Congressional Whitepaper

Creating transparency and competition in the credit markets

Prepared for:

The Chairmen and Members of the Subcommittee on Securities and Insurance, Senate Banking Committee and the Subcommittee on Capital Markets, Insurance and GSEs, House Financial Services Committee

Purpose:

To propose legislative solutions to increase competition and transparency in the credit markets

� Equivalent Disclosure � Grant the SEC authority to revoke NRSRO status

� Create a central repository of default statistics at the SEC

� Designate oversight of the NRSRO relationship to issuer audit committees

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Contents

Page Proposals to Congress 3 Summary The 2007 credit crisis What do credit rating agencies do? Quis custodiet ipsos custodes? Credit rating agency market practice issues Equivalent Disclosure and proposed legislative solutions Background - Legislative & SEC reviews Background - Regulation Fair Disclosure Summary of proposed legislative and regulatory solutions

4 5 9

12 14 24 27 31 33

Resources

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January 15, 2008

Prepared by Cate Long, Multiple-Markets

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Proposals to Congress: � Equivalent Disclosure: Equivalent disclosure would increase the volume of issuer information available to all Nationally Recognized Statistical Rating Organizations (NRSROs). This will greatly enhance transparency in the fixed income markets. Equivalent disclosure will require issuers to share material non-public information with all NRSROs if they share this information with one NRSRO. This will eliminate “ratings shopping” and ensure competition among NRSROs for the most accurate and predictive ratings. This is the expansion of Regulation Fair Disclosure to the fixed income markets.

� Grant the SEC authority to revoke NRSRO status: The Credit Rating Agency Reform Act of 2006 does not include a grant authority to the SEC to revoke the NRSRO status of agencies who do not abide by the disclosure which they make to the Commission. This leaves the Commission without a method of disciplining NRSROs who are not using accurate and reliable methodologies when issuing ratings, have conflicts of interest which are not managed or who no longer have the capital resources to continue as an independent entity. � Create a central repository of default statistics at the SEC:

The Congress and the SEC have required NRSROs to publish their default statistics as one of the schedules required in Form NRSRO. The intent was to require the NRSROs to demonstrate the predictive value of their ratings for securities and to allow a comparative understanding between the rating symbology of NRSROs.

The SEC Final Rule requires NRSROs to publish this data on their website for access by investors. Although the intent of this requirement is very positive unfortunately the placement of these default statistics is difficult to access and the NRSROs are copyrighting the statistics so they cannot be reused without permission.

It would especially useful for Congress to require that this information be aggregated and published in a central location. This central location could be the SEC EDGAR system. EDGAR’s stated purpose is to increase the efficiency and fairness of the securities market for the benefit of investors, corporations, and the economy by accelerating the receipt, acceptance, dissemination, and analysis of time-sensitive corporate information filed with the agency.

� Designate oversight of the NRSRO relationship to issuer audit committees:

There is concern that NRSROs and issuers do not maintain an independent relationship that minimizes or eliminates conflicts of interest. It is vital that NRSROs evaluate issuers without the influence of ratings revenue or other consulting income. It is it critical that issuers do not shop for the highest ratings rather than the most accurate ratings.

The oversight of the NRSRO-issuer relationship should be assigned to the audit committees of the Boards of Directors of issuers or equivalent oversight entity. Additionally, the total amount of fees paid to NRSROs by the issuer should be disclosed in public filings.

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Summary:

US and global bond markets have been in deep distress and lawmakers have been examining issues in the subprime and structured finance areas.

Central in these examinations has been the role of credit rating agencies. This marks the third Congressional review of credit rating agencies in five years. The Credit Rating Agency Reform Act of 2006 had just been fully implemented when the credit markets seized up.

The credit rating agencies, statutorily recognized as "Nationally Recognized Statistical Rating Organizations" (NRSROs) are being questioned concerning the accuracy of their rating methodologies and their potential conflict of interests. Our regulatory framework embodies the expectation that NRSROs will consistently and accurately judge the relative creditworthiness of issuers and securities. Members of Congress are concerned that the regulatory framework may have flaws which inhibit the proper functioning of NRSROs.

Market participants rely on the information implied by ratings to measure the risk, price, and trade fixed income securities. Hundreds of federal and state laws rely on the analysis of NRSROs to determine the suitability of securities for various investors, fiduciaries and institutions. The stability of the financial system is predicated on NRSROs providing accurate analysis and rating methodologies. Stability also requires transparency and a free flow of information.

The 2007 credit crisis is due, in part, to a dramatic reassessment and rerating of subprime and structured products. Extraordinary rerating and repricing of securities such as CDOs, CDOs squared, ABCP vehicles, RMBS and other highly structured and levered products has been happening since July, 2007.

When NRSROs misjudge the creditworthiness of a security, or an entire class of securities, risk can be unknowingly concentrated and mispriced. Investors and institutions can be exposed to severe losses when NRSROs reassess methodologies and rerate securities. Recent events have raised the issue if NRSROs have failed in assessing risk in a similar manner to their performance in the Enron and WorldCom bankruptcies.

Financial institutions, public retirement funds, mutual funds, hedge funds, foreign entities and investors have suffered severe strains as securities have been reevaluated and repriced. The dislocation is of an unprecedented magnitude. The Federal Reserve and other central banks have taken exceptional measures to maintain ample liquidity in the banking system.

The SEC is conducting in depth examinations of the NRSROs under the new statutory authority conferred by the Credit Rating Agency Reform Act of 2006 (CRARA) to understand if conflicts of interest, poor methodologies, lax analysis or other factors impeded the ability of NRSROs to accurately rate large classes of securities. Congress continues its oversight role and reviews the statutory framework that NRSROs, issuers and investors work within.

This whitepaper was prepared for Members of Congress to recommend the adoption of "Equivalent Disclosure" and other measures to increase competition and transparency in credit markets.

Ratings are information. They represent the opinion of a credit rating agency about the relative creditworthiness of an issuer or security. Markets thrive when information is available and when transparency is linked with competition. For the stability of global financial markets we need more disclosure, transparency and competition in the ratings business.

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The 2007 Credit Crisis

Over the past 40 years, the global financial system has evolved from a slow paced world of fixed exchange rates, capital controls, bank-dominated financial flows and modest domestic and international capital markets into one in which capital flows freely across borders, investors and borrowers invest and borrow globally, and capital is allocated by the securities market rather than by banks.

Deregulation, disintermediation and financial innovation have created a financial system that is vastly more efficient than before, and which allows excess savings in one country or region to finance investment in a completely different location. Such free flow of capital has contributed significantly to the growth of the global economy.

Prior to the disintermediation of the markets, credit crunches occurred when a central bank brought the official rate above the time deposit interest rate ceiling to slow the economy. This action caused funds to flow out of the banking system, which in turn forced banks to restrict lending.

Modern credit crunches are caused by unexpected shocks that destroy market confidence e.g.:

� A geopolitical event – the Iraq conflict (1990-1)

� A sovereign default and the near-collapse of a big hedge fund (Russia and Long-Term Capital Management 1998)

� Major accounting frauds and associated defaults – the technology bubble (2001-2)

� The revaluation of a large asset class – U.S. sub-prime bubble (2007)

Last July the credit crisis of 2007 erupted when Moody’s and Standard & Poor's downgraded several billion dollars worth of mortgage-backed collateralized debt obligations (“CDOs”). The general view is that these downgrades were long overdue. Why were the rating agencies slow to downgrade?

This is a difficult question to answer without direct investigation into the practices of the major credit rating agencies. The SEC is currently undertaking this review within the authority granted to the Commission by the Credit Rating Agency Reform Act of 2006. The results of this review will be central to our outstanding of the events and practices which lead to the credit crisis of 2007.

The 2007 crisis has invited comment about the role, function and performance of credit rating agencies. These events have again proven that markets can change rapidly and dramatically. The opportunity to improve market practices, including credit analysis and credit-ratings processes, must be pursued vigorously and transparently if confidence in, and the healthy operation of, credit markets are to be restored.

Press descriptions of the 2007 Credit Crisis

A Sinking Sensation for Subprime Loans >> February 14, 2007 (Business Week) ---

..."But credit deterioration poses pitfalls for investors. Total delinquencies for RMBS transactions issued in 2006 averaged 12.61%, and loans considered seriously delinquent averaged 5.97%, according to research by Standard & Poor's Credit Markets. And there are reports that jitters are hitting the derivatives market as buyers and sellers of mortgage credit protection battle it out, says Action

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Economics.

Delinquencies and foreclosures may get worse. One out of five subprime mortgages issued in the past two years is projected to end in foreclosure, according to a study released in December by The Center for Responsible Lending, a Durham (N.C.)-based research group. The group also noted that even when home prices were rising, subprime home loans fared poorly, with as many as one in eight, or 13%, of these loans ending in foreclosure within five years of origination."...

Subprime Losses Drub Debt Securities >> July 11, 2007 (Bloomberg) ---

More than a few investors would like to know what took the New York-based rating companies so long to discover a U.S. liability of Iraq-sized proportions.

"I track this market every single day and performance has been a disaster now for months,'' said Steven Eisman, who helps manage $6.5 billion at Frontpoint Partners in New York, during a conference call hosted by S&P yesterday. ``I'd like to understand why you made this move now when you could have done this months ago.''

