Credit Rating Agency Reform Act of 2006

^Pr^ep^ar^{ed f}^o^r^M^e^m^b^ers^an^d^Com^mⁱ^t^t^ees^of^C^ong^r^e^ss

P.L. 109-291, the Credit Rating Agency Reform Act of 2006, was enacted to correct the perceived
problems created by the absence of statutory regulation of credit rating agencies. Credit ratings
have become an important component of the financial reputation of a rated company. However,
especially since the bankruptcies of Enron and WorldCom, whose debt had been rated investment
grade, there has been concern that perhaps credit rating agencies should be regulated. P.L. 109-
291 requires a credit rating agency which wishes to be considered a “nationally recognized
statistical rating organization” to file an application with the Securities and Exchange
Commission. The application must disclose detailed information about the agency and about its
methodology used in granting credit ratings. This type of full and accurate disclosure underlies
the philosophy behind all of the major federal securities laws. This report will not be updated.

P.L. 109-291, the Credit Rating Agency Reform Act of 2006, was enacted to correct the perceived
problems created by the absence of statutory regulation of credit rating agencies. Credit rating
agencies rate the creditworthiness of public companies and the debts of those companies so that a
potential creditor or investor will have a presumably professional, objective opinion as to the
likely risk of any investment in a particular company. These ratings have become an important
component of the financial reputation of a rated company.
^Ra^tⁱ^ng^{s ha}^ve^t^a^ke^{n o}ⁿ^gr^e^a^t^sⁱ^gni^fi^c^a^nc^eⁱⁿ^t^h^e^ma^r^k^e^t^,^wⁱ^t^hⁱ^nve^st^o^r^{s t}^r^u^s^tⁱ^{ng t}^h^a^t^a^go^o^d
^{credit ratin}^g^re^f^l^ect^s^t^h^{e res}^u^lts^of^{a carefu}^l^,^uⁿ^b^ia^s^e^{d an}^{d acc}^u^r^{ate as}^s^e^s^s^m^eⁿ^t^b^y^th^e^credit
^ratin^g^a^g^eⁿ^cies^of^t^h^{e rated com}^p^aⁿ^y^....
^Cr^ed^{it r}^a^tin^g^s^,^w^h^ich^ar^{e e}^x^p^r^essedⁱⁿ^{a letter}^g^r^ad^{e, p}^r^o^v^id^{e an}^asses^s^m^eⁿ^{t o}^f¹
^credi^t^w^o^rt^hⁱⁿ^e^ss^{, or t}^h^{e l}ⁱ^k^e^lⁱ^{hood t}^h^at^debt^wⁱ^l^l^{be repai}^d^.
Over the past several years, particularly with the scandals involving such major corporations as
Enron and WorldCom, increased attention has focused on the role of credit rating agencies in the ²³
operation of the securities markets. Section 702 of the Sarbanes-Oxley Act of 2002 required the
Securities and Exchange Commission (SEC or Commission) to “conduct a study of the role and
function of credit rating agencies in the operation of the securities market.” In January 2003, the
SEC issued its report, Report on the Role and Function of Credit Rating Agencies in the
Operation of the Securities Markets. In June 2003, the Commission issued a concept release in
order to solicit public comments about issues concerning credit rating agencies, including the
issue of whether credit rating agencies should continue to be used for regulatory purposes under
the federal securities laws and whether, if these ratings are used, there should be a formal process
of determining whose ratings should be used and what kind of oversight to apply to these credit ⁴
rating agencies.
