less so, but I know what it is like. And those
delegations can be withdrawn, those judgments can be made by
the financial regulators themselves.
Once that is done, the SEC could eliminate the NRSRO
category, and the capital markets would then be free to make up
their own minds: ``Whose judgments do we follow? Whose
predictions of default do we pay attention to? What new ideas
should we be paying attention to?''
Indeed, they might even ask, ``Do we even need rating firms
in the 2003, 94 years after John Moody's first started issuing
ratings?''
This is the best, the clearest, the cleanest and the most
market-oriented approach to dealing with these problems.
But if this route is considered infeasible, then there is
Plan B: The SEC must cease being a barrier to entry, it must
actively certify qualified firms as NRSROs and inevitably it
must periodically assess the suitability of incumbents to
continue to be NRSROs.
The SEC in this process must focus on performance: How well
does the firm, entrant or incumbent, predict defaults?
In this light, the criteria that the SEC proposed in 1997
must be scrapped. Those criteria focused on inputs, not on
performance. An innovative firm that could predict defaults
well could nevertheless fail the input criteria. Also, the
criteria create a Catch-22 that could exclude entrants.
If this expanded regulatory task is considered to be beyond
the capabilities of the SEC, then there is always Plan A:
Withdraw those regulatory delegations, then eliminate the NRSRO
category and let the markets make their own choices and
decisions.
The paths are clear, and I disagree with Ms. Nazareth's
comment this morning. This is not a complicated issue. The time
for action is now.
Thank you very much, Mr. Chairman.
[The prepared statement of Lawrence J. White can be found
on page 144 in the appendix.]
Chairman Baker. Thank you very much.
Time for action has also occurred for me. I have to go vote
and I will be right back. We stand in recess.
[Recess.]
Chairman Baker. If I may ask folks to resume the seats at
table, we will reconvene. Members will be on their way back as
they conclude the vote.
At this time I would like to call on the President and
Chief Executive Officer of Fitch, Inc., Mr. Stephen W. Joynt.
Welcome, sir.
STATEMENT OF STEPHEN W. JOYNT, PRESIDENT AND CEO, FITCH INC.
Mr. Joynt. Thank you, Mr. Chairman. Thank you for inviting
me to come participate today.
My name is Steve Joynt, and I am President and CEO of Fitch
Ratings.
Ratings are used by a broad mix of investors as a common
benchmark to grade the credit risk of various securities. In
addition to their ease of use, efficiency and widespread
availability, credit ratings are most useful to investors
because they allow for reliable comparisons across many diverse
investment opportunities.
Credit ratings assess credit accurately in the overwhelming
majority of cases. Credit ratings have proven to be a reliable
indicator for assessing the likelihood of a securities default
possibilities.
I think it is important to note that while the current
inquiry into the role of rating agencies has been focused on
issues surrounding the ratings of corporate issuers, corporate
ratings only represent approximately 10 percent of the total
rated universe. Fifty percent or more of Fitch's activities and
revenues and ratings come from mortgage-backed and asset-backed
securities analysis. New criteria development, original
analysis, published research and follow-up surveillance
information have support transparency in development of these
markets.
Fitch is also very active in rating other markets, such as
global financial institutions and the 1.8 trillion U.S.
municipal market. Any changes for the rating industry need to
consider the impact on these markets as well.
We believe the SEC's review of the rating agencies is a
constructive process. As a result of this review, the SEC has
already recommended some improvements to our policies and
procedures and we are voluntarily implementing them.
Today's hearings may probe several areas regarding the
business of rating agencies: regulatory barriers to entry,
potential conflicts of interest with issuers and information
disclosure. And I would like to briefly comment on each of
these.
At Fitch we firmly believe in the power of competition.
Fitch's emergence as a global, full-service rating agency
capable of competing against Moody's and S&P across all
products and market segments has created meaningful competition
in the ratings market for the first time in a decade.
Fitch's challenge to the Moody's-S&P monopoly has enhanced
innovation, forced transparency in the ratings process,
improved service to investors and created much needed price
competition.
We also believe that there is a demand for insightful,
independent credit research. The NRSRO system is designed
appropriately, in our view, to assure that recognized
organizations possess the competence to develop accurate and
reliable ratings. Without a system to recognize rating
organizations for their competence, many important capital
adequacy and eligibility investment rules used in financial
institutions regulations would be ineffective.
To address concerns regarding potential conflicts of
interest and issuer fees, Fitch goes to great efforts to assure
that our receipt of fees from issuers does not affect or impair
the objectivity of our ratings. Fitch culture emphasizes the
importance of integrity and independence as critical
foundations of our most important asset, our reputation. Fitch
has separate sales and marketing teams that work independently
of the analysts that cover the issuers.
Our analyst compensation philosophy reflects quality of
effort and individual accomplishment in research and ratings.
Individual company fees, revenue production and individual
department profitability do not factor in analyst compensation.
Analysts may not own securities in companies that they
rate. Fitch does not have an advisory relationships with
companies it rates.
Another issue that merits discussion is better disclosure
of information. We believe for the most part the credit rating
agencies have adequate access to the information they need to
form an independent and objective opinion about the
creditworthiness of an issuer. Non-public information is
provided to the rating agencies as part of the rating process.
The nature and level of that information varies widely, by
company, industry and even country.
Typically, it is not the value of any particular piece of
non-public information that is important to the rating process,
but that access to such information and senior management can
assist us in forming a qualitative judgment about a company's
management and its prospects.
At Fitch, we are working to encourage transparency
throughout all sectors of the capital markets. As we found in
our recently published study on credit derivatives in the
global market, financial reporting and disclosure with respect
to areas such as credit derivatives. off-balance-sheet
financing and other forms of contingencies varies greatly by
sector. Comparability is further obscured by differences in
international reporting and accounting standards.
If this type of information is difficult for us to obtain,
it is almost impossible for the typical investor. Better
disclosure not only leads to more accurate ratings, it creates
a more informed investor.
Fitch is an independent global rating agency valued by the
credit markets, and we are here today open to all suggestions
on how to improve our industry's performance and our
performance.
Thank you.
[The prepared statement of Stephen W. Joynt can be found on
page 87 in the appendix.]
Chairman Baker. Thank you, sir.
Our next witness is Mr. James A. Kaitz, President and Chief
Executive Officer, Association for Financial Professionals.
Welcome, sir.
STATEMENT OF JAMES A. KAITZ, PRESIDENT AND CEO, ASSOCIATION FOR
FINANCIAL PROFESSIONALS
Mr. Kaitz. Thank you, Mr. Chairman.
I am Jim Kaitz, President and CEO of the Association for
Financial Professionals, and we thank you for the invitation
today.
Chairman Baker. And I took my best guess on the name. I am
sorry. Mr. Kaitz.
Mr. Kaitz. You did a great job. Thank you.
AFP represents 14,000 finance and treasury professionals
from over 5,000 organizations throughout the United States. Our
members are drawn generally from the Fortune 1000 and the
largest of the middle market companies in a wide variety of
industries.
Our members are responsible for issuing short-term and
long-term debt and investing corporate cash and pension funds
for their organizations. They rely on the rating agencies when
their companies issue debt and when they make investment
decisions. As such, their experience with the rating agencies
provides them with an opportunity to form opinions on both the
strengths and weaknesses of the agencies.
AFP's members recognize the important role that the SEC and
the rating agencies play in ensuring the efficient operation of
the capital markets.
In September 2002, we surveyed senior-level corporate
practitioners, such as chief financial officers, vice
presidents of finance and corporate treasurers, regarding the
accuracy and timeliness of credit ratings, the role the SEC
should take in regulating the rating agencies, and the impact
additional competition may have on the marketplace for ratings
information.
In summary, survey respondents expressed concerns about the
accuracy and timeliness of credit ratings. Twenty-nine percent
of corporate treasury and finance professionals who work for
companies with rated debt indicate that their companies'
ratings are inaccurate. This is true for companies that have
recently been upgraded, as well as for those that have been
downgraded.