Eisman was referring to the rise in borrowing costs that has forced thousands of Americans to default on their mortgages. A total of 11 percent of the loan collateral for all subprime mortgage bonds had payments at least 90 days late, were in foreclosure or had the underlying property seized, according to a June 1 report by Friedman, Billings, Ramsey Group Inc., a securities firm in Arlington, Virginia. In May 2005, that amount was 5.4 percent.

Investors depend on guesswork by Wall Street traders for valuing their bonds because there is no centralized trading system or exchange for subprime mortgage securities. Credit rating companies supported high prices because they failed to downgrade the debt as delinquencies accelerated.

Rate Agencies Move Toward Downgrading >> July 11, 2007 (New York Times) --

..."The slumping housing market again rattled the bond market yesterday.

Standard & Poor’s, the credit rating firm, said that it would tighten the standards it used to rate bonds backed by subprime mortgages, a tacit acknowledgment that it might have been too optimistic about the housing market.

At the same time, Standard & Poor’s said that it would probably downgrade bonds totaling a relatively small $12 billion, a move that surprised investors with its tone and timing. A rival agency, Moody’s Investors Service, followed

suit later in the day, saying that it would downgrade 399 bonds with a face value of $5.2 billion and put another 32 bonds on watch.

Yesterday’s actions are expected to draw further attention to the role of credit agencies in the market for mortgage securities, which helped fuel the housing boom by extending credit to people who may not have otherwise qualified for loans.

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Investors and policy makers are increasingly asking whether Standard & Poor’s, Moody's and a third agency — Fitch Ratings — were lax in their evaluations of the mortgage bonds that Wall Street banks sold to investors like pension funds, insurance companies and endowments.

James Grant Says World Credit Market Has Yet to Reach Bottom >> Jul 16, 2007 (Bloomberg TV) --

James Grant, editor of Grant's Interest Rate Observer, talked with Bloomberg's Pimm Fox in New York on July 13 about the outlook for the credit market amid U.S. subprime mortgage troubles, credit ratings of residential mortgage-backed securities.

This is a video... running time = 19:27 minutes

00:00 "We are not at the bottom in credit." 01:28 Mortgage-backed securities' ratings, pricing 06:08 "Opacity" of subprime mortgage market 08:53 Credit market, impact on private equity

Ohio Attorney General Says Raters "Likely Aided and Abetted" Fraud

(Bloomberg TV) This is a video. Running time = 7:11 minutes

Ohio Attorney General, Marc Dann, discusses his agencies civil and criminal investigations of the credit rating agencies and their role in mortgage fraud committed on Ohio homeowners.

Florida's Pension Fund Holds Same `Suspect' Debt >> Dec 4, 2007 (Bloomberg)

"Florida's pension fund owns more than $1 billion of the same downgraded and defaulted debt that sparked a run on a state investment pool for local governments and forced officials to freeze withdrawals.

The State Board of Administration, manager of $37 billion in short-term assets, including the pool, also oversees the $138 billion Florida Retirement System. The board purchased $3.3 billion of debt whose top ratings were reduced following the collapse of the subprime mortgage market, according to documents obtained by Bloomberg News through an open records request.

Like the hundreds of school districts and towns unable to access $14 billion frozen in the Local Government Investment Pool, Florida's 1.1 million current and retired state workers rely on the board's management to boost returns on the funds that pay their pensions. That has left them vulnerable to the same potential for losses. A state-created home insurer and the treasury are also at risk.

"These were highly inappropriate investments for taxpayers' money,'' said Joseph Mason, a finance professor at Drexel University in Philadelphia. ”This is the tip of the iceberg for pension funds. We know the paper is sitting there. There are substantial subprime-related losses that haven't shown up yet.''

Florida Fun Run >> Nov 30, 2007 (The Financial Times) --

..."Not much unites the Arctic outpost of Narvik and the sunshine state of Florida. Except their troubled finances – courtesy of the US housing bust.

On Thursday, Florida temporarily froze redemptions from its state-run Local Government Investment

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Pool, a $17 billion money market-like facility for local districts, to prevent a run on deposits.

It followed news that Narvik and three other remote Norwegian towns had lost a bundle on investments in complex securities sold by Wall Street and undone by the credit turmoil."...

Mr. Josh Rosner of Graham Fisher discusses credit rating agencies >> Bloomberg TV

Mr. Rosner discusses the role of credit rating agencies on the credit markets.

This is a video. Running time = 10:59 minutes

See additional news accounts in the "Resources" section at the end of this whitepaper.

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What do credit rating agencies do?

Credit rating agencies are public or private companies who are compensated to evaluate securities issued by companies, financial institutions, governments and structured finance sponsors. Credit rating agencies are staffed by analysts who are trained to evaluate the quality of fixed income securities. The analysts assign "credit ratings" to the securities.

Ratings are opinions expressed by rating agencies about the relative creditworthiness of issuers and securities. Credit ratings help investors understand the risk of default (default = not receiving interest and principal payments for the security). The higher the credit rating the less chance of a security defaulting.

Credit rating agencies that go through the "recognition" process at the SEC are known as "Nationally Recognized Statistical Rating Organizations" (NRSROs). The SEC recognition allows their ratings to be used in many federal, state and local rules and laws.

The credit rating agencies derive their revenue in two ways. The dominant agencies charge the issuer of the bond for a rating. This is known as the "issuer pay" model of rating agencies.

The rating fees for issuers are listed below:

Asset type Moody's S&P

Corporates 4.25 bp 4.25 bp

Minimum corporate fee $

$ 50k $ 65k

Public finance minimum $

$ 1k $ 2k

Sovereigns $ 50-200k

Structured finance up to 12 bp

Bp = basis point or 1/100th of a percent

The other method of revenue for rating agencies is when users pay for the ratings and the accompanying commentary. This is the "user pay" model. The dominant agencies charge both issuers and users for their ratings.

>>>>>>>>>>>>>>>>>>

US Treasury securities (Treasuries) are the "gold standard" of fixed income securities. The probability of US Treasuries defaulting is considered to be zero. This chart shows the rating scales of the current dominant NRSROs. All the ratings in the green section are "investment grade". The yellow and red sections denote speculative or "junk" grade securities.

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Definition Moodys S & P Fitch

Investment Grade

10.0 US Treasuries *** *** ***

9.5 Prime, maximum safety Aaa AAA AAA

9.0 Very high grade/quality Aa1 AA+ AA+

8.5 " Aa2 AA AA

8.0 " Aa3 AA- AA-

7.5 Upper medium quality A1 A+ A+

7.0 " A2 A A

6.5 " A3 A- A-

6.0 Lower medium grade Baa1 BBB+ BBB+

5.5 " Baa2 BBB BBB

5.0 " Baa3 BBB- BBB-

Color code

Number Definition Moodys S & P Fitch

Speculative grade

4.5 Speculative Ba1 BB+ BB+

4.0 " Ba2 BB BB

3.5 " Ba3 BB- BB-

3.0 Highly speculative B1 B+ B+

2.5 " B2 B B

2.0 " B3 B- B-

1.5 Substantial risk Caa1 CCC+ CCC+

1.0 In poor standing Caa2 CCC CCC

0.5 " Caa3 CCC- CCC-

0.0 Extremely speculative Ca CC CC

0.0 Maybe in or extremely close to default C C+,C,C- C+,C,C-

0.0 Default D D

Multiple-Markets Patent pending

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Credit rating agencies use different types of methodologies to evaluate securities. Generally these methodologies are classified as "qualitative" and "quantitative" methods. The Credit Rating Agency Reform Act allows rating agencies to use either "qualitative" or "quantitative” methods or a combination of both.

Qualitative methodologies involve the rating agency analyst reviewing the financials and capital structure of the issuer, talking to the management, and reviewing the industry, interest rate and economic conditions.

Quantitative methodologies used by rating agencies vary but generally rely on a model through which the issuer’s variables are computed.

Most agencies use a combination of qualitative and quantitative methodologies. One of the provisions of the Credit Rating Agency Reform Act of 2006 is a requirement that the NRSRO detail the procedures and methodologies that are used in the determination of credit ratings.

Number of ratings outstanding by NRSRO by asset type as reported to the SEC in 2007:

NRSRO Financial

institutions & BDs

Insurance companies

Corporate issuers

Asset backed

securities

Issuers of government securities

NRSRO paid by issuer or

obligor

AM Best Company Inc.

1 6,068 2,439 53 --- Yes

DBRS, Inc. 870 30 720 610 40 Yes

Egan-Jones 60 46 800 --- --- No

Fitch, Inc. 65,621 4,024 13,791 70,731 765,699 Yes

Japan Credit Rating Agency, Ltd.

154 32 551 64 73 Yes

Moody's Investor Services, Inc.

78,000 6,000 29,000 108,000 154,000 Yes

Rating and Investment Information, Inc.

100 35 609 235 88 Yes

Standard & Poor's Rating Services

42,800 6,800 28,300 187,600 976,000 Yes

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Quis custodiet ipsos custodes?

"Quis custodiet ipsos custodes?" A Latin phrase from the Roman poet Juvenal, variously translated as:

"Who will guard the guards?"

"Who watches the watchmen?"

"Who shall watch the watchers themselves?"

