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U.S. Securities and Exchange Commission

Speech by SEC Commissioner:
Statement at Open Meeting Regarding NRSRO Rule Proposal


Harvey J. Goldschmid

U.S. Securities and Exchange Commission

Washington, D.C.
March 3, 2005

Greater transparency is the strength of this recommendation. We should, however, not underestimate the importance of the language in the second prong of the proposed definition of Nationally Recognized Statistical Rating Organization ("NRSRO"), which indicates that the term NRSRO can be available to credit rating agencies that confine their activities to a limited sector of the debt market or a limited (or non-U.S.) geographic area. This feature of the definition lessens barriers to entry and problems of that type.

The fact that the staff will issue a no-action letter stating that it considers A.M. Best to be an NRSRO is an indication of how important a role the language in the second prong can play. A.M. Best is a rating agency that specializes in the insurance area, but because it does that work so well and can expand, the staff considers it to be an NRSRO in the full sense of the term. This outcome, in fact, mitigates competitiveness problems, adds a new competitor, and helps reduce entry barriers, all of which are very healthy for the system.

If we were going to have new legislation in the area of credit rating agencies - which I will come back to - I would question the no-action process itself. New legislation, if it comes, ought to make this a Commission, as opposed to a staff, activity. NRSRO is too important a designation, as the economic consequences have worked out, to be handled at a staff level.

The NRSRO designation now plays a critical role. All of us would like to get rid of the "NR" - the "Nationally Recognized" - which is, in certain ways, misleading, given that limited-segment and limited-region credit rating agencies can qualify as NRSROs. But the term has become too important to the federal government, states, localities, the private sector - everyone is relying on this designation now. If we do not keep the term, there would be an awful lot of legislation throughout the world, certainly in this country, that would need to be changed.

We ought to keep in mind, too, that credibility and reliability are very important here. The antitrust, competitiveness type in me could well imagine a world without this designation. Indeed, if we were starting over, we might well not get into the business. On the other hand, the designation has become too important in too many areas, as commenters have indicated; it would be foolish and economically destructive to move away from use of the designation now.

That brings me to the need for oversight of credit rating agencies. This is a business fraught with potential conflicts of interest. And indeed the room for conflicts may be growing as rating agencies enter other businesses that may put issuer pressure on them. Their relations with issuers and potential misuse of confidential information call out, at least to me, for oversight here.

Yet, the Commission's General Counsel, I think with a fair amount of wisdom, is cautious in terms of our statutory authority. And there are sufficient questions, so legislation is, I think, called for at this time.

As to the so-called "voluntary framework" for oversight of credit rating agencies, none of us has seen a document from the industry setting it forth. If and when the "framework" does come, it is going to lack independent oversight; it is going to lack SEC inspections; and it is going to lack an enforcement process that is vigorous. It is very troubling to see this industry now operating with no significant oversight at all.

The bottom line for me is that credit rating agencies have fairly been described as "play[ing] a critically important role in the efficient functioning of the fixed income markets" and as gatekeepers to our capital markets with "quasi-public responsibilities." The staff is to be congratulated for its work in bringing forward this proposal, which represents a positive, though limited, step in an important area. The new, specific definition of NRSRO will create greater clarity, transparency, and certainty. And I think it will help to limit the entry barriers that have been there.

But part of transparency is being very clear about what this proposal does not do. As the proposing release states, this proposal is intended only to address the meaning of the term NRSRO. It does not attempt to address the broader issues that are out there. In particular, this proposal does not address regulatory oversight of credit rating agencies.

In policy terms, I agree with many who have studied this area that oversight of credit rating agencies is now inadequate - and that is by far the mildest term I would use. Credit rating agencies, like other key gatekeepers, deserve scrutiny and oversight commensurate with their role and importance in the securities markets and with the potentially serious problems - for example, various conflicts of interest and misuses of information - that can arise in the operation of the business. Oversight cannot and should not mean that government is telling any rating agency how to do ratings. But potential conflicts of interest and misuse of confidential information do call for serious oversight.

In my view, we should be candid with Congress. The SEC staff has concluded that significant issues can be raised about our current oversight authority. The Commission now needs explicit regulatory authority from Congress if the oversight job is to be done right. Otherwise, I fear, serious NRSRO problems will be lurking around a not-too-distant corner.


Modified: 03/11/2005