Respondents from companies that have seen their debt
upgraded indicate that the change took place more than six
months after the improvement in the company's financials.
Additionally, some respondents from companies that were
downgraded report that it took more than six months for their
ratings to reflect a deterioration in the company's financial
condition.
The survey also found that rating agencies are primarily
serving the interests of parties other than investors. Less
than one-quarter of treasury and finance professionals believe
that ratings most favored the interests of investors. Rather,
they believe ratings favored debt issuers, investment banks and
commercial banks.
Our members believe that the SEC plays an important role in
overseeing the rating agencies. The overwhelming majority of
respondents indicate that the SEC should take additional steps
in the oversight of the rating agencies.
Currently, there is no clearly defined process for credit
agencies to achieve nationally recognized statistical rating
organization status. Most respondents believed that the SEC
should clarify the procedures it follows to determine whether
it will recognize a rating agency as an NRSRO. Granting NRSRO
status to other credit-rating agencies would provide additional
competition that could result in improved accuracy and
timeliness of ratings. Respondents believed that additional
competition could increase both the accuracy and timeliness of
credit ratings and lead to greater certainty in the assessment
of corporate credit risk.
Once the SEC recognizes a rating agency as an NRSRO, there
is currently no ongoing process to ensure that the agency's
methodologies and procedures continued to be appropriate. Our
survey respondents believe that periodic review of the rating
agencies is necessary.
In conclusion, AFP believes that our survey results clearly
show that the time has come to reexamine the role, function and
regulation of credit-rating agencies. We are encouraged by the
SEC report delivered to Congress in January and the issues it
identified for further examination. Many of those issues are
consistent with the findings of our survey. We look forward to
reviewing and commenting on the SEC's concept release when it
is published.
We are also encouraged by the SEC's recognition of Dominion
Bond Rating Service as a fourth nationally recognized
statistical rating organization. As I mentioned, our members
expect additional competition to improve the accuracy and
timeliness of the information provided by rating agencies,
providing them with a greater certainty in assessing corporate
credit risk.
AFP believes that the credit-rating agencies are vital to
the efficient operation of capital markets and is pleased that
you have taken the lead in examining these issues. We hope that
this hearing will bring to light opportunities to increase
competition in the market for credit ratings and improve the
quality of the information provided by credit-rating agencies
for the benefit of issuers and investors in the securities
markets.
Thank you, Mr. Chairman, and I would be pleased to answer
any questions you might have.
[The prepared statement of James A. Kaitz can be found on
page 95 in the appendix.]
Chairman Baker. Thank you, Mr. Kaitz.
Our final witness is Mr. Raymond W. McDaniel, President,
Moody's Investors Service, Inc.
Welcome, sir.
STATEMENT OF RAYMOND W. MCDANIEL, PRESIDENT, MOODY'S INVESTORS
SERVICE, INC.
Mr. McDaniel. Thank you, Chairman Baker.
My name is Ray McDaniel. I am the President of Moody's
Investors Service. On behalf of my colleagues, I appreciate the
opportunity to be here today.
As you know, a large number of companies over the past two
years have experienced serious financial difficulties, causing
suffering for their employees and sometimes significant losses
for the investors in their stocks and bonds.
Attempting to understand, and where appropriate redress the
underlying reasons associated with these failings, has been
both necessary and beneficial.
Yet it is also important to keep in mind that the economy
and financial markets of the United States remain the envy of
most of the world.
Moody's is proud of our role as a supporting participant in
these markets. Credit ratings help level the playing field for
information between borrowers and investors. Ratings improve
both transparency and efficiency in debt markets by promoting
investor confidence, which in turn allows creditworthy
borrowers greater access to capital.
With that perspective in mind, I would like to offer a few
comments about our industry and Moody's in particular.
Founded at the beginning of the last century, Moody's is
the oldest credit-rating agency in the world. From the start,
Moody's has focused on rating debt instruments.
Our long-term debt rating system for public bonds is the
heart of our business. We have 21 long-term debt rating
categories which provide a relative measure of risk. The
probability of default increases with each step down our
ratings scale.
Our ratings are reliable predictors of relative
creditworthiness. Their predictive content has been
demonstrated and consistently confirmed through Moody's
publication of annual corporate bond default studies and by
third-party academic analysis.
What this means is that, as forward-looking opinions, our
ratings have effectively distinguished bonds with higher credit
risk from bonds with lower credit risk.
At Moody's, we are committed to providing the highest
quality credit assessments available in the global markets. We
are committed to continuous learning, both from our successes
and our mistakes.
In this spirit, we have undertaken substantial internal
initiatives to learn from recent difficulties in the credit
markets, as well as in response to potential shortcomings in
our own analytical approach and in the broader system of market
checks and balances.
Our business model is based primarily on receipt of fees
from debt issuers. Issuers are the natural source of rating
agency fees for several related reasons, but most importantly
for one key attribute demanded of our ratings: that they be
freely and widely disseminated to the investing public.
Ratings are critical because they condense and transmit a
great deal of credit information about issuers and because they
do so for the equal benefit of all investors, publicly and
promptly.
We recognize that being paid by issuers creates potential
conflict of interest. Moody's has taken strict measures to
avoid conflicts. As a corporation, for example, Moody's does
not offer investment products, nor do we buy, sell or recommend
securities. Within our ratings practice, committees, rather
than individual analysts, assign Moody's ratings. Analysts are
neither compensated based upon the revenues associated with the
companies that they analyze, nor are they permitted to hold or
trade the securities in their areas of primary analytical
responsibility.
Over time, the use of our ratings has been adopted by
numerous capital market participants for multiple and sometimes
conflicting objectives. For example, issuers use our ratings
because many investors demand ratings on debt issues.
Not surprisingly, issuers would like the highest possible
plausible ratings and greater control over the rating process.
Large institutional investors often use our ratings in their
portfolio composition and governance guidelines. Generally,
these investors prefer stability in the ratings on securities
that they own.
Finally, global governmental authorities have incorporated
ratings into banking, insurance, securities and other
regulations to limit risk in financial institutions for the
dual purposes of promoting investor protection and improving
financial market stability.
Because each group has different objectives in using
ratings, the performance or quality of ratings has been
subjected to multiple assessment processes. In some cases,
those assessments are incompatible with Moody's goal of
leveling the information playing field.
Let me briefly turn to the degree of competition within the
industry. We are confident of our ability to compete in diverse
competitive environments, if competing successfully is driven
by who offers the most reliably predictive credit opinions.
That form of competition requires diverse, independent
opinions. As such, we urge that any new framework not
inadvertently encourage competition based on forced
harmonization or reduced standards.
Lastly, we believe that in examining ratings quality and
rating-agency performance, two essential principles must be
kept in mind.
First, ratings at their core must be independently formed
opinions. They must capably predict bond issuers' future
creditworthiness, which means that the rating agencies must be
motivated to act independently of each other, of governments
and of issuers and their agents to reach the highest standards,
not the most popular or most convenient standards.
And second, rating agencies must disseminate ratings
broadly and promptly to all of the investing public. Without
this attribute, ratings would cease to be a public good. They
would become a tool for the few and would further tilt the
playing field for information.
Only by preserving these principles can ratings continue to
fulfill the larger public values of transparency and investment
protection that the marketplace, regulatory authorities and
lawmakers expect of us.
Moody's greatly appreciates the subcommittee's invitation
to participate in this important panel discussion, and I look
forward to answering any questions that you might have.
Thank you.
[The prepared statement of Raymond W. McDaniel can be found
on page 123 in the appendix.]
Chairman Baker. Thank you, Mr. McDaniel.
To Moody's, especially, Mr. McDaniel, I want to express the
view that the committee's work is not about any particular
company's performance in light of the past 36 months of market
disappointments. But rather an obligation to examine the
structure and question on periodic basis, whether there are
alterations that are warranted or significant structures that
would be justified in light of the past pass performance.