Rating agencies are the "gatekeepers" or "watchmen" of the financial system. They play a critical role in evaluating the securities sold by companies, governments, financial institutions and structured finance entities. Their assignment of a "rating" to a security is a "signal" to market participants of the risk of owning a fixed income instrument.

This "gatekeeper" role is statutorily granted through recognition as a "Nationally Recognized Statistical Rating Organization" (NRSRO).

(The following is taken from the testimony of Professor John Coffee to the Senate Banking Committee)

When a debacle occurs in the financial markets—whether it be the crisis triggered by the failure of Enron and WorldCom in 2002, the contemporary mortgage meltdown, or earlier problems in the junk bond market—one can usually identify a “gatekeeper” in whom investors have lost confidence.

By the term “gatekeeper,” I mean those professionals on whom investors necessarily depend to provide certification and verification services: auditors, securities analysts, credit rating agencies, investment banking firms and sometimes corporate attorneys.

These professionals develop “reputational capital” over many years and many clients that leads investors to rely on them, in part because investors know that the gatekeeper will suffer a serious reputational injury if it is associated with a fraud or unexpected insolvency. Because this injury should be greater than any amount the issuer can pay the gatekeeper to acquiesce in fraud, it should deter the gatekeeper from involvement in fraud.

From this perspective, “reputational capital” is in effect “pledged” by the gatekeeper in support of the issuer’s statements. But when the market learns that the gatekeeper failed to uncover fraud or related problems (or that it blinked at them), the resulting loss of confidence, both in the gatekeeper and the market’s mechanisms generally, can produce a sharp decline in stock market values, a liquidity crisis as buyers flee the market, or even, in an extreme case, a panic. Recent market developments suggest that there has been such an erosion in investor trust and confidence.

Thus, when accounting irregularities and financial statement restatements soared in the period between 1998 and 2002, and eventually culminated in the Enron and WorldCom insolvencies, investors lost confidence in audited financial statements, and stock market prices collapsed. As a result, Congress enacted the Sarbanes-Oxley Act to eliminate conflicts of interest and restore confidence in the auditing profession. Controversial as that statute may have been, it basically worked.

Today, attention has shifted to the performance of a different gatekeeper: the credit-rating agency. Functionally, it plays much the same role for debt purchasers that auditors and securities analysts perform for equity investors.

Structured finance particularly relies on the credit-rating agency because investors have no ability to evaluate on their own the securitized pools of financial assets that structured finance creates.

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That is, while a sophisticated debt purchaser might be able to evaluate the creditworthiness of the bonds of a major corporation by examining the corporation’s financial statements, the debt purchaser has no corresponding ability to assess the risk level of a mortgage pool backing an issue of collateralized debt obligations (“CDOs”) and so must rely on a “gatekeeper”—here, the credit rating agency.

The major change that destabilized rating agencies appears to have been the rise of structured finance. Not only are the process and criteria for rating a securitized pool of financial assets opaque, but major investment banks that assemble these pools bring them to the rating agency for advance negotiation over the rating before they are marketed.

The process can become one of extended negotiation, because if an investment grade rating is initially denied, the investment bank can seek to supplement and/or improve the quality of the asset pool.

This is a qualitatively different process than the evaluation of the financial statements of a corporate issuer, whose financial statements cannot be changed or improved in response to criticism in the short run.

As a consequence, the rating agency is no longer facing an atomized market of clients who each come to it only intermittently (and thus lack market power), but instead large repeat clients who have the ability to take their business elsewhere.

Today, structured finance accounts for a major share of some rating agencies’ total revenues; equally important, these amounts are paid by a small number of investment banks that know how to exploit their leverage—and get the rating just over the line and into the promised land of investment grade.

Moody's Investors Service ratings revenue by asset type (data from Moody's 3Q '07 10Q pg. 17)

9 months ended

9 months ended

In millions $ 9/30/7 9/30/6

Ratings revenue

Structured finance $ 611 $ 505

Corporate finance 285 238

Fin inst/Sovereigns 196 189

Public finance 61 71

Total ratings revenue $ 1,154 $ 1,004

Research revenue 189 158

Total Moody's $ 1,344 $ 1,162

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Credit rating agency market practice issues...

How securities are issued and rated:

The current credit crisis has illuminated certain market practices that are impeding the operation of the securities markets.

Two of these issues relate to practices of issuers of fixed income securities:

� Issuer selective disclosure of material non-public information

� "Rating shopping"

Three issues relate to practices of the dominant credit rating agencies:

Issuer

Investment bank - underwriter

NRSRO

NRSRO

Investor

Investor

Investor

Investor

Investor

The process of rating a security begins when an issuer (company, government, structured finance sponsor) begins to work with rating agencies (NRSROs) and a lead underwriter to structure a fixed income offering. Currently issuers can meet with various NRSROs, receive a preliminary rating and then choose which NRSROs to compensate. This is called “rating shopping” and is used to find the NRSROs that will award the highest rating to the offering. By using the highest ratings the cost of borrowing is lower. Generally, NRSROs that are not compensated by the issuer do not receive access to the issuer and material non-public information of the issuer. This limits the non-compensated NRSROs from having equivalent information upon which to conduct its analysis. It creates information asymmetry for users because some ratings incorporate management’s input and material non-public information and some ratings do not.

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� "Issuer pay" business model

� NRSROs participating in structuring securities

� Differential default rates between asset classes

The legislative and regulatory frameworks for the credit markets assume that NRSROs are providing accurate and unconflicted ratings. NRSROs have stated in the credit crisis of 2007 that their methodologies did not incorporate adequate information and their modeling was not especially predictive for certain asset classes especially mortgage back securities (MBS) and structured finance products that bundled MBS securities. The credit crisis of 2007 demonstrated that market participants were not always receiving accurate and unconflicted credit analysis. Investors lost confidence in the ratings assigned by NRSROs and the value of securities and were unwilling to trade them. In essence the credit markets “froze”. Many of these market practices lead to reduced transparency and inhibited competition between credit rating agencies to provide the best methodologies and analysis. These practices caused market participants to be unable to measure and price risk.

� Issuer selective disclosure of material non-public information Issuer selective disclosure occurs when an issuer shares with select NRSROs the documents underlying a transaction and/or access to the material non-public information of the issuer. This provides chosen NRSROs with broader information to judge the creditworthiness of securities. Other NRSROs, not favored by the issuer, must rely on publicly available information to develop a rating for the security or are unable to rate the security because they don’t have the underlying information. The issuer has full control of the adequacy of disclosure to the NRSROs. Issuers do not face any legislative or regulatory requirement to disclose information equally with NRSROs. The right of issuers to selectively disclose material non-public information comes from an exemption granted to communications between issuers and NRSROs in Regulation Fair Disclosure.

This selective disclosure restricts many NRSROs from evaluating the creditworthiness of an issuer and issuing ratings. And selective disclosure undermines the intent of the CRARA to increase competition and transparency in rated fixed income securities. Many NRSROs simply do not have access to the information needed to evaluate a security or issuer. This limitation constrains the market from making informed decisions about the creditworthiness of securities because only a small number of ratings might be available on a security or issuer. The following is a comparison between the number of equity analysts and NRSROs covering several very large corporations who have large amounts of debt outstanding. (Note that NRSROs who are not compensated to rate this issuers may generally rely on the public filings of the issuer available on EDGAR and other financial documents published by the issuer.)

Issuer Equity market cap ($B)

# of equity analysts

Debt outstanding

($B)

# of NRSRO rating the

issuer NRSROs rating

the issuer

Citigroup 170 20 558 5 D, F, M, R, S

Ford 17 14 137 5 D, F, M, R, S

General Electric 398 13 491 3 F, M, S

For NRSROs: D = DBRS, F = Fitch, M = Moody’s, R = Rating & Investment Information, S = S&P

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Issuer selective disclosure is intimately connected with issuer “rating shopping”. This is the process of issuer sharing material non-public information and the underlying documents with NRSROs who they believe will give them the highest ratings. There is no evidence that all issuers are selectively disclosing information to NRSROs that award them the highest ratings. But there is plenty of evidence in the public record that points to some issuers “rating shopping”. The credit crisis of 2007 suggests that issuers were not choosing and compensating the NRSROs with the most rigorous or predicative methodologies. Issuers were choosing and compensating NRSROs who awarded the highest ratings to their securities. We have a three tier system of NRSROs.

Compensated by

the issuer Access to material

non-public information

First tier NRSRO Yes Yes

Second tier NRSRO Maybe Maybe

Third tier NRSRO No No

� The first tier of NRSROs is paid by the issuer to rate its securities and as part of that compensated relationship is given access to material non-public information. Typically the issuer compensates only two NRSROs. Moody’s and Standard & Poor’s are the NRSROs most often compensated by issuers. Fitch is a minor third player in this tier as is AM Best in the “insurance company” asset class. These NRSROs also sell subscriptions to their ratings.

� The second tier of NRSROs can be paid by the issuer to rate their securities but are not often

chosen by an issuer and are not given access to material non-public information. The following NRSROs are in this category DBRS, Japan Credit Rating Agency, and Rating and Investment Information. These NRSROs occasionally receive fees from issuers to rate securities and they sell subscriptions to users of ratings.