The SEC’s 2003 Concept Release stemmed from ongoing concerns regarding the development of
the Nationally Recognized Statistical Rating Organization (NRSRO) concept. In 1975, the ⁵
Commission issued the Net Capital Rule, which set new net capital requirements for broker-
dealers and required these broker-dealers to take a larger discount on below investment grade
bonds than for investment grade bonds. The rule required that the ratings come from a “nationally
recognized statistical ratings organization.” There was some concern that there was no official
federal statutory or regulatory definition of “nationally recognized statistical ratings
organization.” Instead, “[u]pon request the staff of the Division of Market Regulation [of the SEC ⁶
would] provide a ‘no-action’ letter” to a credit rating agency if it granted the agency’s request to

¹^Sta^f^f^of^Se^na^te^C^o^m^m^{. on G}^o^v^e^rⁿ^m^e^nta^l^A^f^f^a^ir^s^,¹⁰⁷^th^C^o^ng^{., Fi}ⁿ^a^nc^ia^{l O}^v^e^r^sⁱ^g^h^{t of}^Enr^on:^T^h^e^SEC^a^nd^Pr^iv^a^t^e
^Se^c^t^or^W^a^tc^hdog^s^76-⁷⁷⁽^S^.^P^r^t.¹⁰⁷^-⁷^{5 2}⁰⁰²⁾^.
²^T^h^e^m^a^{jor c}^r^e^d^{it ra}^ting^a^g^eⁿ^cⁱ^e^s^m^a^inta^ine^dⁱⁿ^v^e^stm^e^nt^g^r^a^d^e^ra^ting^s^{on En}^ron^’^{s de}^bt^uⁿ^{til c}^l^ose^to^t^h^e^tim^e^of
^Enro^{n’s ba}^nk^ru^ptc^y^f^iling^.⁶⁰^W^AS^H^&^L^EE^L.^R^EV^.³⁰⁹^,³²³⁽²⁰⁰³⁾^.
³^P^.^L^.¹⁰^7-²⁰⁴^.
⁴^Se^c^u^ritie^{s A}^c^{t Re}^le^a^s^e^{No. 3}³^-8²^36,⁶⁸^Fe^d.^Re^g^.³⁵^,2^{58 (J}^une^12,²⁰⁰³⁾^.
⁵^R^u^le¹⁵^c³^-¹^,^{17 C}^.^F.R^.^§²⁴^0.¹⁵^c³^-¹^.
⁶^S.^P^r^t.¹^07-⁷⁵^{, a}^t⁸⁰^{. “}^[^A^]^c^r^e^d^it^r^a^ting^a^g^eⁿ^c^y^initia^te^{s th}^eⁿ^o^-a^c^tio^{n le}^tte^{r pr}^oc^e^{ss by}^re^que^sting^aⁿ^o^-a^c^tion^le^tte^{r tha}^t
^w^{ill sta}^t^e^tha^t^the^Com^mⁱ^s^s^{ion sta}^f^f^w^{ill not re}^c^o^m^m^e^{nd e}ⁿ^f^o^rc^e^m^eⁿ^{t a}^c^tio^{n a}^g^aⁱ^{nst pe}^rsoⁿ^{s w}^{ho use}^the^fⁱ^rm^{’s c}^r^e^d^it
^r^a^ting^s^f^o^r^pur^p^o^s^e^s^of^the^C^o^m^m^is^sⁱ^on’^s^ne^{t c}^a^p^ita^{l r}^u^le^.”^SEC^pr^o^pos^e^d^r^u^le^de^fⁱ^ning^N^a^ti^ona^lly^R^e^c^o^gⁿ^iz^e^d
^Sta^tis^tic^a^l^R^a^ting^O^r^g^a^niz^a^tion,⁷⁰^Fe^d.^R^e^g^.²¹^,3^06,²¹^,3¹⁹^(A^{pril 25,}²⁰⁰⁵^{). A}^f^te^{r a}ⁿ^inv^e^stig^a^{tion, the}^Com^mⁱ^s^s^ion’s
^st^aff^d^e^t^e^r^mⁱⁿ^e^w^h^et^h^e^{r t}^h^{e cred}ⁱ^t^ratⁱⁿ^{g agen}^c^y^m^e^et^{s NRS}^R^{O cri}^t^e^ri^{a an}^d^ei^t^h^{er i}^s^s^u^{e o}^r^d^eⁿ^y^t^h^{e req}^u^e^st^ed^no^-actⁱ^oⁿ
^le^tte^r.

