Senators Warn that Millions of Investors Nationwide are Still at Risk
Today, U.S. Sens. Al Franken (D-Minn.), Roger Wicker (R-Miss.), and Chuck Schumer (D-N.Y.) called on the Securities and Exchange Commission to take the necessary next steps to reform the credit rating industry and protect millions of investors nationwide.
The text of the letter is below.
February 14, 2013
Dear Chairman Walter,
We write today to encourage the Commission and its staff to continue to focus attention on the existence of conflicts of interest in the credit rating industry. We applaud the Commission for completing its Report to Congress on Assigned Credit Ratings ("the Assigned Ratings Report"), and its 2012 Summary Report of Commission Staff's Examinations of Each Nationally Recognized Statistical Rating Organization ("the Examination Report"), but note that the Commission has yet to convene a roundtable, as recommended in the Assigned Credit Ratings Report, or initiate a rulemaking on this issue.
Section 939F of the Dodd-Frank Wall Street Reform and Consumer Protection Act calls for the Commission to carry out a study on assigned credit ratings and to submit a report on its findings to Congress. Section 939F further directs the Commission to proceed with a rulemaking on assigned credit ratings if the Commission determines that it is necessary or appropriate to protect the public interest or investors. Now that the study is complete and the Commission has released its Assigned Ratings Report, which suggests that conflicts of interest exist, we encourage the Commission to take concrete action to resolve such conflicts.
We note that the Assigned Ratings Report references an "inherent conflict of interest" in the current issuer-pays model, as the potential exists "that the NRSRO will be influenced to issue the credit ratings desired by the arranger." The Assigned Ratings Report also highlights continuing market concentration concerns, explaining how the loss of business of one of the small number of banks that issue structured finance products "could have a substantial impact on an NRSRO's revenues."
While the Commission received some comments that were critical of meaningful reforms, the majority of such comments were submitted by industry participants that prefer the status quo. The Assigned Ratings Report cites several comment letters supporting the adequacy of existing rules, or rules already under consideration by the Commission, to prevent conflicts of interest, but it also suggests that current rules do not in fact adequately address conflicts of interest. The Examination Report concludes, for example, that a majority of NRSROs did not appear to follow their methodologies and certain policies and procedures in determining certain credit ratings. In the case of at least one such NRSRO, the Commission staff was concerned that the NRSRO "may have been influenced by market share and business considerations in its application of the methodology used. . ." In addition, a majority of NRSROs did not fully disclose certain conflicts of interest, or their related policies and procedures may not have adequately managed certain conflicts of interest. One NRSRO did not have policies in place to comply with Rule 17g-5(c)(6), which prohibits NRSRO employees who are involved in the ratings process to also negotiate fees.
The problems presented in the Commission's Examination Report are the same problems identified by the Permanent Subcommittee on Investigations in its inquiry into the causes of the recent financial collapse. The Subcommittee concluded that "inaccurate AAA credit ratings introduced systemic risk into the U.S. financial system and constituted a key cause of the financial crisis" - a determination echoed in the Financial Crisis Inquiry Commission report. The conflicts of interest that contributed to the financial collapse remain prevalent in the industry today, and further action by the Commission would better protect both the public interest and investors.
The Assigned Ratings Report recommends that, as a next step, the Commission convene a roundtable with relevant stakeholders to discuss the study's findings. Given the attention and study that the Commission has already devoted to this issue, we anticipate that the Commission should be able to convene this roundtable within the next three months. We would be happy to assist the Commission in selecting roundtable participants, if requested. In addition, we respectfully request that the Commission provide us with a written plan and expected timeline for further steps the Commission plans to take, and provide us with quarterly updates on its progress in this area. Thank you for your continued efforts, and please let us know if we can assist the Commission in this endeavor to end conflicts of interest in the credit rating industry.