� The third tier of NRSRO is paid by subscribers and/or other market participants and do not

accept compensation from issuers of securities. Generally these NRSROs must rely on publicly available information to conduct their credit analysis. These NRSROs generally have no access to the material non-public information of the issuer. Egan-Jones appears to be the only NRSRO that has stated in their Form NRSRO that they do not receive fees from issuers.

The existence of three tiers of NRSROs, with substantively different access to the information of issuers, has limited the transparency of the credit market. It has also limited competition between the NRSROs in their race to conduct the most accurate and timely credit analysis. Some NRSROs are provided broader access to the material non-public information as part of a compensated relationship with issuers. As we have seen recently this has significant consequences for the financial markets. Professor John Coffee of Columbia Law School stated in his testimony of September 26, 2007 to the Senate Banking Committee the following, “Although I doubt that subscription-funded agencies will displace the traditional rating agencies, subscription-funded rating agencies are less conflicted, and they could play an important watchdog role. But such new entrants face barriers, as issuers may not wish to deal with them or disclose sensitive information. Indeed, the issuer may withhold access to non-public information for precisely the same reason that public companies use to withhold data from securities analysts who were skeptical of them: to punish them. Thus, some have sensibly proposed that an equivalent of Regulation Fair Disclosure (“Reg FD”) should be adopted to require “equivalent disclosure” to all NRSROs of any information that is given by an issuer to any NRSRO. “

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� "Rating shopping"

Rating shopping happens when an issuer reviews the preliminary ratings of NRSROs to determine which rating agencies will assign the highest rating to its securities. The issuer then chooses the NRSROs with the highest rating to work with and compensate. This is another dimension of “selective disclosure” discussed in the previous section. Brian Clarkson, President of Moody's Investors Service and Chief Operating Officer, described “rating shopping” as the following in a letter to the SEC: … “In the asset-backed market, rating shopping describes instances where a sponsor refuses to engage in discussions with and provide information to a rating agency that may give a less favorable perspective on the issuance’s creditworthiness and instead the sponsor “takes its business” to other agencies that provide higher ratings. Therefore, and to put it bluntly, in the ABS market:

The issuer could take its business elsewhere unless the rating agency provides a higher rating.

As the Commission is likely aware, over the past several years, investors and the market as a whole have responded to some extent to the problem of rating shopping. While securities have grown increasingly more complicated, and investors have become increasingly more sophisticated and demanding, most sponsors presently obtain two ratings and publish in the prospectus the lower of the two ratings attained. This development has helped curtail the sponsor’s ability to shop for the single highest investment grade rating available and thereby satisfying its regulatory requirement.” The Wall Street Journal describes how Moody’s loses business when it tightens its requirements for commercial mortgage back securities. (Moody's Says It Is Loses Business As Issuers 'Rate Shop', July 18, 2007) …”Moody's Investors Service says it is paying a high price for its tough stance on lax lending standards for commercial mortgage-backed securities.

In a new report that assesses the status of the market, the Moody's Corp. unit said it was passed over and not hired for 75% of the commercial mortgage-backed securities rating assignments issued in the past few months as a result of its requirement that issuers add an extra layer of credit enhancement. Moody's said issuers are "rating shopping" -- meaning they were hiring competitors that would hand out higher ratings on securities. Because Moody's makes money rating the creditworthiness of bond issuances, blacklisting could potentially eat away at the firm's bottom line if the trend continues.

On a recent CMBS offering issued by Morgan Stanley, which included 225 fixed-rate loans on 268 multifamily, commercial, and manufactured housing community properties, S&P and Fitch issued the ratings. Morgan Stanley didn't return calls seeking comment on why it selected these two rating outlets. Moody's says it cannot comment on the details of a specific deal or issuer, but suspects its higher subordination levels are the reason it isn't in on most of the deals.

Analysts say the rejection of Moody's by some issuers -- typically investment banks -- is a direct result of its April announcement. Since the lower-rated bonds needed to increase subordination levels are more expensive, Moody's move could trim profit margins for CMBS issuers.”

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Professor John Coffee discussed the following implications of “rating shopping” in his testimony to the Senate Banking Committee (page7),

“An important dimension of “rating shopping” is the ease with which issuers can move their ratings business from NRSRO to NRSRO. They are not required to report publicly which NRSRO they are compensating for ratings or whether they have requested that an NRSRO withdraw ratings. In contrast, firing an auditor is difficult because SEC rules require full disclosure of the circumstances surrounding the termination and permit the auditor to comment.

Also, when the auditor is fired, there is great uncertainty about what the incoming auditor will do; perhaps, it will be even tougher, and certainly, it has leverage over the client. Precisely because issuers usually hire multiple rating agencies, they can drop one with less visibility or adverse consequences. In any event, the evidence clearly shows that there is a market penalty for downgrading one’s ratings.

Moody’s has reported that since it downgraded a series of structured finance offerings in July, 2007, its market share in the relevant market for mortgage-backed securitizations has dropped from 75% to 25%. In short, business in the market for ratings is mobile, retaliation is relatively costless, and hence the gatekeeper can become compromised, particularly with regard to structured finance products.”

� "Issuer pay" model

When Congress passed the Credit Rating Agency Reform Act of 2006 (CRARA) there was much debate about the conflicts of interest inherent in the “issuer pay” model. “Issuer pay” is where the issuer or sponsor of securities pays the NRSROs to rate their securities. This is the current predominant method of compensation for NRSROs. Seven of the eight NRSROs now recognized state that they receive fees from issuers for rating securities. If NRSROs receive compensation from issuers then CRARA requires the NRSRO to disclose this conflict of interest and state how it is managed. CRARA also directs NRSROs to report to the SEC, in a

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confidential manner, revenue from their twenty largest clients. This provides the SEC with a roadmap to the sources of revenue for the NRSRO. If an NRSRO receives a significant portion of their revenues from a concentrated group of issuers or sponsors then the Commission can look more closely at the interaction between those parties and the NRSRO. And examine how well the NRSRO is managing the conflicts of interest. The credit ratings industry is an oligopoly dominated by two NRSROs (Moody’s and Standard & Poor’s) with Fitch having a significant but much smaller market share. The CRARA does not mandate a business model for NRSROs. NRSROs are free to develop any method of compensation and ratings distribution that leverages the capability and resources of their firm. Rather the CRARA mandates two requirements about how NRSROs distribute their ratings into the financial markets. One requirement is to provide ratings to market participants for “free or a reasonable fee” and the other is to make their ratings “readily available”. “Free or a reasonable fee” The CRARA directs the SEC to require NRSROs to distribute rating symbols for “free or a reasonable fee”. The SEC has not stated a definitive view on the concept of “reasonable fee” although comments were sought on this issue in the Proposed Final Rule. We believe that “reasonable fee” should vary by fixed income classification. For example due to the complexity of structured finance, and their exclusive use by institutional investors, a “reasonable fee” for those ratings could be considerably more expensive than ratings for corporate issuers or municipal issuers. If new NRSROs want to charge more than the current NRSROs, ratings subscribers would be in the best position to determine if the bundle of services offered (number and quality of ratings, distribution method, and syndication opportunities, etc.) provides better value. We do not encourage the SEC or Congress to adopt an approach that could be viewed as “rate setting” for access to ratings published by the NRSROs. We believe that the fee issue is best addressed by creating a regulatory environment where the highest quality and most competitive NRSROs are able to create the best analytic methods and tools. Further, we encourage the Congress and Commission to be flexible and allow NRSROs to distribute their ratings in unique, low cost ways that best fits their business model and the varied sectors of the investment community. If Congress or the Commission attempts to proscribe a set of specific distribution methods and pricing models for firms applying for NRSRO status it is likely that firms would adopt business models and analytic methods that already exist and do not leverage new streams of information and distribution. NRSROs should be able to develop various approaches to their fee models. For example, NRSROs could provide ratings to large financial portals for distribution into the market and share advertising revenue with the portal. Alternatively NRSROs could distribute ratings for a fixed fee, fee per rating, a fee based on the number of trades within a platform, or by sharing market data revenues with a vendor. Ratings are information and their use and packaging should evolve as information processes and platforms develop. We believe that NRSROs that want to create increased market share will compete against other NRSROs by increasing the predictive quality and accuracy of their analysis and reducing the cost to users of this information. For some NRSROs the free distribution of their ratings is of value to demonstrate to issuers that the fees they are paying are being used to broadly inform the market of the creditworthiness of the issuer’s securities. Other NRSROs believe that restricted distribution of their ratings is beneficial for their business model. We believe that NRSROs will have various views on the value of distributing ratings into the financial markets.

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“Readily available” The second requirement for NRSROs is to make their ratings “readily available” to market participants. The following information is drawn from the Form NRSROs.

NRSRO Method of making ratings “readily available”

AM Best Best's credit ratings can be accessed free of charge on Best's web site at www3.ambest.com/ratings/default.asp

DRBS With the exception of private ratings and ratings for certain private placement transactions, DBRS distributes its ratings publicly at no cost through its website, www.dbrs.com. Ratings are also publicly distributed through Bloomberg, Reuters, First Call, ABSNet and other electronic and print service providers.

Egan-Jones A reasonable fee will be charged; that is rates approximating S&P’s and Moody’s or similar services.