obtain NRSRO status. The SEC has stated that there have been nine firms identified by the
Commission staff as NRSRO’s but that with consolidation there are currently five: A.M. Best
Company, Inc.; Dominion Bond Rating Service Limited; Fitch, Inc.; Moody’s Investors Service, ⁷
Inc.; and the Standard & Poor’s Division of the McGraw Hill Companies, Inc.
Ratings by NRSRO’s, despite there having been no official federal statutory or regulatory
definition, were given significant weight in such areas as federal and state legislation, rules issued
by financial regulators, and private financial contracts. A credit rating agency, particularly one ⁸
with NRSRO status, was exempted from certain federal securities regulations.
In 1997 the SEC proposed to amend the Net Capital Rule in order to define “NRSRO.”⁹ Among
other requirements in the proposal for receiving NRSRO status was that a credit rating agency ¹⁰
would be required to register as an investment adviser under the Investment Advisers Act. The
rule was not adopted, but in the apparently somewhat informal process that the SEC has used in
issuing its no-action letter to a credit rating agency, providing it with NRSRO status, the SEC
appeared to desire registration under the Investment Advisers Act by a credit rating agency
seeking NRSRO status.
On April 25, 2005, in response to a number of concerns, the SEC published a proposed new rule ¹¹
which would have defined “nationally recognized statistical rating organization.” The rule,
which was to be added to the Code of Federal Regulations at 17 C.F.R. section 240.3b-10, would
have defined the term as any entity that:
^{(a) Is}^s^u^es^pu^blicl^y^a^v^ailable^{credit ratin}^g^s^t^h^{at are cu}^rr^en^{t as}^s^e^s^s^m^eⁿ^t^s^o^f^t^h^e
^cr^ed^it^w^o^r^t^hⁱⁿ^e^s^s^o^f^o^b^lig^o^r^s^w^ith^r^e^sp^{ect to}^sp^ecifⁱ^{c sec}^u^r^itie^{s o}^r^m^oⁿ^e^y^m^a^r^k^e^tⁱⁿ^s^t^r^u^m^eⁿ^t^s;
^{(b) Is}^g^eⁿ^e^rall^y^{accepted in}^{the f}ⁱⁿ^aⁿ^c^ial^m^a^rk^et^s^as^aⁿ^is^s^u^e^r^of^{credible an}^{d reliable}
^r^a^tⁱⁿ^g^s^,ⁱⁿ^c^l^udⁱⁿ^{g r}^a^tⁱⁿ^g^s^fo^r^a^p^a^r^tⁱ^c^ul^a^rⁱ^ndus^t^r^y^or^g^e^og^raphi^c^s^e^gm^ent^,^by^t^h^e^predomⁱⁿ^ant
^use^r^{s o}^f^se^c^u^rⁱ^tie^{s r}^a^ti^ng^{s; a}ⁿ^d
^{(c) Us}^es^s^y^s^t^e^m^at^{ic procedu}^r^es^desⁱ^gⁿ^e^{d to en}^s^u^{re credible an}^{d reliable}^r^a^tⁱⁿ^g^s^,^m^aⁿ^a^g^e
^p^o^t^en^{tial co}ⁿ^f^{licts o}^fⁱⁿ^ter^e^st,^an^d^p^r^ev^en^{t t}^h^e^mⁱ^su^{se o}^fⁿ^oⁿ^p^u^b^{lic i}ⁿ^f^o^r^m^atioⁿ^,^aⁿ^d^h^a^s¹²
^s^u^ff^icieⁿ^t^fⁱⁿ^aⁿ^c^{ial res}^o^u^r^ce^s^t^o^en^s^u^{re co}^m^p^liaⁿ^ce^wⁱ^t^h^t^h^os^{e procedu}^r^es^.