There have been issues raised, for example, not with
Moody's, that a rating agency might perform for as much as a
$150,000 fee, a corporate governance examination to tell the
corporate management how they can better improve their methods
of operations in order to presumably enhance their ratings. It
would be difficult to see someone pay such a fee, and then not
have a subsequent enhancement in the rating result, otherwise
the recommendations seem to be without merit. Just that one is
an example.
We could go to other issues where a rating agency executive
could serve on a broad of a company which they might be rating.
When we went through the Sarbanes-Oxley debate, much was
made to do about the relationship of analysts with investment
bankers with clients and that there needed to be more
separation or at least disclosure where separation was not
deemed advisable of those relationships; transparency.
It may be okay to do business with someone for a fee
outside your principle public responsibility, as long as the
individuals who rely on that information are made aware of the
relationship and make their own judgments about the quality of
that review. I think that is fine.
And I am not suggesting that we need to have dramatic new
regulatory structures, but given where we are today, in light
of some of the comments made by those here on the panel and
other information brought to the committee's attention, it
would seem some modifications.
For example, a clear-cut guideline by the SEC as what
constitutes the approval process within a fixed period of time
in which you would either get approval or not get approval as a
designated rating organization.
A clear-cut set of standards for the SEC in oversight of
your activities to ensure that Moody's high standards of
conduct are being attained by all others. Finally, a clear-cut
process by which, if one fails to perform to that standard, one
could be de-designated or undesignated. Would those kinds of
principle constructs present any operational concern to an
organization, such as Moody's?
Mr. McDaniel. With respect to the general nature of your
question and transparency and disclosure, Moody's could not
agree more strongly that disclosure and transparency of
information is critical to the sound operation of our financial
markets.
We are a consumer of good information, as much as we are a
provider of good information. And in that respect, we
absolutely would support any efforts to improve transparency
not only in the markets, but in our own industry. That is
something that is very easy for us as a firm to get behind.
With respect to two of your specific comments, I should
just say that Moody's does not offer any corporate governance
fee-based service, nor do we have any of our executives sit on
the boards of any rated companies.
Chairman Baker. To that end, let's assume for the moment
that members of the committee would find some generalized
package not to be necessarily advisable, in light of the rating
agency's performance over past years, what about the flip side?
What would be the negative to a company with the stature and
market share of Moody's in simply not having an SEC impromptu
on the front bumper of the corporate automobile.
I do not believe neither S&P nor Moody's needs that
designation to maintain its market position and may, then,
obviate the need for all these standards relative to entry,
oversight and decommissioning because the market would do that
between the two. Or is there a third position that you proffer
as being more appropriate?
Mr. McDaniel. Moody's had a very strong position in the
market prior to 1975 and prior to the introduction of what was
the more rapid acceleration of the use of the NRSRO designation
in regulations and legislation. And we would certainly expect
that we would be able to compete effectively if that
designation were removed. In fact, we have a similar position
elsewhere around the world where the NRSRO designation does not
play a role in----
Chairman Baker. In your opinion, would such a determination
be to the public's disinterest in any way?
Mr. McDaniel. For a number of years, Moody's observed that
there were risks of incorporating ratings and regulation. More
recently, however, I think we have taken a pragmatic view that
the concept of or the interaction of regulation with the rating
agency industry as a practical matter, has become very broad
and deep and it would be difficult to reverse that process. We
feel that we can perform a valuable public service and compete
effectively regardless of the existence or nonexistence of this
designation.
Chairman Baker. Thank you.
My time has expired.
Mr. Kanjorski?
Mr. Kanjorski. I just want to correct something. Mr.
Alexander is the Chairman of Moody's?
Mr. McDaniel. Mr. Alexander, Cliff Alexander is the
Chairman of the Board of Moody's Corporation currently, that is
Moody's Investors Service parent company, yes.
Mr. Kanjorski. Well, didn't he serve as a director of MCI
from 1981 to 1998 and on WorldCom from 1998 until June of 2001?
Mr. McDaniel. I do not know the dates specifically, but he
did serve on the board of MCI, and then of WorldCom.
Mr. Kanjorski. Well, didn't you rate those two
corporations?
Mr. McDaniel. Yes, we did.
Mr. Kanjorski. Well, isn't that in conflict to what you
just testified that your officials and officers are not allowed
to serve on boards?
Mr. McDaniel. He is nonexecutive Chairman of our Board----
Mr. Kanjorski. So Board of Directors Chairman----
Mr. McDaniel. Yes. I am sorry. If I either misspoke or----
Mr. Kanjorski. Well, he has sort of an interest, so----
Mr. McDaniel. He is the nonexecutive Chairman of----
Mr. Kanjorski. Chairman?
Mr. McDaniel. ----Moody's corporation. Yes. Absolutely.
Mr. Kanjorski. I would imagine that he is a major
stockholder of Moody's.
Mr. McDaniel. I do not know that.
Mr. Kanjorski. Okay. So you are giving a very limited
qualification. Those in direct line authority are not allowed
to serve on boards of corporations that are rated.
Mr. McDaniel. The management and executives of Moody's
Investor Service and Moody's Corporation did not serve on the
boards of any rated companies. We do have members of the board
of----
Mr. Kanjorski. But Directors and Chairman of the Board of
Directors are allowed to.
Mr. McDaniel. Yes.
Mr. Kanjorski. And you make a distinction.
Mr. McDaniel. Yes.
Mr. Kanjorski. Okay.
Mr. Egan, did you rate Enron or WorldCom or any of the
failed corporations in your organization?
Mr. Egan. Yes, we did.
Mr. Kanjorski. Okay. Do you think that some of the
questions should have been asked by Moody's and other rating
organizations of these corporations? Should they have known the
answers that would have indicated that they should not have had
the ratings that they had immediately prior to bankruptcy? What
did your organization rate Enron and WorldCom, et cetera? At
what time did you change your ratings relative to when Moody's
changed their ratings?
Mr. Egan. It is a part of the written testimony that I
provided. Let me just refer to it.
We started downgrading Enron in January 27th of 2001. Okay?
Mr. Kanjorski. About six months before bankruptcy.
Mr. Egan. That is correct, yes.
And then, you can see in the testimony our other negative
actions on Enron.
Mr. Kanjorski. Okay.
Mr. Egan. WorldCom is the same sort of thing.
Mr. Kanjorski. Was that based on the fact that your
examiners or raters asked certain questions that indicated
there were offshore transactions that you felt were risky
toward the viability of the organization?
Mr. Egan. We rely on information in the public domain. In
fact, we encourage companies not to give us any information
that is not public.
Mr. Kanjorski. You mean without asking the questions of the
company you came to this conclusion?
Mr. Egan. That is correct. There is enough information out
there to perform the analysis.
Mr. Kanjorski. Because Mr. Egan did not attack Moody's
directly because you are on the same panel, let me throw out
the question: Why did you operate only within a week of
bankruptcy to find out what they found out six months before?
Mr. McDaniel. The actions that Moody's took with respect to
Enron were based on all the information that we were able to
gather both publicly and privately on Enron.
Mr. Kanjorski. So you had the information of the offshore
transaction?
Mr. McDaniel. I am sorry?
Mr. Kanjorski. You knew about all the offshore
transactions, the off-balance sheet transactions?
Mr. McDaniel. No, absolutely not. We did not know about all
of those. We knew about a very small handful of them.
Mr. Kanjorski. So Mr. Egan's people, assuming they only
knew what you knew, made a six-month perception that there was
a problem here, six months ahead of when you were able to do
it.
But the question that we are faced with is we are trying to
protect investors. How is he did not ask these questions. You
were not aware that they were offshore transactions? Some of
them were actually disclosed, if I recall, in the statements'
footnotes.
Mr. McDaniel. Yes, we did have information on a handful of
offshore transactions, that is correct.
Mr. Kanjorski. Well, didn't you follow through what they
were, what was the nature of them, how large were they, why
were they there? Didn't that send up any signal that they were
putting debt off the books?
