Thursday, May 13, 2010

Franken Amendment Approved Directing SEC to Set Up SRO to Assign Credit Ratings on Rotating Basis

The Senate approved an amendment to the financial reform bill that seeks to end the conflicts of interest in the prevalent issuer pays model of credit rating agencies. Sponsored by Senator Al Franken, the amendment creates a board overseen by the SEC that will assign credit rating agencies to provide initial ratings on a rotating basis in order to eliminate inherent conflicts of interest. Currently, firms choose which credit rating agencies will rate the quality of their securities and other financial products.

The SEC will create a Credit Rating Agency Board, a self-regulatory organization, tasked with developing a system in which the Board assigns a rating agency to provide a product’s initial rating. Requiring an initial credit rating by an agency not of the issuer’s choosing will put a check on the accuracy of ratings, in the Senator’s view. The amendment does not prohibit an issuer from then seeking a second or third or fourth rating from an agency of their choosing

The amendment leaves flexibility to the Board to determine the assignment process. Thus, the Board gets to design the assignment process it sees fit, which can be random or based on a formula, just as long as the issuer doesn’t get to choose.The Board will select a subset of credit rating agencies to be eligible for the assignment pool. The Board will be required to monitor the performance of the agencies in the pool. If the Board so chooses, it can reward good performance with more rating assignments. It can recognize poor performance with fewer rating assignments. If the rater is bad enough, that might even be zero assignments.

The rotating system of assigning credit ratings is designed to reduce forum shopping and, in the Senator’s opinion, gets to the root of the conflict of interest problem with rating agencies. By allowing an SRO to assign more work to rating agencies that produce accurate ratings, he reasoned, will allow the market to reward accuracy and increase true competition and enhance faith in the rating process. Cong. Record, May 10, 2010, S3465.