⁷⁷⁰^Fe^{d. R}^e^g^.^21,³⁰^6-²¹^,³⁰⁷⁽^A^pr^{il 2}⁵^,²⁰⁰⁵⁾^.
⁸^Oⁿ^e^of^the^s^e^e^x^em^ptions^c^o^nc^e^rⁿ^s^R^e^g^u^la^{tion F-}^D⁽¹^{7 C}^.^F^.^R^.^P^a^r^t²⁴³⁾^,^w^h^ic^{h pr}^oh^ibits^is^s^u^e^r^s^f^r^om^m^a^kⁱ^ng
^se^le^c^tiv^e^disc^losure^of^m^a^te^ria^l^inf^o^r^m^a^{tion in}^orde^r^{to a}^tte^m^p^{t to}^m^a^k^e^c^e^rtaⁱ^{n tha}^t^the^pu^blic^ha^{s i}ⁿ^f^o^rm^a^{tion ne}^e^d^e^d
^{to m}^a^ke^inv^e^st^m^e^{nt de}^cⁱ^{sions. T}^h^{is pro}^h^ib^itioⁿ^doe^{s n}^o^{t a}^p^pl^y^“^[^t^]^o^aⁿ^eⁿ^tity^w^hose^prim^a^r^y^busine^s^s^{is the}^issuaⁿ^c^e^of
^c^r^e^d^{it ra}^ting^s^{, pr}^ov^ide^d^theⁱⁿ^f^o^rm^a^{tion is}^disc^lose^{d s}^o^le^ly^f^o^r^the^pur^pos^e^of^de^v^e^lopi^ng^a^c^r^e^d^{it r}^a^tⁱ^ng^a^nd^the^eⁿ^ti^ty^’^s
^ra^ting^s^a^r^e^publ^ic^ly^av^a^ila^ble^”⁽¹⁷^C.F.R.^§²⁴^3.1⁰⁰⁽^b)(²⁾⁽ⁱⁱⁱ⁾^.^A^not^he^{r e}^x^em^{ption c}^o^nc^e^r^ns^{SEC R}^u^l^e⁴³⁶⁽¹^{7 C.F}^.^R.^§
²³⁰^.4³⁶⁾^{, w}^h^ic^{h w}^a^s^is^s^u^e^d^pur^s^u^aⁿ^{t to}^s^e^c^tion¹¹^of^the^Se^c^u^rⁱ^tⁱ^e^s^A^c^{t o}^f¹⁹³^{3 (}¹^{5 U}^.^S.C^.^§^77k⁾^.^T^h^e^s^t^a^t^ute^pr^ov^ide^s
^f^o^{r c}ⁱ^v^{il lia}^bilitie^{s f}^o^{r th}^ose^a^tte^sting^{to t}^h^e^inf^o^rm^a^{tion c}^o^ntaⁱ^ne^dⁱⁿ^a^re^gⁱ^stra^{tion sta}^t^e^m^eⁿ^{t. Rule}⁴³⁶^pr^ov^ide^s^tha^t^a
^ra^ting^a^ssigⁿ^e^d^by^a^na^tiona^lly^re^c^o^gⁿ^iz^e^d^sta^tistic^a^l^ra^ting^org^a^niz^a^{tion is}^no^{t t}^o^be^c^o^ns^ide^r^e^d^a^pa^r^t^of^the^r^e^gⁱ^s^t^r^a^tion
^s^t^a^t^em^eⁿ^{t, thus}^a^r^g^u^a^b^ly^s^h^ie^ldiⁿ^g^a^N^R^SRO^f^r^o^m^lia^bility^unde^{r s}^e^c^{tion 1}¹^of^the^Se^c^u^ritie^s^A^c^{t. The}^rule^s^t^a^t^e^s^tha^t
^“t^h^e^t^e^rm^nation^a^lly^re^c^o^gⁿ^ize^d^st^a^tis^tic^al^r^a^ti^ng^or^g^aniz^a^ti^on^[^e^m^p^h^a^si^{s i}ⁿ^o^rⁱ^gⁱⁿ^al^]^sh^al^l^h^a^{ve t}^h^{e sa}^me^m^eanⁱⁿ^{g as}
^us^e^dⁱⁿ^R^u^le^15c^3-¹⁽^c⁾⁽²⁾⁽^vⁱ⁾⁽^F⁾⁽^{17 C}^.^F.R^.²⁴^0.^15c^3-¹⁽^c⁾⁽²⁾⁽^vⁱ⁾⁽^F⁾⁾^”⁽^17C^.^F^.R^.^{§ 2}³⁰^.⁴³⁶⁽^g⁾⁽²⁾⁾^.