Fitch Fitch publishes all public ratings and related rating actions and opinions free of charge on a non-selective basis on its website, www.fitchratings.com

Japan Credit Rating Agency

Internet web site (for free), JCR-RatingEye (web for JPY300,000/User ID/Year), J-CRIS (database service communicated to customers electronically for JPY960,000/user/Year plus initial cost JPY2,500,000) Monthly report (publication for JPY1,800/copy), E-mail service (for free) and facsimile service (for JPY100,000/Year)

Moody’s All public credit ratings are available free of charge on our website, www.moodys.com

Rating and Investment Information

The credit ratings in the classes indicated in Item 7A are readily accessible for free on R&I’s website at http://www.r-i.co.jp/eng/

Standard & Poor’s

Public ratings and rating actions are made available at no charge on the S&P website, www.standardandpoors.com, and through various subscription based products, such as RatingsDirect.

NRSROs often met the requirement for “readily accessible” by publishing rating assignments or changes on their websites. The public notification is done simultaneously with the notification to their subscribers. The rating symbol they assign to a security remains available for free on their website. But for vendors or other users to redistribute ratings most of the dominant NRSROs charge a redistribution fee. These two requirements embodied in the CRARA work well for NRSROs that are compensated by issuers to rate their securities. The compensation from the issuer allows NRSROs to hire staff and management and to pay for infrastructure and ratings distribution. The two CRARA requirements (“free or a reasonable fee” and “readily available”) can pose problems for NRSROs who are funded by subscribers or users of their ratings. The challenge for “user pay” NRSROs

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is to provide ratings to their subscriber for a fee and also comply with the two requirements of the CRARA, “for free or a reasonable fee” and “readily available”. The primary thrust of these requirements is to insure that market participants (particularly retail investors) not be disadvantaged. Because rating changes affect the value of securities there is importance in the entire market having access to rating actions taken by NRSROs. The process of making ratings “readily available” is similar to the way that equity ratings are managed. Equity ratings are published by the broker-dealer simultaneously to the public, their brokerage force and their clients. The equity “rating symbol” becomes available in the public for free use and redistribution. The underlying rational developed by the equity analyst is shared only with clients of the firm and others that compensate the broker-dealer for the research. CRARA recognizes that credit ratings are critical to the functioning of the credit markets and attempts to insure that some market participants are not disadvantaged.

� NRSROs participating in structuring securities

There has been much discussion and media attention paid to the issue of NRSROs participating with sponsors of securities in structuring products. We believe that the examination and review of NRSROs by the SEC will shed appropriate light on this issue.

Additionally at the end of 2007 the Committee of European Securities Regulators (CESR) asked credit rating agencies active in the European markets to respond to a set of questions about structured finance. CESR has published the responses on the credit rating agencies.

On this topic CESR asked the following questions (Question number 34):

“Is the analyst assigned to a certain Structured Finance rating deal allowed to give advice to the participants (before the rating is issued) about how to structure the deal in order to raise the rating? Is the analyst allowed to give feedback to the participants of a deal if the initial rating does not meet expectations? Are there limits to which elements of the deal can be addressed and to what extent (i.e. does the analyst provide suggested changes to the structure)? Is this covered in any internal policies? Is this interaction monitored by the agency?” Response by Fitch (page 62): “Analysts do not structure transactions or provide structuring advice. In the course of providing feedback to an issuer, analysts will not propose alternative assets, legal structures or target rating levels. More specifically, as part of feedback to an arranger’s proposed capital structure, analysts may identify credit enhancement levels within a given pool, consistent with one or more tranche rating levels, from which an arranger can deduce how much the size of each tranche may be varied from the original proposal to become consistent with Fitch’s criteria for a given rating. These levels are the result of a committee discussion, and represent the application of Fitch’s published and publicly-available criteria. The decision to alter (or not) enhancement levels, or any other structural, legal or economic element of the transaction, remains that of the arranger, based on the arranger’s or originator’s view of the economic merits or advisability of the capital structure in which they wish investors to participate. As part of its communication training for analysts, Fitch operates dedicated training sessions for structured finance analysts, addressing the dialogue that is held with arrangers, investors and other parties.” Response by Moody’s (page 215): MIS (Moody’s Investor Services) does not structure, advise on, create or design securitisation products. We are not competent to, and we do not, recommend one proposed structure over another. Structures are designed by arrangers and investment bankers to fit the needs of particular investors. We are not

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privy to many of the discussions that contemplate features of a securitisation (especially non-credit related features) and we do not know who the ultimate investors in the transaction will be. However, in rating any structured security (or any corporate or governmental security), we may hold numerous, in-depth analytical discussions with issuers and/or their advisors. These discussions do not transform credit rating agencies into investment bankers, consultants or advisors. Instead, they serve the dual purpose of: (1) helping us better understand the particular facts of the transaction as proposed by the issuer; and (2) clarifying to the issuer the rating implications of our methodologies for that transaction. In circumstances where there is considerable performance history for the particular asset and where the structure has been used previously, our published methodologies may provide sufficient transparency about our analytical approach to significantly reduce the need for detailed “back-and-forth” discussions. In contrast, we have more extensive conversations with issuers who are securitising new asset classes or using novel structures. In these situations, issuers present circumstances that are different from those we have discussed in our published methodologies (revealing limitations of a “one-size-fits-all” approach). Therefore, we need to engage in a dialogue to assess the attributes of the proposed transaction against existing, published methodologies. Importantly, MIS does not receive incremental or additional payments for holding such discussions. We believe, however, that these discussions help enhance overall market transparency and stability, in that both issuers and investors have a better understanding of our analytical approach and the ratings that result. The interactions of MIS (and its credit professionals) and other entities participating in structured finance transactions are addressed in Section 2 of Part III of the MIS Code, the MCO Code of Business Conduct and implementing internal policies of general application. Regardless of the fact that MIS does not structure, create or design securitisation products, we are aware that a perception persists that rating agencies are involved in these activities. We are considering various means to address more effectively this misperception. Response from Standard & Poor’s (page 236) Ratings Services’ analysts do not advise issuers as to how to structure transactions. In practice, analysts do talk to issuers as part of the ratings process, just as analysts have traditionally had discussions with corporate issuers with respect to the rationale behind the rating their securities. This dialogue provides benefits to the market. Critical to our ability to rate transactions is a robust understanding of those transactions. Reading documents and reviewing the results of modeling are important, but so is communication with those responsible for the transaction itself. Through dialogue with issuers and their representatives our analysts gain greater insight into transactions to be rated, including any modifications to those transactions that may occur as the process goes forward. This dialogue promotes transparency as to our ratings process which regulators have consistently encouraged. This dialogue does not amount to “structuring” by Ratings Services, even in cases where the discussion is about the effect different structures may have on ratings. Ratings Services does not tell issuers what they should or should not do. Our role is reactive. Using our models and publicly available methodologies, issuers provide us with information and we respond with our considered view of the ratings implications. In the process, and as part of our commitment to transparency, we also may discuss the reasoning behind our analysis. Some issuers structure transactions so as to achieve a specific rating result as a variety of potential structures could merit a particular result. Our role is to come to a view as to the structures presented, but not to choose among them. Again, we do not compromise our criteria to meet a particular issuer’s goals. As Ratings Services makes methodologies publicly available, the market can assess in a straightforward manner whether the methodology was applied, thereby reinforcing Ratings Services’ interest in consistent application of the methodologies and their credibility.

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� Differential default rates between asset classes

CRARA requires that NRSROs publish on an annual basis the quantitative evidence of the predictive value of their rating symbols. This quantitative evidence is the default rates for various rating symbols. This default data is of enormous value to users to compare and contrast ratings issued by various NRSROs for specific securities.

Of equal value to users is the ability to compare the default rate between asset classes for example corporate securities, municipal securities and asset backed securities. There are significant differences in the default rates between corporate and structured finance securities even within one NRSRO.

Professor Coffee cites an example in this Senate testimony about the differential default rates on various classes of securities. He uses these default statistics to make a point about the conflicts of interest that may exist for NRSROs. The important point is that the default statistics of NRSROs create a chain of evidence about their performance and allow market participants and regulators to examine the NRSROs predicative accuracy. From Professor Coffee’s testimony:

“Looking at the default rate on Moody’s lowest investment grade rating (Baa), two financial economists recently reported that the five year cumulative default rate on corporate bonds receiving a Baa rating from Moody’s between 1983 and 2005 was only 2.2%, but the same five year cumulative default rate for CDOs receiving the same Baa rating from Moody’s between 1993 and 2005 was 24%—more than ten times higher.

Moody’s informs me that they consider the default or impairment rate for 2005 to be aberrational for several reasons, and they have advised me that the comparable five-year cumulative default rates ending in 2006 (as opposed to 2005) were 2.1% for corporate bonds and 17% for CDOs.

But even on their preferred comparative basis, the ratio is still over 8 to 1 (as opposed to over 10 to 1).

Even as so modified, the most plausible interpretation of this disparity is that ratings were inflated on CDOs (at least more so than on the corporate bonds), probably because only the issuers of the former had sufficient leverage with the rating agency. This hypothesis is not presented as established fact or as a permanent tendency, but it is exactly the type of issue that the SEC should focus on in its investigation.”