Mr. McDaniel. The scope of fraud with Enron was
unprecedented. And we asked many questions over the course of
the rating relationship with Enron to try and have the best
possible understanding of that company's credit worthiness.
However, there were multi-billion dollars worth of
transactions and assets off the balance sheet which were not
revealed.
Mr. Kanjorski. I understand all that. But what we are
trying to find is a mechanism here of how to find out, get
transparency of those things, so that the information is
related to the investor.
It seems to me you are telling us that, under the existing
ways of what rating agencies are doing, they are not going to
find this fraud, and they are not going to find this
misinformation that is being given to the investor and the
public and everyone else in the marketplace. So then you seem
to be telling me that we have a very serious problem here that
we do not have a functioning credit-rating system.
Mr. McDaniel. In hindsight, Congressman, we could have done
a better job----
Mr. Kanjorski. I know, but that is what the accountants
said. What do we have to fix?
You heard my opening statement. I do not want to clutter up
the marketplace with anymore regulations that are absolutely
necessary to get to positive ends. I mean, we can have the SEC
come in here with books of regulations that by the time--as a
matter of fact--that will limit the business because nobody
will be able to compete cause they will not be able to spend
the money to conform to the regulations, and then we will
really have a monopoly.
Forgetting all of that--and we do not want to do that--how
do we advise the public and the marketplace of scurrilous
activity like this? For example, let's forget Enron for a
moment. Did you rate HealthSouth?
Mr. McDaniel. Yes, we did.
Mr. Kanjorski. What was it rated at?
Mr. McDaniel. It has been a junk bond rated credit for
three years.
Mr. Kanjorski. Okay. Now why was it rated that way?
Mr. McDaniel. Because our analysis of the fundamentals of
that company indicated that it was a relatively weak company.
Mr. Kanjorski. Right. And one of the things would have
been, maybe, the CEO's income and residence and yachts and
airplanes may exceed what he should be getting, and then maybe
the board is not really a board.
All of these things are what analysts should be looking at
in making the ratings. Obviously, you got the bell to ring over
there. You saw something was wrong and you notified the
investor. It would be interesting to see how many people listen
to your rating and got out in time to save their money.
Chairman Baker. Will the gentleman yield on that point?
Mr. Kanjorski. Sure.
Chairman Baker. I would just help in the cause here.
What troubles me is that we were very upset with the
conduct of the analysts who were supposed to be advising the
broader market. But in this case, rating agencies have a level
of access to data which even the analysts do not have. From my
uninformed position, it would appear that the rating agencies
should be out ahead of the professional analysts. Did the
gentleman know that?
Mr. McDaniel. Yes.
Mr. Kanjorski. You are in the same position, as I see it,
as the auditor. You can ask any question. They must have the
fear of God of you, and the CEO is not going to give you
misinformation that is going to kick his bond ratings and other
ratings down significantly. So it would seem to me he is going
to respond or else the response is going to indicate that there
is some fraud going on, something is being misstated here. It
should become apparent.
All I would like to correct is to fill that vacuum. I
probably would like the industry to make a self-analysis. What
happened? Why? Where did the vacuums occur? What responsible
actions should the Congress or the SEC also take to make sure
it does not happen again in the future so that we have a better
market?
I say that because, quite frankly, I am so impressed with
the fact that we are making so much out of 10 or 15 major
failures. A lot of money was lost. But, there are the thousands
and thousands of good companies, good executives, and good
people that are out there. I cannot over emphasize that point.
We are just talking about problems in the margins, more
than two standard deviations from the norm. We are way out
here. But still we cannot allow hundreds of billions of dollars
to be lost fraudulently or by misrepresentation that either the
accountants, the rating agencies, the analysts, or somebody
else has to be out there picking up.
I come to the question Dr. White proposed. He said that we
had two alternatives: We can do it in-house or we can enlarge
the number of recognized entities that can perform this
function and try and agitate some competition out in the field.
Are you suggesting a government-sponsored enterprise to perform
ratings?
Mr. White. Absolutely not, Congressman. The basic choices I
laid out were essentially the position that Moody's held until
a few years ago. If you look at their comments to the SEC back
at the 1997----
Mr. Kanjorski. What did they do a few years ago that
changed them? In your estimation, what made them lose the
right----
Mr. White. I do not know. And I must confess, I was
distressed to hear Mr. McDaniel's statement. I fear that this
is a bargain with the devil and that you [Mr. McDaniel] are
going to regret it when you find SEC regulations coming down on
top of you. I think that this is a mistake.
I think the clean market-oriented result is to get the
regulators out of delegating, have them do their jobs, make
their own judgments about the safety of, for example, corporate
bonds in bank portfolios----
Mr. Kanjorski. But when you were talking about the
regulators----
Mr. White. ----and then the capital markets can make their
own decisions.
Mr. Kanjorski. But when you were talking about the
regulators, Dr. White, you are talking about the SEC as being
one major regulator?
Mr. White. That is right.
Mr. Kanjorski. And this Congress refused to appropriate
sufficient funds for them to hire the personnel to do the job.
I say in the last three years since the peak of the bubble,
thank God we had the private market to self regulate. I mean,
those people at the SEC were inundated. What were they doing,
one audit every five years of major corporations?
When we have the political swings and the philosophical
swings in this country there is a tendency if you want to avoid
regulations you can repeal them. But if it is not politically
acceptable or if you do not want to do it, just starve the
agency that has the responsibility and you have accomplished
the same thing. And we did starve the SEC.
Mr. White. Congressman, I could not agree with you more and
I think that was a big mistake. Where regulation is needed, the
regulators should have the funds and the resources to do the
job.
Here is one area, though, where I think we could pull back
and let the financial markets make their own decisions. We
would get more innovation, more new ideas, and we would not
have to worry about, ``Is the SEC doing the right thing or the
wrong thing with respect to the NRSRO.''
Mr. Kanjorski. Accomplishing that by taken a designation
away as a nationally recognized statistical rating
organization.
Mr. White. That is right, get rid of the category. But it
does mean you have to get the other regulators, including the
SEC to make their own judgments----
Mr. Kanjorski. But then we would have to back up and change
a lot of prior legislation that used that standard.
Mr. White. It is really worth doing. You would not be
holding this hearing today in that kind of world.
Mr. Kanjorski. How about if we have a Texas cowboy--and I
hate to use that expression----
[Laughter.]
But what if we have a Texas cowboy rating agency that comes
along and says, you know, ``You hire us for $1 million, and you
just may get the best rating you have ever heard of.''
Mr. White. And very quickly the markets--if you do not have
that regulatory overlay, the markets will figure out, ``This
guy's ratings ain't worth the paper they are written on. We
will pay no attention to this guy's ratings.'' And very quickly
other companies will realize they do not get anything by paying
this guy whatever he is asking.
Mr. Kanjorski. After several years. But up until that time,
what would happen?
Mr. White. Oh, I think it will be quicker than that.
Chairman Baker. If I can, recognize Chairman Oxley?
Mr. Oxley. Thank you, Mr. Chairman.
Mr. Joynt, in your prepared testimony you talk about
addressing concerns raised about conflicts of interest posed
when rating agencies offer ratings advisory services. And
according to your testimony, I understand that you have already
decided to stop providing this service to some issuers and are
contemplating doing away with it altogether. Is that correct?
Mr. Joynt. It is. But it is sort of an easy concession
because we just started doing rating assessments last June, and
we had only completed three. So we did not have an extensive
practice at all. And so what we have decided to do for now,
while it is being looked into, is not accept any new proposals
in the U.S., at least for any rating assessment services, and
consider whether they should be done by separate analysts,
nothing to do with our rating analysts.
Mr. Oxley. And after three examples, what changed your
mind?
Mr. Joynt. Only the outside spotlight on that practice
coming from the SEC's review and thinking about it; not a
concern of our own internally.
Mr. Oxley. I see.
Mr. Root and Mr. McDaniel, what is the status in that
particular issue with Dominion and Moody's? Do you offer
similar services, and have you determined whether you wish to
continue those?