⁹^R^e^le^a^s^e^N^o^{. 34-}³⁹⁴⁵^7,⁶²^Fe^{d. R}^e^g^.^68,0¹⁸⁽^D^e^c^.³⁰^{, 1}⁹⁹⁷⁾^.
¹⁰¹⁵^U^.^S^.^C^.^§§⁸⁰^b^et^seq^.
¹¹⁷⁰^Fe^{d. R}^e^g^.^21,³⁰^6.
¹²⁷⁰^Fe^{d. R}^e^g^.^21,³²^3.

There was congressional concern, however, that the SEC might not have adequate statutory
authority to oversee the credit rating agency industry. With the introduction of H.R. 2990, titled ^th
the Credit Rating Agency Duopoly Relief Act of 2005, on June 20, 2005, the 109 Congress
began the process of considering legislation to regulate the registration of credit rating agencies. ¹³
At the end of this legislative process, S. 3850, the Credit Rating Agency Reform Act of 2006,
was passed by unanimous consent by the Senate on September 22, 2006, and under suspension of
the rules by the House on September 27, 2006. It was signed into law by the President on
September 29, 2006, as P.L. 109-291.
Section 2 of P.L. 109-291 sets forth the congressional findings leading to the need for regulation
of credit rating agencies. This section, referencing the above-mentioned section 702 of the
Sarbanes-Oxley Act and comments on the SEC’s concept releases and proposed rules, states the
finding that “credit rating agencies are of national importance.” Among the reasons provided for
the need for legislation to regulate credit rating agencies are that the two largest credit rating
agencies [Moody’s and Standard & Poor’s] serve most of the market and that additional
competition is in the public interest and that the SEC has stated that it needs statutory authority to
oversee the credit rating industry.
Section 3 adds five new definitions to the Securities Exchange Act of 1934:¹⁴ credit rating, credit
rating agency, nationally recognized statistical rating organization, person associated with a ¹⁵
nationally recognized statistical rating organization, and qualified institutional buyer. The
definition of “nationally recognized statistical rating organization” would appear to resolve
uncertainty which might have existed concerning the SEC’s somewhat informal recognition of
such an organization. Under the new statute a “nationally recognized statistical rating
organization” is a credit rating agency that has been in business as a credit rating agency for at
least the three consecutive years immediately preceding the date of its application for registration
as a NRSRO and which issues credit ratings certified by qualified institutional buyers concerning
financial institutions, brokers, or dealers; insurance companies; corporate issuers; issuers of asset-
backed securities; issuers of government securities, municipal securities, or securities issued by
foreign governments; or a combination of one or more categories of obligors described in any of
the afore-mentioned categories.