The folllowing is an important story by Bloomberg which talks about the differential default rates between corporate and municipal securities. “Moody's Municipal Ratings Obscure Bond Safety, Citigroup Says”

Nov. 19 (Bloomberg) -- Moody's Investors Service ranks municipal bonds with a system that may obscure the fiscal strength of cities and states, according to Citigroup Inc. Municipal bond prices have fallen relative to Treasuries on concern the insurers of half of all municipal bonds, including FGIC Corp., Ambac Financial Group Inc., and MBIA Inc., may lose their AAA credit ratings because they've backed bonds linked to subprime mortgages. The price declines may not be justified because municipal bonds are strong credits even without insurance, according to George Friedlander, Citigroup's municipal bond strategist. The problem is the rating system, he said. “During periods like the present, the use of parallel scales with different default risk characteristics can be extremely problematic, because it can obscure the actual strength of muni credits,'' Friedlander wrote. Moody's released a report last spring that allowed investors to see how the default risk of municipal bonds compares to the risk on corporate and other types of bonds. Using a `map' to adjust municipal ratings, Moody's showed how school districts, water authorities, hospitals, cities and states moved up as many as nine levels in ranking when compared with other types of debt in terms of likelihood of default. Unlike the municipal scale, which ranks cities and states relative to each other, the global scale takes

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into account the virtually nonexistent rate of default by municipalities which turn to higher levels of government or taxpayers if they are unable to pay their debts.

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Equivalent Disclosure and proposed legislative solutions

We propose the adoption of "Equivalent Disclosure" rules for issuer communications with NRSROs. Equivalent disclosure would require an issuer, or person acting on its behalf, to disclose material nonpublic information to all NRSROs if it discloses that information to one NRSRO. Equivalent disclosure would remove the issues associated with issuer selective disclosure primarily “rating shopping”. The institution of equivalent disclosure would strengthen financial markets by ensuring that all NRSROs have adequate and equivalent information from issuers upon which to base their credit analysis. We are not proposing that issuers be required to share material non-public information with all market participants as is embodied in Regulation Fair Disclosure. We are proposing a more narrow application to the credit markets.

Issuer disclosure would be required to all NRSROs that rate securities in the specific asset category (as outlined in the Credit Rating Agency Reform Act of 2006 and the SEC Final Rule) for which the issuer has securities outstanding. This broadened disclosure will increase the volume of information available to NRSROs and help unbind a market that has relied on the opinions of creditworthiness from a very small group of credit rating agencies. This proposal does not alter the ability of NRSROs to have any form of business model that they choose. Issuers can continue to pay NRSROs to rate their securities. Issuers may likely continue this practice because of the bundle of services offered by the NRSROs to market participants. Fitch, Moody's and Standard & Poor's have satisfactory track records in predicting defaults but current events in the credit markets suggest that a broader array of opinions from more NRSROs would be useful for the integrity of the markets. We are currently expecting too much from a small handful of firms to provide timely, aggressive, and consistent credit analysis for the entire universe of fixed income securities. The Credit Rating Agency Reform Act of 2006 creates a new framework for rating agencies to become NRSROs but the important problem of information asymmetry from issuers to the NRSROs persists. The adoption of equivalent disclosure will go a long way to improve the current shortcomings in the credit markets. It would beneficial for investors to have a wide variety of NRSROs providing credit analysis. We believe a wealth of credit rating firms will only come about when there is a wealth of information from issuers.

SEC Chairman William Donaldson made the following remarks to the Subcommittee on Capital Markets, Insurance, and GSEs, House Committee on Financial Services, May 21, 2001 in reference to the adoption of Regulation Fair Disclosure for the equity markets. "Selective disclosure raises several concerns. The primary issue is the basic unfairness of providing a select few with a significant informational advantage over the rest of the market. This unfairness damages investor confidence in the integrity of our capital markets. To the extent some investors decide not to participate in our markets as a result, the markets lose a measure of liquidity and efficiency, and the costs of raising equity capital are increased. Further, if selective disclosure is permitted, corporate management can treat material information as a commodity to be used to gain or maintain favor with particular analysts or investors. This practice could undermine analyst objectivity, in that analysts will feel pressured to report favorably about a company or slant their analysis to maintain access to selectively disclosed information.

Thus, selective disclosure may tend to reduce serious, independent analysis."

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Professor John Coffee, of Columbia Law School, made the following comments to the Senate Banking Committee in his testimony of Sept, 26, 2007 concerning the proposal for "Equivalent Disclosure":

“Indeed, the issuer may withhold access to non-public information for precisely the same reason that public companies use to withhold data from securities analysts who were skeptical of them: to punish them. Thus, some have sensibly proposed that an equivalent of Regulation Fair Disclosure (“Reg FD”) should be adopted to require “equivalent disclosure” to all NRSROs of any information that is given by an issuer to any NRSRO."

� How would Regulation Equivalent Disclosure work?

When the adoption of Regulation Fair Disclosure was being debated representatives of issuers claimed that it would cause equity issuers to share less information with the markets. In fact, the implementation of Regulation Fair Disclosure was a significant step forward for equity markets. Information is more transparent and available to market participants at all levels from the largest institutions to the smallest retail investors. Reg FD restored an enormous amount of confidence to the equity markets.

It was also unclear how equity issuers would discharge their responsibility to disclose information fairly. Although this required the adoption of new market practices solutions were developed and implemented.

For the fixed income markets the following might be adopted as a method of managing “equivalent disclosure”.

In the case of a new issue (especially a leveraged loan or a speculative grade bond but also to a lesser extent for a investment grade name), the NRSRO would be given the draft offering materials for the basic obligor and covenant structure. Questions would be directed to the issuer—not the underwriter. The NRSROs would want to see the use of proceeds, pro forma capitalization tables, etc. An issuer could do this on a conference call or a meeting with the NRSROs recognized in the asset class of the security. For structured products, the issue would be more complicated and might heavily involve the underwriter since there is no real "issuer" in terms of what you have with corporate and sovereign borrowers.

One area that would require additional review and discussion is the private placement market and loan market. There are no public documents available to NRSROs and they would need to receive disclosure from the issuer. A possible analogy would be that the issuer might deal with NRSROs in the way that they deal with bank lenders in terms of an organizational meeting and updates. The disclosure process with more exotic issuers or asset classes would also require more review and discussion.

� Handling material non-public information

The CRARA requires that NRSROs disclose their procedures for handling confidential and material non-public information as part of NRSRO recognition process. NRSROs have a long history of working with issuers and carefully protecting information that must remain confidential from information that can be shared with the public and subscribers. We do not believe that this condition will pose a hurdle to the adoption of “equivalent disclosure”.

Revocation of NRSRO status –

The Credit Rating Agency Reform Act of 2006 does not include a grant authority to the SEC to revoke the NRSRO status of agencies who do not abide by the disclosure which they make to the Commission. This leaves the Commission without a method of disciplining NRSROs who are not using accurate and reliable methodologies when issuing ratings or who have conflicts of interest which are not managed or properly disclosed or who no longer have the capital resources to continue as an independent entity.

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This would be a significant grant of additional authority to the Commission but is necessary. If the numbers of NRSROs increase as expected there likely will be instances where a NRSRO has stopped providing accurate ratings to the markets and has not voluntarily withdrawn their recognition.

Confer issuer audit committees oversight of the NRSRO relationship –

Former SEC Chairman Arthur Levitt, Jr. wrote in the Wall Street Journal (September 7, 2007), “In addition, just as Sarbanes-Oxley gave audit committees direct responsibility for the selection, monitoring and compensation of external monitors, audit committees should be given this responsibility over credit ratings agencies. This would bolster their independence from management and lessen any pressure brought to bear on them.”

NRSROs are “external monitors” of the creditworthiness of an issuer. It is important that market participants believe that the relations between issuers and NRSROs are non-conflicted. Although operationally the communications between issuer and NRSROs must remain with management oversight of these relationships can be done by the audit committees of board of directors.

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Background - Legislative and SEC reviews

Three rounds of legislative effort concerning credit rating agencies has occurred within the past five years:

� Sarbanes-Oxley - 2002 � Credit Rating Agency Reform Act - 2006 � Post CRARA examination – 2007/08

These successive examinations by the Congress and the SEC have increasingly made clear the central role and importance of NRSROs to the efficient functioning of the credit markets.

Sarbanes-Oxley mandated the SEC to review the role and function of the credit rating agencies. This review highlighted the need for a more transparent method for rating agencies to be recognized by the SEC. The SEC requested additional statutory authority for oversight of NRSROs.

Congress granted additional authority to the SEC in the Credit Rating Agency Reform Act of 2006.

Statutory authority of NRSROs >> 17 CFR Parts 240 and 249b

Legislative Review One - Sarbanes-Oxley 2002

Following the collapse of Enron and WorldCom Congress mandated a review of the performance of the NRSROs. Section 702(b) of the Sarbanes-Oxley Act of 2002 tasked the SEC to conduct an analysis of the role of the credit rating agencies. Concern was expressed that the lack of competition among NRSROs inhibited the aggressiveness of raters in analyzing issuers.

The SEC responded to Congress in January, 2003 with a "Report on the Role and Function of Credit Rating Agencies in the Operation of the Securities Markets" .