Mr. Root. At Dominion, we do not offer those services. Our
revenue stream is strictly from the rating of institutions and
the research that we provide.
Mr. McDaniel. We do offer the service called the rating
assessment service. It constitutes less than 1 percent of our
annual revenues. I would expect, even if we continue it, that
it would continue to represent 1 percent or less of our total
revenues. And we do it as an accommodation for companies that
are contemplating major transactions, acquisitions or mergers
or something of that sort. And are looking for some idea of
what the consequences of those activities might be on the
credit rating.
We frankly would prefer to provide informal feedback. It is
less time consuming. It is a process that does not carry some
of the issues that, I think, concern the SEC and other
authorities that have looked into the business, and we do
encourage that.
Mr. Oxley. Informal meaning, noncompensated?
Mr. McDaniel. Yes, exactly, noncompensated.
Mr. Oxley. Do other members of the panel have any opinions
on the conflict of potential conflict of interest in this
particular service.
Mr. White. Congressman, it cannot be a completely black
box. Suppose a company needs to know, ``Now, if I do X, what
are the consequences going to be?'' The answer just cannot be,
``Well, we cannot tell you, just go ahead and do it, and then
we will tell you.'' That is just not a feasible way to proceed.
I am very sympathetic to this process. But you know, I am not
sympathetic to the whole, larger structure.
Mr. Oxley. So you like what Mr. McDaniel's said in terms of
the informal aspect to it?
Mr. White. Whether it is formal or informal is not
important. It cannot be a black box.
Mr. Oxley. Now, Mr. Chairman, I could raise a question, and
I apologize for this because Ms. Nazareth, our first panelist,
in her testimony this morning talked about some issues
regarding the potential changes in regulation and how this
whole concept is treated at the SEC. And she made the comment--
and I made a note at the time, and then we had to go vote and I
did not get a chance to ask her.
I am kind of paraphrasing this, but she indicated that
there were some First Amendment issues raised by the ratings
agencies--and I see the professor shaking his head--could you
help me on that? What First Amendment issues are out there and
how are they raised.
Mr. White. Sorry, I am not a lawyer. I do not practice law
without a license, especially in this August body----
Mr. Oxley. We give you a dispensation here.
Mr. White. Well, thank you.
I think the representatives of the agencies would be in a
better position to be able to explain.
My understanding is that they have described themselves as
publishers. They are publishing opinions and are thereby
covered by the First Amendment, in terms of commercial speech.
Mr. McDaniel. Chairman Oxley, I would be happy to add. I
agree with Professor White. The basis for the First Amendment
comments that Ms. Nazareth made, I believe relate to the fact
that we are publishers of opinions, and our opinions are
released to the general public in the form of ratings and press
releases explaining the ratings. And it is not just simply an
assertion on our part, there is case law history that supports
that.
Mr. Oxley. Yes?
Mr. Egan. In our view, the First Amendment has provided an
ideal cover for the major rating firms to take anti-competitive
behavior. They were sued by two municipal issuers in the early
1990s when in Moody's case, they were not retained by the
issuer and they issued a punishment rating. The issuers sued
Moody's. And Moody's said: ``This is our opinion. I am sorry we
did not have enough information, we had to issue a very low
rating.'' The fact is, they were protecting the monopoly.
Mr. Oxley. And that defense was a First Amendment defense?
Mr. Egan. Exactly.
Mr. Oxley. And that was the case that you referred to.
Mr. Egan. That is what I was referring to, yes.
Mr. Oxley. Was that the case--I am sorry--Mr.--was that the
case you referred to?
Mr. McDaniel. Well, I am not sure if I am talking about the
same case as Mr. Egan. We have never issued a punishment
rating. We would never put anything into market other than our
best possible opinion. It may be right, it may be wrong, but it
is our best possible opinion.
And we have had cases where issuers have not wanted us to
publish opinions. And in a particular case, one in Colorado is
one I would be referring to, an issuer did sue us for assigning
a rating on an unsolicited basis. And we had a successful First
Amendment defense to that suit.
Mr. Oxley. Mr. Egan, is it your understanding that that
case is a controlling authority in that area?
Mr. Egan. I think it was--well, I do not know.
Mr. Oxley. Mr. Chairman, I would ask unanimous consent,
perhaps, that Mr. Egan could supply us with some of that
information in writing.
Mr. Egan. Yes. There are some articles in Wall Street
Journal in the mid-90s about the two municipal issuers that did
sue Moody's for the punishment ratings----
Mr. Oxley. And for balance in if I may suggest we ask Mr.
McDaniel for the same information to have their--that would be
helpful, I think, for staff and the members to better
understand that whole First Amendment issue.
Mr. Egan. Yes.
Mr. Oxley. Thank you, Mr. Chairman.
Chairman Baker. Mr. Shays?
Mr. Shays. Thank you, Mr. Chairman, again, for holding this
hearing.
And thank you to the witnesses.
When bad things happen it is easy to, with hindsight,
obviously to cast dispersions, and I do not want to do that,
but I am interested, with hindsight, how people reacted. And I
found Ms. Nazareth's response is frankly, you know, not
alarming, but very disappointing.
And I also want to say, you know, since I have been in
college, Moody's and Standards & Poors, you know, I just put
them way up there, but I have to say, I also put Enron up
pretty high, too. And for me, what happened in Enron, was a
wake-up call. I want to know if we are waking up.
So let me ask you, first, Mr. McDaniel, what was your
reaction when you learned about what happened at Enron?
Mr. McDaniel. The Enron situation was, I would agree,
indeed a wake-up call not just for Moody's, but for the market
generally. And we took a number of steps in response to the
collapse of Enron, as well as some of the other corporate
collapses that have followed over the last 18 months or so.
We began publishing liquidity risks assessments which
focused on the short-term liquidity position of the firms that
we rate. We conducted a comprehensive rating trigger survey,
both in the United States and in Europe asking companies
specifically whether they had elements in financial contracts
that would cause posting of collateral or cash calls in the
event that rating fell below a certain level. And we found that
there were a large number of those and a large number of those
that were not otherwise disclosed.
We created two regional chief credit officer positions for
our corporate ratings; one in the United States and one in
Europe. Most importantly, though, we began what we call a
specialist initiative or an enhanced analysis initiative where
we have been hiring accountants, off-balance sheet risk
transfer specialists and corporate governance specialists to
both broaden and deepen the scope of our rating analysis.
Mr. Shays. Let me ask you, though, in terms of your own
state of mind, was this a shock to you?
Mr. McDaniel. Yes.
Mr. Shays. Were you embarrassed that Moody's was so high on
this company for, you know, until death do us part?
Mr. McDaniel. I want to be careful in answering because we
were not high on the company. We had rated it in our lowest
investment grade category.
Mr. Shays. Yes, but your lowest investment rating is
still--I mean, was it that in the standard of one to 20-
something, it is still pretty high up there, right?
Mr. McDaniel. Yes. Well, it is in the middle.
Mr. Shays. But it clearly--you mean it is like a 10 or is
it more like a four? I mean, in terms of your rating scale.
Mr. McDaniel. It is in the middle. A BAA rating is--there
are three rating categories above it and three rating
categories below it. So it is a rating indicating that we do
believe it is investment grade and, as we publish in our
definitions, contains----
Mr. Shays. Do you have people that are totally focused on
Enron or is your business so big that you just--I mean, do you
have people dedicated to just looking at Enron?
Mr. McDaniel. We never had a single individual dedicated to
Enron.
Mr. Shays. When VIVA, a Germany company, wanted to unite
with Enron, and another accounting firm was called in, like two
years before Enron took a nose dive, I think, the U.S.
accounting firm said there is $2 billion of undisclosed
liability. Why didn't that impact Moody's determination of this
company?
Mr. McDaniel. I apologize, Congressman, but I do not have
those specific facts at hand. I would be happy to, you know,
provide them for you afterward.