In order to be deemed by the SEC as a nationally recognized statistical rating organization, a
credit rating agency must submit in its application to the SEC detailed information, such as the
following: 1. credit ratings performance measurement statistics over short-term, mid-term, and
long-term periods; 2. the procedures and methodologies that the applicant uses in determining
credit ratings; 3. policies or procedures adopted and implemented by the applicant to prevent the
misuse of material, nonpublic information; 4. its organizational structure; 5. whether it has in
effect a code of ethics and, if not, why not; 6. any conflict of interest relating to its issuance of
credit ratings; 7. on a confidential basis a list of the twenty largest issuers and subscribers that use
its credit rating services by amount of net revenues received in the fiscal year immediately
preceding the date of submission of the application; and 8. any other information and documents

¹³^Oⁿ^Fe^br^ua^r^y^{8, 20}⁰⁵^{, the}^Se^na^te^C^o^m^m^itte^e^{on B}^a^nk^ing^,^H^ousⁱⁿ^g^,^a^{nd U}^r^ba^{n A}^f^f^a^ir^s⁽^C^o^m^m^itte^e⁾^h^e^{ld a}^he^a^r^ing
^title^{d “}^E^x^a^mⁱ^ning^the^Role^of^Cre^d^{it Ra}^ti^ng^A^g^eⁿ^cⁱ^e^s^{in th}^e^Ca^pi^ta^{l Ma}^rk^e^t^s.”^{On Ma}^rc^{h 7,}²⁰⁰⁶^{, t}^h^e^Com^m^itte^e^he^{ld a}
^he^a^r^ing^title^{d “}^A^sse^ssing^the^Curre^{nt Ov}^e^r^sig^h^{t a}^{nd Ope}^r^a^tⁱ^ons^of^Cre^d^{it Ra}^ting^A^g^eⁿ^cⁱ^e^s^.”^T^h^e^Com^m^itte^e^{on A}^u^g^u^st
^{2, 2}⁰⁰⁶^,^orde^re^d^aⁿ^orig^ina^l^m^e^a^s^ure^to^be^re^p^o^rte^d^{. O}ⁿ^Se^pte^m^be^{r 6, 2}⁰⁰⁶^,^the^orig^ina^l^m^e^a^s^ure^,^w^{ith w}^r^itte^{n re}^port
^N^o^{. 1}^09-³²^{6, w}^a^s^r^e^por^te^{d t}^o^t^h^e^Se^na^te^.
¹⁴¹⁵^U^.^S^.^C^.^§§⁷⁸^a^et^seq^.
¹⁵^A^dding^s^e^c^tions^3(a^)(60)-(⁶⁴⁾^to^the^Se^c^u^ritie^s^Ex^c^h^aⁿ^g^e^A^c^{t of}^1934.

which the SEC may by rule prescribe as necessary or appropriate in the public interest or for the ¹⁶
protection of investors.
The SEC is required to follow a specific time frame and procedure in determining whether to
grant the application for treatment as a nationally recognized statistical rating organization.
The legislation makes it unlawful for any nationally recognized statistical rating organization to
represent or imply that it has been designated, sponsored, recommended, or approved by the
United States or by any United States agency, officer, or employee.
The legislation requires each nationally recognized statistical rating organization to establish,
maintain, and enforce written policies and procedures reasonably designed to address and manage
any conflicts of interest that might arise.
P.L. 109-291 fits within the general philosophy of all of the major federal securities laws. This
philosophy is premised upon the belief that, so long as there is full and accurate disclosure of all
material information by a covered company, the investing public will have sufficient information
upon which to make its investment decisions. The Credit Rating Agency Reform Act of 2006
requires a credit agency wishing to have the status of a nationally recognized statistical rating
organization to disclose to the SEC significant information about its business and its methods for
issuing credit ratings so that the investing public will have information to help determine the
likely accuracy of credit ratings which the agency has assigned.
^Mich^{ael V. Seitz}^ing^e^r
^L^e^gⁱ^s^l^at^iv^{e A}^t^torn^e^y
^m^s^ei^t^zⁱⁿ^g^e^r^@^crs^.^l^o^c.g^o^v^,^7-⁷⁸⁹⁵

¹⁶^Se^c^tion⁴^of^P.L^.¹⁰^9-2^91,^a^d^dⁱⁿ^g^se^c^{tion 1}⁵^{E t}^o^t^h^e^Se^c^u^ritie^{s Ex}^c^h^aⁿ^g^e^Ac^{t of}¹⁹³^4.