The report addressed issues including information flow, potential conflicts of interest, alleged unfair or anti-competitive practices, reducing potential regulatory barriers to entry, and ongoing oversight, (from page 31 of the SEC report).

..."In the aftermath of the Enron situation and other recent corporate failures, some have criticized the performance of the credit rating agencies, and questioned whether they are conducting sufficiently thorough analyses of issuers, particularly given their special position in the marketplace. Concerns also have been raised regarding the training and qualifications of credit rating agency analysts.

In particular, the Staff Report, issued in connection with the investigation by the Senate Committee on Governmental Affairs of the Enron situation, found that, while the credit rating agencies did not completely ignore the problems at Enron, “their monitoring and review of [Enron’s] finances fell far below the careful efforts one would have expected from organizations whose ratings hold so much importance.”

According to the Staff Report, in some cases the rating agencies appeared simply to take the word of Enron officials when issues were raised, and failed to probe more deeply. In addition, the credit rating agency analysts seemed to have been less than thorough in their review of Enron’s public filings, even though these filings are a primary source of information for the ratings decision.

Among other things, the rating analysts appeared to pay insufficient attention to the detail in Enron’s financial statements, failed to probe opaque disclosures, did not review Enron’s proxy statements, and failed to take into account the overall aggressiveness of Enron’s accounting practices.

In essence, the Staff Report found that the rating agencies failed to use the necessary rigor to ensure their analysis of a complex company, such as Enron, was sound.

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Accordingly, as discussed in Section III.A.2. above, the Staff Report recommended the Commission impose standards for credit rating agencies in deriving their ratings.

The rating agencies tend to have a more limited view of their role in verifying information reviewed in the credit rating process. In general, the rating agencies state that they rely on issuers and other sources to provide them with accurate and complete information. They typically do not audit the accuracy or integrity of issuer information.

Though rating agencies may at times be able to use their influence in the marketplace to compel issuers to provide additional information, they have no legal power to subpoena issuer information.

In cases where a rating agency concludes that important information is unavailable, or an issuer is less than forthcoming with them, the rating agency may, depending on the significance of the information involved, issue a lower rating, refuse to issue a rating, or even withdraw an existing rating. In general, the rating agencies indicate that reputational concerns are sufficient to ensure that they exercise appropriate levels of diligence in the ratings process. Nevertheless, as noted in Section V below, the Commission intends to explore whether NRSROs should incorporate general standards of diligence in performing their ratings analysis, and with respect to the training and qualifications of credit rating analysts.”

Legislative review two: Credit Rating Agency Reform Act of 2006

Legislation adopted in the 109th Congress has already enhanced competition and transparency in the credit ratings industry. The Credit Ratings Agency Reform Act of 2006 (CRARA) was an important bipartisan accomplishment after many years of review and discussion.

The CRARA codified the authority of the SEC to implement rules with respect to registered credit rating agencies for the following:

� Registration

� Record retention

� Financial reporting

� Policies preventing the misuse of confidential information

� Conflicts of interest

� Prohibition of unfair, abusive practices

To implement the CRARA the Commission published a Proposed Rule (Release No. 34-55231; File No. S7-04-07 ), solicited comments on the Proposed Rule and published the Final Rule on June 5th, 2007 (Release No. 34-55857; File No. S7-04-07). The new rules went into effect on June 26, 2007.

SEC Chairman Cox described the outlines of the implementation of the CRARA as follows:

“The Rating Agency Act replaced the no-action letter process with a program of Commission oversight of credit rating agencies that elect to register as NRSROs. Under the Rating Agency Act, a credit rating agency seeking to be registered as an NRSRO must apply for registration with the Commission, make public in its application certain information to help persons assess its credibility, and implement procedures to manage the handling of material nonpublic information and conflicts of interest. Consistent with the statutory mandate, the Commission’s implementing rules require disclosure of an NRSRO’s conflicts of interest, and proscribe certain conflicts of interest. Key provisions of the Rating Agency Act and the new Commission rules are summarized below.

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Disclosure Requirements and Performance Measurement Statistics The Rating Agency Act and its implementing rules require an NRSRO to disclose in its public filings with the SEC a general description of its procedures and methodologies for determining credit ratings. In addition, an NRSRO must make public certain performance measurement statistics including historical downgrade and default rates within each of its credit rating categories over the short, medium, and long terms. These statistics are intended to serve as important indicators of the performance of an NRSRO in terms of its ability to assess the creditworthiness of issuers and obligors. Finally, as described in the Commission’s adopting release in June 2007 regarding the NRSRO rules, the Commission is studying whether it would be appropriate to require additional types of performance statistics to be disclosed as an alternative, or in addition, to historical default and downgrade rates, such as a credit rating downgrade that occurs long after a significant drop in the value of the securities being rated. We believe that the disclosure requirements of the Rating Agency Act, as implemented now and in the future through our rulemaking, will assist users of credit ratings in assessing the reliability of an NRSRO’s ratings over time, and will increase transparency with respect to the accuracy of an NRSRO’s ratings. Conflicts of Interest and Prohibited Practices The Rating Agency Act requires an NRSRO to disclose the conflicts of interest that are inherent in its business of determining credit ratings and to establish, maintain, and enforce written policies and procedures reasonably designed, taking into consideration the nature of its business, to address and manage the conflicts of interest. The Rating Agency Act also provided the Commission with authority to prohibit or require the management and disclosure of conflicts of interest relating to the issuance of credit ratings by an NRSRO. Pursuant to this authority, the Commission adopted rules that prohibit an NRSRO from having certain conflicts of interest if it has not complied with the requirements in the Rating Agency Act to disclose and manage them. One of the conflicts in this category is receiving compensation from an issuer or underwriter to rate securities issued or underwritten by the entity. The Commission’s rules also prohibit an NRSRO from having certain other conflicts in all circumstances. One of the conflicts in this category is receiving compensation for determining a credit rating where the person paying for the credit rating provided the NRSRO with net revenue in the most recently ended fiscal year that equaled or exceeded 10% of the NRSRO’s total net revenue. Finally, the SEC rules, among other things, also address the handling of material non-public information by an NRSRO and prohibit certain unfair, coercive, or abusive practices by the NRSROs – including modifying or threatening to modify a credit rating or otherwise departing from systematic procedures and methodologies in determining credit ratings, based on whether the obligor, or an affiliate of the obligor, purchases the credit rating or any other service or product of the NRSRO or any person associated with the NRSRO. Books and Records, Financial Reports, and Examination In addition to significant disclosure requirements and conflict of interest provisions, the Rating Agency Act and the Commission’s implementing rules also require an NRSRO to make and keep certain books and records, including documentation of its established procedures and methodologies used by the NRSRO to determine credit ratings. These recordkeeping rules will allow Commission examiners to review whether an NRSRO is following its stated procedures and methodologies and otherwise complying with the Rating Agency Act. NRSROs also are required to keep external and internal communications received and sent by the NRSRO or its employees that relate to initiating, determining, maintaining, changing or withdrawing a credit rating. The Rating Agency Act and implementing rules also require NRSROs to furnish to the Commission, on a confidential basis, certain financial reports, on an annual basis, including audited financial statements. In addition to the audited financial statements, the rules also require NRSROs to furnish separate unaudited financial reports that will assist the Commission in carrying out its statutory responsibilities under the Rating Agency Act.

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The Rating Agency Act provides that all records of an NRSRO are subject to such reasonable periodic, special, or other examination by representatives of the Commission as the Commission deems necessary or appropriate in the public interest, for the protection of investors, or otherwise in the furtherance of the purposes of the Securities Exchange Act of 1934. Prohibition on Regulating Rating Procedures Finally, in implementing this statute, the Commission is ever mindful of the explicit intent of Congress that we not substitute the Commission’s judgment for that of the rating agencies.

Legislative review three: Post CRARA examination (2007-08)

As a consequence of the credit crisis of 2007 Congress and the SEC have initiated reviews of NRSROs and potential conflicts of interest.

The Senate Banking Committee held a hearing on September 26, 2007 on the "Role and Impact of Credit Rating Agencies on the Subprime Credit Markets" (see hearing web cast and testimony here).

The House Financial Services Committee also held a hearing on September 27, 2007 regarding the "Role of the Credit Rating Agencies in the Structured Finance Market"(see hearing web cast and testimony here).

The SEC has broad new authority for oversight of NRSROs and examination of adherence to stated methodologies and management of conflicts of interest. SEC Chairman Cox stated the following in his testimony to the Senate Banking Committee on September 27, 2007:

“We have as yet formed no firm views on any of the reasons put forth by the credit rating agencies, but we are carefully looking into each of them in the context of an examination the Commission has begun with respect to NRSROs active in rating RMBS. This examination – which is being conducted on a non-public basis – was commenced in response to the recent events in the mortgage markets. In particular, the Commission is examining whether these NRSROs were unduly influenced by issuers and underwriters of RMBS to diverge from their stated methodologies and procedures for determining credit ratings in order to publish a higher rating. The examination is also focusing on whether the NRSROs followed their stated procedures for managing conflicts of interest inherent in the business of determining credit ratings for RMBS. In this regard, the examination will seek to determine whether the NRSROs’ role in the process of bringing RMBS to market impaired their ability to be impartial. In addition to the Commission’s examination of NRSROs, the President has requested that the President’s Working Group on Financial Markets examine the role of credit rating agencies in lending practices, how their ratings are used, and how securitization – the repackaging and selling of assets – has changed the mortgage industry and related business practices. As a member of the President’s Working Group, the Commission is taking a leading role in this study. The Commission is also a member of the credit rating agency task force created by the International Organization of Securities Commissions (“IOSCO”) and we recently hosted an IOSCO meeting at which the credit rating agencies most active in rating residential mortgage-backed securities made presentations with respect to their role in developing structured finance products, and how they manage the conflicts of interest that arise in providing rating services.”