Mr. Shays. Help me out, Mr. White. I would also say I do
not often get someone from the Stern's school, where I
graduated in economics, but never had you, sir, only cause I
was there 30 years ago.
I am intrigued by the fact that evidently there are no
standards, no formal requirements in which to joint this select
group of nationally recognized statistical rating
organizations--and it is done in private--how someone--to know
how they qualify.
Mr. White. Congressman, I think that is an excellent
question. I do not have a good answer for you, and I was not
happy with Ms. Nazareth's answers either. Basically it is body
language. If you look at the 1997 proposed criteria, the SEC
said, ``We have been sort of using this criteria for our no-
action letters. We might as well put them out and see what the
reaction is.'' So----
Mr. Shays. But it strikes me, how are you able to determine
if you do not have--I mean, it is almost like what you would be
taught in ninth grade or earlier that you got to have some kind
of standards and people have to meet these standards and then
you know. I mean, it is like I have an impression that the
business community is pretty smart. And that when people
criticize politicians, you know, we sometimes take hits. But I
am begging to think the business community almost makes
politicians look brilliant.
Because, seriously, I mean--I am almost sounding very self-
righteous here--but someone on this panel tell me why you do
not need, first, if you disagree and you think there are
standards, and then tell me why we do not need standards. One
person here tell me why.
Mr. White. Again, Congressman, if we are going to have the
NRSRO category, then we need standards. They need to be
transparent. And they need to be applied equally to incumbents,
as well as to entrants. They should be performance standards,
not input standards the way the 1997 criteria were stated.
Mr. Shays. Does anyone on this panel disagree with that,
with what Mr. White said? Anybody? I am going to infer that all
of you agree with that.
Chairman Baker. Mr. Shays, if I can seize upon that moment?
We are going to come back for another round. And Mr. Inslee's
arrived, and since he has not had an opportunity to ask, I
would like--Mr. Inslee do you have questions at this time?
Well, that makes it easy. Well, we will start a second
round here. Just briefly; following on Mr. Shays' point, I may
suggest in writing, to each of you, just to respond to us on
some points that were raised during the course of the hearing
today, one of which will be the Shays' observation about no
objection to the generalized points he made.
Mr. Kanjorski had a few points he wanted to get on that
record that, I think, we would include in that document.
And I want to find out, basically, two generalized
approaches. If we maintain the current system, from each of
you, what do you see as the minimal steps necessary to have a
functioning system treating all participants equally that is
transparent and understood by the market without getting into
day-to-day regulation of your business, whether you engage in
rating and consulting with the same client or not? I am not
prejudging any activity. But if you do it, how do you disclose
that?
Whether officers and officials of the rating agency serve
in a board capacity of a rate enterprise? Fine. But if you do
it, how do you disclose that in a broad context, not as
narrowly defined today?
And further, the comment as to whether or not you deem it
advisable to maintain the current system, meaning the bumper
sticker on the front of the corporate vehicle, as a necessity
for the flow of information to the capital markets and to the
public? And it will be cleaned up where it makes more sense
than that.
But just indicate to you that I hope we have several
members of the committee sign on and we may very well send the
same letter to the appropriate SEC officials for comments,
which will enable us to kind of get to closure on this. I do
not want to have this hearing raise a bunch of issues, and then
not subsequently take some steps to bring us to resolution. So
I think Mr. Shays' question is a good starting point. And Mr.
Kanjorski and others who are interested will engage in that
activity and get it out forthwith.
Mr. Kanjorski, I believe you had some more questions.
Mr. Kanjorski. Yes. I am going to take advantage of my
position and the quality of our panel. I direct this question
to everybody on the panel, but primarily the representatives of
the major rating agencies, including Mr. Egan.
A number of months ago, probably less than six, probably
more than three--I cannot quite yet place it in, I had an
extensive meeting with a very highly appointed official of the
present Administration who has a great deal to do with
economics, financial markets, et cetera. I will leave it at
that.
In the course of that meeting, in analyzing the
macroeconomic condition of the United States and the world, he
indicated to me that he had great worries that there were
perhaps more than 200 corporations that had difficulties yet
undisclosed and unknown that he saw coming down the road. Most
recently, HealthSouth fell into that category.
Now, those of you who are in the rating agencies, are you
giving the investors a macroeconomic picture of that possible
future? Are you giving the public any awareness that could help
us out? Do we have to go through every company that is on all
the exchanges to try and come up with the identification of who
those companies may be?
The thing that worries me, since I do not either have the
time nor the inclination to examine every publicly traded
corporation to try and identify those 200, is would they, the
problem companies clearly, in your ratings, show up so that a
simpleton, such as myself, could look at those ratings and say,
``Here are the 200 of them that are in trouble, and that we can
anticipate problems that will have a definite impact on the
economy.''
Mr. Egan. Yes. We maintain a list where we compare our
ratings against Standard & Poors ratings, and there are a
number of companies where we are significantly lower. And by
the way, we are in the business of protecting investors,
period. So we want to get to the truth quickly.
We measure ourselves on what is called hits and misses.
That is, if there is convergence where S&P or Moody's move
toward our ratings, that is considered a hit. If they move
away, it is a miss. Last year, there were 440 hits and about 19
misses; year before, about the same. So we constantly keep
track of it.
And we do see a number of huge problems out there. Probably
the biggest one that has not been dealt with is the pension
fund and health care liabilities. A lot of corporations are not
treating it as real liabilities. They are hoping that the
market is going to zip up 100 percent over the next two years.
We tell our clients or identify where there are huge problems.
Many times we get into difficulty because our ratings are so
far apart from the majors. And the Enron, the WorldCom, the
Global Crossing has given us the leeway with our clients to
maintain that huge discrepancy.
Chairman Baker. Would the gentleman yield?
How many companies do you rate?
Mr. Egan. Approximately 800.
Chairman Baker. And how many does S&P rate?
Mr. Egan. In the corporate area, significantly more----
Chairman Baker. Including bond market and everything. The
scope of their full authority, what do they do in an annual
period of time?
Or if I can, I will jump Mr. McDaniel. What is your rating
responsibility? I am trying to get some sense of scale here.
Mr. McDaniel. Almost 6,000 corporate and structured
finance--corporate entities and structured financed vehicles,
about 16,000 public finance issuers.
Chairman Baker. So a total of 22,000 obligations versus----
Mr. Egan. Eight hundred, maybe 900. But we focus on the
corporate.
Chairman Baker. I understand.
I thank the gentleman for yielding.
Mr. Kanjorski. Mr. McDaniel, do you have any macro picture
that you could make available? In other words, I am trying to
determine whether this remark was off the top of his head or is
this really a serious matter where we have 200 major
corporations that may be in significant difficulty out there
that the public is not aware of?
Mr. McDaniel. Well, we rate slightly over 1,000
corporations in the junk category, speculative grade, below
investment grade. I think your question is going more to, ``Are
we providing a macroeconomic framing around that?'' And we do
do that through our economics department, and that is published
both on our Web site and through major media outlets, and that
includes economic analysis and default probability analysis and
forecasting.
Mr. Kanjorski. Is this information readily made available?
It was rather shocking to me when he told me that statement,
but maybe it just means I am under read.
Mr. McDaniel. It is available on our Web site. Our
economists would speak to the major news outlets. I do not know
how broadly it might be consumed. I have not looked at the Web
sites hits on that in some time.
Mr. Kanjorski. Mr. Joynt, do you have a comment on that?
Mr. Joynt. I have a couple of comments. One, I think, also
Fitch does industry surveys describing whole industries and how
they would be affected by economic development. So if we expect
in the next several years deteriorating economic conditions
globally or in the U.S., then you could first look at those
industry pieces to try to identify companies that might be
problematic; the airlines industry today. So I could not have
maybe told you the amount of problems they would have had a
year ago, but in light of what has happened in the world today
and with the war, then they are having significant problems and
they are quickly deteriorating.
Also, by looking at industry studies you can look at groups
of companies that are competing against each and how they are
leveraged. And so there are a significant number of companies,
as Mr. McDaniel has pointed out, that Moody's rates 1,000 that
are non-investment grade, many of which would be highly
leveraged, and so those would be candidates for a more rapid
deterioration.
Is that helpful?
Mr. Kanjorski. Yes, it is helpful.
I am sitting back here and listening to a lot of analysis
coming out of government, coming out of industry, coming out of
academia, and it does not seem to me that there are many people
out there discussing real potential economic risks.
Some people call it meltdown, others have termed it
something else. Everybody can use their own imagination to
describe it. But it is something that we must explore. For
example, about two or three months ago, the Japanese Government
went to the bond market and they wanted to sell Japanese bonds
and there were no buyers. Is that correct?
And I do not know how they were rated.
Now, just around two weeks ago, the Deutsche Bank formally
notified the German government that under present conditions,
if they continue as they might, the German banking system might
become insolvent.
So now we have the second-largest economy in the world
unable to sell its bonds; we have the third-largest economy in
the world talking about bank insolvency; and we are the first
economy in the world and I do not know whether we are in the
stage of prosperity or recession. We do not know. I would say,
however, we are probably in stagnation, and in the midst of a
war.
Additionally, I am hearing hue and cry out there indicating
that not only the United States but the world may have some
very, very, very serious economic situations. We seem to be
only talking about the economic situation of the United States
vis-a-vis the 2004 presidential and congressional elections at
this point. You know, as long as we can do anything to not
address this issue between now and then, we do not want to
shake the population up.
And yet, let me go further with this analysis, this
discussion, because it did disturb me and does continue to
disturb me. It is something I want to take up with my chairman
in the not too distant future. The unnamed official then
indicated that the problematic period would be 12 to 18 months.
We subsequently did talk about an economic meltdown.
We did not just talk about an industry meltdown, such as
the airlines, but a global meltdown. I said I was always
worried about that problem and I had always wanted to look at
that problem. I also estimated at best there would be maybe a
one-in-ten chance of that meltdown happening, but he shook his
head knowingly. He then said that he thought it was more like a
one-in-three chance of that meltdown happening.
Is there any reasonable truth to that analysis?
Mr. Egan. We would not disagree with that. The problem that
we face is when we sound the alarm, and we did on some of the
auto companies recently, that we have run into a lot of
difficulty. We have sounded the alarm on some major government-
sponsored entities and some major bond insurers who have Triple
A ratings by our competitors; we think they are far from it.
There are a number of things that can happen that can
trigger it and we are very concerned. So we are balancing that
high level of concern with protecting investors and really
trying to steer them to the safe harbors.
Mr. McDaniel. The issues that you are identifying that are
macroeconomic level, Congressman, particularly in the situation
of Japan and Germany, I think might be more fairly
characterized as longer term, chronic problems, rather than
acute problems that are likely to have significant
deterioration over the next 12 to 18 months. We have a Single A
rating on Japanese government bonds, those are the Yen
denominated bonds----
Mr. Kanjorski. Those are the ones they could not sell?
Mr. McDaniel. The ones that they sold several months ago,
yes, we rate them A-2.
Mr. Kanjorski. But there were some that they had no buyers?
Mr. McDaniel. And the Bank of Japan and governmental
authorities may step in and buy the paper.
Mr. Kanjorski. The real market did not buy those bonds,
though you had an ``A'' rating?
Mr. McDaniel. I read the papers, in terms of what the
market appetite was for those bonds. You know, we did not have
conversations with the Japanese government about what the
appetite was for those bonds. But we do hold a Single A rating
on the government of Japan for the yen-denominated bonds. That
is down from a number of years ago, from Triple A. So we have
been moving down on the rating scale for the yen-denominated
securities. And, in fact, they are substantially below their
dollar-denominated securities.
Chairman Baker. If I can, Mr. Kanjorski, can I jump to Mr.
Shays.
Mr. Shays?
Mr. Shays. Mr. Chairman, I want to say, this is an
excellent panel. We have just kind of scratched at the surface,
though. For instance, Ms. Cummingham, I would like to ask you,
the rating agencies are important to you because of law, but do
they provide a valuable service to you if the law was not
requiring that you use them?
Ms. Cunningham. They are one of many inputs that go into
our decision-making process for the securities that we purchase
in the institutional marketplace with funds that we manage. I
think that by and large the fixed income marketplace is an
institutional marketplace; it is really not a retail
marketplace.
If you are going to buy bonds as a retail investor, you
would probably buy Treasury securities. So it is not
necessarily something you would be utilizing rating agencies
for.
On the assessment of the other types of fixed-income
securities that are in the marketplace, I think by and large
the retail investor is looking to independent adviser services,
such as Federated, that utilize the rating agencies as one of
the inputs, but certainly not entirety.
Mr. Shays. Do you have to use the nationally recognized
statistical rating organizations or can you use Mr. Egan's
organization?
Ms. Cunningham. We can use any input that we would like. We
are required by law to recognize if a rating is designated from
one of the NRSROs.
Mr. Shays. So it becomes pretty important that it be from
one of the four?
Ms. Cunningham. It is a hurdle level that is mandated on a
regulatory basis if it exists. If it does not exists, we do not
have to use them.
Mr. Shays. Mr. Egan, would you explain to me why you have
worked so hard to be one of these four, now five. What
difference does it make to you? You have how many employees?
Mr. Egan. I think we are up to about 13 right now. We have
about 300 institutional clients, mostly institutional
investors, some broker dealers. A number of institutions simply
will not look at our ratings since we are not an NRSRO. The
thought is that if you are any good, you would have the
designation.
It is interesting, but I just heard yesterday from a client
when they heard about this hearing, they said, ``Please,
please, do not become an NRSRO because their ratings are no
good.'' In other words, they did not want us to be compensated
by the issuers, who--they think that is a fundamental conflict,
and we said, ``We could not agree with you more.'' And we are
not going to change our business practice. We are going to
continue to refuse compensation from the issuers, and just get
it from the investors.
So to answer your question, it will broaden our voice in
the market.
Chairman Baker. If the gentleman will yield on a point you
asked Ms. Cummingham about, just to make sure that I got it
correct. In your earlier testimony you did indicate that the
Investment Company Act does require you by law to utilize the
NRSROs with regard to money market funds and asset-backed
securities.
Is that correct?
Ms. Cunningham. That is correct.
Chairman Baker. Okay, thanks. I thank the gentleman for----
Mr. Shays. So you only have, basically, four companies to
turn to?
Ms. Cunningham. That is correct, if those ratings exist. If
those ratings do not exist for those particular issuers that we
are purchasing we can buy non-rated securities.
Mr. Shays. Mr. Kaitz observes in his testimony that 29
percent of corporate treasury and finance professionals who
work for companies with rated debt, indicated that their
companies ratings are inaccurate.
He also states that only 65 percent of the corporate
respondents that use credit ratings to make investment
decisions believe that the ratings of the companies in which
they invest are accurate.
Doesn't this lack of confidence in the accuracy of firms
ratings raise concerns about their ability to perform their
jobs. And, Mr. Kaitz, would you start and then I want to ask
each of you to answer.
Mr. Kaitz. The premise of the survey really was a result
of, to your point earlier, Mr. Shays, the debacle with Enron.
So this was an outgrowth of our membership, which is a
professional organization.
And I think that it was expressed in some of our membership
that this was a broader issue, which is why we did this survey.
Obviously, the results speak for themselves in terms of the
accuracy and the timeliness of those ratings. And interestingly
enough, as I pointed out, members revealed that not only with
upgrades, but also with downgrades that there was a significant
time lag.
So I think the survey speaks for itself that our membership
does believe that there are some issues, both in accuracy and
timeliness of the rating agencies.
Mr. Shays. Before I go to the other panelists, to answer
who rates the rating agencies?
Mr. Kaitz. From a----
Mr. Shays. From a standpoint of how accurate they are in
comparing them? Does Fortune Magazine look at the others?
Mr. Kaitz. To my knowledge there is no one that currently
does that.