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Background - Regulation Fair Disclosure

Although there is no specific regulatory or legislative authority for an issuer to selectively disclose material non-public information to NRSROs the general process was carved out when Regulation Fair Disclosure was developed.

When Congress and the SEC were reviewing and developing Regulation Fair Disclosure to address information asymmetry in the equity markets the following Comment Letter from Moody’s was submitted in support of an exemption of selective disclosure of material non-public information to NRSROs. The letter is dated April 27, 2000 from John J. Goggins, Vice President and Associate General Counsel, Moody’s Investors Service.

“This letter is submitted by Moody’s Investors Service, Inc. ("Moody’s") in response to the request of the Securities and Exchange Commission ("Commission") for comments on proposed Regulation FD, which addresses concerns about selective disclosure of material nonpublic information.

Specifically, Moody’s requests that, if the Commission determines to adopt Regulation FD, it add a specific exemption to Rule 100 or include language in the adopting release recognizing that rating organizations regularly receive and use nonpublic information in the rating process and may continue to do so.

In order to formulate an opinion as to the credit risks applicable to an issuer, Moody’s looks at factors such as industry characteristics, technology, management policies and performance, profitability, regulatory trends, capital structure, and business fundamentals. In order to obtain this information, Moody’s reviews public financial information, including registration statements and other periodic reports filed with the Commission. In addition, Moody’s often receives information directly from issuers, such as earnings forecasts, financing plans, intended shifts in business or product lines, and planned capital expenditures, and frequently meets with representatives of issuers, and their advisors, to consider such information.

Some of the information provided to Moody’s by issuers may be material and nonpublic. For example, management may discuss detailed plans for future business changes, including proposed divestitures and acquisitions, product modifications, and financing needs. Issuers provide this nonpublic information with the understanding that it will be used solely in order to evaluate and express an opinion on the issuer's creditworthiness. Accordingly, Moody’s regularly receives and uses nonpublic information in the rating process with the understanding that it will be used only in the process of developing its rating opinion.

Indeed, the Commission has recognized that, as part of the rating process, rating organizations have "contacts with the management of issuers, including access to senior level management of the issuers." In its proposed rule to define the term nationally recognized statistical rating organization ("NRSRO"), the Commission not only recognizes that NRSROs have extensive contact with issuer management, but also considers such contacts an essential attribute for such organizations. The same proposed rule states that in determining whether to designate a NRSRO the Commission will evaluate the rating agency's "internal procedures to prevent misuse of nonpublic information and compliance with these procedures." This factor is assessed today when the Commission designates a NRSRO through the no-action letter process. Thus, the Commission clearly has recognized that rating organizations obtain nonpublic information in connection with the rating opinion process.

In light of the foregoing, Moody’s requests that if the Commission decides to adopt Regulation FD, the Commission add a specific exemption to Rule 100 providing that receipt and use of material nonpublic information by rating organizations does not violate the rule. Moody’s and other rating organizations provide a valuable service to the securities markets which would be severely hampered if issuers could not share material nonpublic information in the rating process without fear that it would have to be simultaneously disclosed to the entire market. The Commission has recognized both the value of NRSROs ratings and the importance of access to nonpublic information in the ratings process.

If the Commission determines not to include such an exemption in Regulation FD, the adopting release should include language making it clear that disclosure by an issuer (or a person on its behalf) to

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Moody’s and other rating organizations does not give rise to the obligation to make public disclosure under Regulation FD. At a minimum the release should make clear that issuers are not required to enter into confidentiality agreements with a rating agency when they give it nonpublic information in connection with the rating process.”

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Summary of proposed legislative and regulatory solutions

� Allow the SEC inspection to be completed - hold additional action (CC)

� Adopt “equivalent disclosure” for issuer communication with NRSROs (JC) (CK) (CL)

� Confer additional regulatory authority to the SEC (SS)

� Increase the SEC’s NRSRO oversight budget (AL)

� Delink analyst compensation from business development (AL)

� Issuer public disclosure of NRSRO fees and consulting (AL) (CK) (CL)

� Improve transparency of rating triggers in structured finance (AL)

� NRSROs should be held liable for malfeasance (AL)

� Give issuer audit committees oversight of the NRSRO relationships (AL) (CL)

� SEC to monitor the accuracy of ratings methodologies (AL)

� Create “cooling off” period for NRSRO analysts (AL)

� Grant the SEC authority to revoke NRSRO status (AL) (JC)

� Create a central repository of default statistics at the SEC (CL)

� Altering the methods of NRSRO compensation (CK)

� Institute rotations among NRSROs for issuers (CK)

� Standardize the reporting and meaning of rating symbols by asset class (JC)

� Improve the transparency of underlying debt products (CK)

� Require complex products to season prior to rating by NRSRO (CK) (JM)

� Separate the advising and rating functions of NRSROs (EM)

� Make the ratings industry non-profit

� Remove the government sanctioned status as NRSROs

� Institutional investor sponsored rating agency (AP)

(AL) = Former SEC Chairman Arthur Levitt

(AP) = Alex Pollock, American Enterprise Institute

(CC) = SEC Chairman Chris Cox

(CK) = House Capital Markets Subcommittee Chairman Kanjorski

(CL) = Cate Long

(EM) = Eric Mindich

(JC) = Professor John Coffee

(JM) = Professor Joseph Mason

(SS) = Senate Banking Committee Ranking Member Shelby

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Resources:

>> Primer on the US Treasury market: http://research.stlouisfed.org/wp/2007/2007-052.pdf >> Global underwriters of debt 3Q 2007

http://www.thomson.com/pdf/financial/league_table/de/3Q2007/3Q07_Debt_Capital_Markets

>> Bank of England Financial Stability Report (3Q 2007)

http://www.bankofengland.co.uk/publications/fsr/2007/fsr22.htm

>> Moody's written testimony to the House of Commons

>> Independent credit ratings research http://db.riskwaters.com/public/showPage.html?page=288722

Links for Form NRSRO AM Best http://www.ambest.com/nrsro/formnrsro.pdf

DBRS http://www.dbrs.com

Egan-Jones http://www.egan-jones.com/publicdocs/Form%20NRSRO%20Nov%202007.doc

Fitch Ratings http://www.fitchibca.com/jsp/corporate/PolicyRegulation.faces?context=3&detail=4

Japan Credit Rating Agency

http://www.jcr.co.jp/english/pdf/NRSRO.pdf

Moody’s http://www.moodys.com/

Ratings and Investment Information

http://www.r-i.co.jp/eng/rating/nrsro/nrsro.html

Standard & Poor’s

http://www.standardandpoors.com

>> Minutes of evidence from representatives of rating firms taken before the Treasury Committee, House of Commons, Tuesday 13 November 2007

http://shopyield.com/blog/2007/11/22/raters-at-the-house-of-commons-treasury-committee/

>> Transcript from the National Housing Forum held December 3, 2008 at the National Press Club, Washington, DC - 148 pages http://www.ots.treas.gov/docs/r.cfm?481057.pdf

>> NEW YORK (Reuters) December 3, 2007 - Further deterioration of global credit markets can be avoided if ratings agencies perform more due diligence on loans that are securitized and liquidity returns to the secondary market, a panel of financial services executives said on Monday.

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"The models at the ratings agencies did not work and they did not appropriately price the risk inherent in the underlying mortgages that were being securitized," Michael O'Hanlon, senior managing director at Marathon Asset Management LLC, said on a panel hosted by the Office of Thrift Supervision. "People trusted the ratings agencies and it is very clear that their models were obviously wrong," he said. "More due diligence should take place going forward to avoid further problems." The National Housing Forum was held at The National Press Club in Washington and broadcast by CSPAN. "The ratings agencies are among the most powerful unregulated companies," said Rod S. Dubitsky, managing director at Credit Suisse First Boston. "Investors want to see results of their due diligence." Adequately pricing securities not backed by government-sponsored enterprises Fannie Mae and Freddie Mac is next to impossible right now, the panelists said. http://www.reuters.com/article/economicNews/idUSN0342582020071203

>> Innovating Our Way to Financial Crisis >>> Dec 3, 2007 (The New York Times) --

..."How bad is it? Well, I’ve never seen financial insiders this spooked — not even during the Asian crisis of 1997-98, when economic dominoes seemed to be falling all around the world.

This time, market players seem truly horrified — because they’ve suddenly realized that they don’t understand the complex financial system they created.

Before I get to that, however, let’s talk about what’s happening right now.

Credit — lending between market players — is to the financial markets what motor oil is to car engines. The ability to raise cash on short notice, which is what people mean when they talk about “liquidity,” is an essential lubricant for the markets, and for the economy as a whole."...