Mr. Shays. I would think that would be a great business to
go into.
Mr. Egan. In fact, the----
Mr. Shays. No, I am serious, it would seem to me that if
you could start to develop a standard on how accurate these
folks are, that you would basically provide a tremendous public
service.
I would think an entrepreneur like you, Mr. Egan, would
jump on that.
Mr. Egan. In fact, the Federal Reserve Board of Kansas City
just came out with a study, it was published yesterday, and it
indicated that there is a lot of stickiness in the investment
grade ratings of S&P and Moody's----
Mr. Shays. There are a lot of what?
Mr. Egan. What they call stickiness. In other words, like
the Enron case, where the rating was kept too high for too
long--same with WorldCom.
And that the other rating agencies, S&P and Moody's moved
in, down to our ratings afterwards, an average of about three
months or something like that.
But, yes, you are absolutely right. And they went through
all of our ratings from when we started in December of 1995. I
think I sent to your staff, it just became available yesterday,
a copy of that survey.
Mr. Shays. I guess that I could kind of change the design
of the question that I asked Mr. Kaitz and ask, the four rating
agencies, three that have the designation, how are you held
accountable?
Mr. McDaniel. At Moody's we publish annual default
studies----
Mr. Shays. Annual what?
Mr. McDaniel. Annual default studies. It looks at all of
the ratings that we have out in the corporate bond market, and
it looks at the defaults that have occurred over the previous
year.
I think we have just published our 16th annual default
study. That shows whether or not our ratings are predictive. It
shows whether or not companies that receive higher ratings
default less frequently that companies that receive lower
ratings.
Mr. Shays. Would that be the standard or should there be
some levels in between? A default means bankruptcy, basically?
Mr. McDaniel. A failure to pay on an obligation.
Mr. Shays. But what, would there be anything that would be
in between that that you could also--I mean, I think that is
good that you do that, obviously.
So, but that is the extreme, correct?
Mr. McDaniel. Well, it is an aggregate measure of whether
as you move down the rating scale defaults become more frequent
or whether there is not a relationship between a lower rating,
in increasing degrees, with higher default probability.
Mr. Shays. How about, I am sorry, thank you.
Mr. Joynt. I might just add to that, actually, to address
your question, there is also transition studies that are
published by Moody's, Standard & Poor's and Fitch, of the
movement of ratings among categories, A to A minus, so in
addition to the ultimate default probability there is the
movements that are studied.
Mr. Shays. Okay.
Mr. Joynt. And Fitch also----
Mr. Shays. And the study of the movement suggests what?
That you are describing the movement or you are saying we could
have called it better here or here?
Mr. Joynt. No, it is actually looked at in the many ways
one would want to look. Does it look like the ratings are
moving too quickly--overreactions? Are they moving too slowly?
Have they jumped categories? Do they move by one notch at a
time?
So, and to come back to your more basic question, which is,
who rates the rating agencies? Investors do, all the time.
I think the effectiveness of rating agencies comes from
investor scrutiny and the improvements in rating agencies come
from investor demands for more research and more background
information, not just the published rating alone.
And I think that is who is rating the rating agencies. And
I think that is a separate matter from just the NRSRO
designation, which I would acknowledge has some bearing and
merit on people's usage of ratings, as well.
But not the sole----
Mr. Shays. Just to put it on the record.
Mr. Root. Yes, I am going to add, you know, our core
business is in Canada, and there is no such thing as NRSRO; so,
you know, kind of following up on what Steve just said that,
you know, who is rating us, who is grading us? It is the
marketplace.
Because there is no regulatory designation that gives us
the similar type of status, if you will, as we have here. So to
the extent----
Mr. Shays. So you would argue that you do not need that
status?
Mr. Root. As long as everybody else did not have it,
correct.
Mr. Shays. Right.
No, but that is interesting. I think that is a summation
for me. I mean, if the others do not have it then let the
marketplace--I mean, S&P and Moody's would be way up there, it
is just, they are both great companies, they are big, they are
large, and it is not like the ratings are enabling the new
folks with just 13 employees to jump in and be given that
status.
Would you agree with Mr. Egan that maybe you just get rid
of it all?
Mr. Egan. I believe so. What has happened to this point is
that there has become a whole infrastructure that has supported
the two majors. For example, if an issuer decided not to hire
S&P and Moody's, and they hired somebody else, the investment
bankers could very well make it difficult for that issuer and
discourage the issuer from using those other sources.
It is very--the system has already been set up, it does not
work and there are a lot of parties supporting the current
system. So maybe--it probably would be better than what is
currently, but I do not know if that is the ultimate answer.
Mr. Shays. Okay, Mr. White, I am going to just let you
finish, I am sorry.
Mr. White. Thank you. I want to give you my reaction to
what you have just heard.
Mr. Shays. Okay.
Mr. White. First, I did not before and I was derelict as a
professor at the NYU Stern School of Business in not commending
you for having made a good choice of institutions.
Mr. Shays. Yes, you made a good choice in the past.
Mr. White. I have been there for 27 years, so I think we
just----
Mr. Shays. 1974 is when I graduated.
Mr. White. And I arrived in 1976. But I will make sure our
alumni office has you----
Mr. Shays. Trust me, they do.
Mr. White. Okay.
As I stated earlier, I believe in a markets-oriented
approach; I think that this is the best way to ensure that we
get new ideas, innovations, in the whole assessment of
corporate health and viability. That is the direction we need
to go. But if we going to go in that direction, then we have to
realize that this does require a number of financial regulators
to cease delegating their judgments to the rating companies.
They must make those judgments themselves.
For example, since 1931, bank regulators have been telling
banks that the banks must pay attention to the ratings on the
bonds that the banks hold in their portfolios. Since 1936,
banks have not been permitted to hold bonds that were below
investment grade in their portfolios.
The immediate question is: Whose judgment----
Mr. Shays. Right.
Mr. White. ----as to investment grade? And that was in
limbo until 1975 when the SEC stepped up, to its credit, and
said, NRSRO, that will be the category whose judgments should
be adhered to.
If you are going to get rid of the NRSRO category, then you
have to somehow deal with this issue of what is to prevent the
XYZ rating company from coming along, giving out AAA ratings to
anybody----
Mr. Shays. Very good point.
Mr. White. ----willing to line their pockets?
And the bank regulators can do it. They need to deal with
bonds the way they deal with loans: Bonds are just another form
of loans. When the bank regulators sent their examiners into a
bank, on day one the examiner says, ``tell me about your
loans.'' And on day two the examiner should say, ``tell me
about your bonds.''
Moody's, back in 1997, offered similar types of suggestions
to the SEC as to how the SEC could substitute its own judgments
for its use of NRSRO status. That could be done across the
board.
Mr. Shays. You took about four minutes to give me a one-
second answer, but I got it.
Well, I get the point. In other words, you made your point.
Mr. White. Okay. Thank you, Congressman.
Mr. Egan. I question whether bank regulators would be able
to catch Enron or Worldcom or Genuity. I do not think they have
the training, the incentive, the tools to do it. I think to
reform the system you need rating firms not to be paid by the
issuers, get rid of some of these basic conflicts of interest,
that is the first step to reforming it.
Encourage young firms, like ourselves, to have a vibrant,
healthy credit analysis industry, as opposed to what we have--
this basic partner monopoly, with people sitting on boards and
all the other unhealthy aspects.
Chairman Baker. Okay. Thank you, Mr. Shays.
Mr. Shays. Thank you.
Chairman Baker. I want to thank all of you for your
participation in a what was not expected--if anybody had told
me that a hearing on transparency in credit reporting agencies
would last until 1:30 in the afternoon, I would have had them--
well, in any event, I am surprised by the events of the day.
And I do find it very helpful to the committee's work. We
will followup with our letter of inquiry. And we look forward
to your responses, as timely as possible. We thank you for your
participation. And this meeting is adjourned.
[Whereupon, at 1:32 p.m., the subcommittee was adjourned.]
A P P E N D I X
April 2, 2003
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