In New Letter, Franken and Colleagues Call for Long-Overdue Action to Clean Up Industry that Contributed to Economic Collapse
Today, a bipartisan ground of Senators continued their push to end the inherent conflict of interest in the credit rating industry that played a key role in the 2008 financial crisis and continues to jeopardize the economic security of Americans.
In a new letter led by Sen. Al Franken (D-Minn.) and joined by a bipartisan group of his colleagues, the senators pressed the Securities and Exchange Commission (SEC) Chairman to bring real reform to the credit rating agencies--such as Moody's, S&P, and Fitch--and end the industry's risky business practices that contributed to the financial meltdown. Other senators who signed onto the letter include Sens. Roger Wicker (R-Miss.), Charles E. Grassley (R-Iowa), Dick Durbin (D-Ill.), Lindsey Graham (R-S.C.), Angus King (I-Maine), Heidi Heitkamp (D-N. Dak.), Tom Harkin (D-Iowa), Ed Markey (D-Mass.), Elizabeth Warren (D-Mass.), Barbara Boxer (D-Calif.), Bill Nelson (D-Fla.), and Jeff Merkley (D-Ore.).
"There is ample evidence to suggest that the public interest conflicts present in the credit ratings agency business model that played a key role in the financial collapse five years ago persist," wrote the Senators in the letter. "We urge the Commission to prioritize credit ratings reforms that address conflicts of interest, increase transparency, and promote competition in the credit ratings industry."
In the letter, the Senators requested that the SEC move forward with actions to address these problems within the credit rating industry model and also asked the Commission to answer several questions about moving forward with these much-needed reforms to protect the public interest.
Sens. Franken and Wicker are the authors of a bipartisan provision in the 2010 Wall Street Reform Act designed to end the current pay-to-play credit rating system, where banks choose which credit rating agency will rate the quality of their stocks, bonds, and other financial products. This conflict of interest motivates agencies to give high ratings to "junk" financial products in order to attract business.
The final version of the Franken-Wicker provision called for the SEC to complete a study of the ratings system and implement additional measures to address conflicts of interest if they are needed to protect investors and the public. The required study, which was completed by the Commission in December 2012, noted the conflicts of interest that persist in the credit rating agency model. And at Sen. Franken's urging, the SEC held a roundtable last May to discuss what further steps need to be taken to eliminate such conflicts.
You can read the full letter below. The two articles mentioned in the letter can be found here and here.
January 8, 2014
The Honorable Mary Jo White
U.S. Securities and Exchange Commission
100 F Street NE
Washington, DC 20549
Dear Chairman White,
We write to urge the Securities and Exchange Commission ("the Commission") to promptly address the ongoing conflicts of interest in the credit rating industry. In the years leading up to the 2008 financial collapse, the credit rating agencies enjoyed substantial profits by providing credit ratings for new types of complex structured financial products. But the credit rating industry's business model, where banks directly pay credit rating agencies to provide ratings of their financial products, was and continues to be plagued by conflicts of interest.
Credit raters know that if they do not provide the rating that an issuer wants, that issuer can just go to a competing credit rating agency and seek a higher rating, a problem known as "ratings shopping." Unsurprisingly, ratings shopping led to junk products, such as subprime mortgage-backed securities, receiving AAA ratings. These inflated ratings built up our financial sector like a house of cards. That house of cards collapsed in 2008 and helped bring our entire economy down with it.
To address the conflicts of interest in the credit ratings industry, Congress instructed the Commission to study this problem and issue a report. After submitting the report, the Commission is authorized to establish a system "for the assignment of nationally recognized statistical rating organizations to determine the initial credit ratings of structured finance products" to prevent conflicts of interest with a product's issuer, sponsor, or underwriter.
Moreover, the amendment states that "by rule, as the Commission determines is necessary or appropriate in the public interest or for the protection of investors" the Commission "shall implement the system" as passed by the Senate "unless the Commission determines that an alternative system would better serve the public interest and the protection of investors." After completing its report on credit ratings in December 2012, the Commission has not moved forward with these much-needed reforms.
There is ample evidence to suggest that the public interest conflicts present in the credit ratings agency business model that played a key role in the financial collapse five years ago persist. Numerous news reports, such as the attached New York Times articles, indicate that these conflicts continue to leave retirees, investors, and our entire economy vulnerable. Therefore, we urge the Commission to prioritize credit ratings reforms that address conflicts of interest, increase transparency, and promote competition in the credit ratings industry.
In light of these ongoing problems, we request a response to the following questions:
What actions is the Commission taking to ensure that the interests of public investors, particularly those investors representing large public investments such as pension and retirement accounts, are taken into account moving forward in its review of conflict of interest reforms? What is the timeline for those actions?
The Commission's December 2012 staff report notes the conflicts of interests that continue to exist, stating that the current model "presents an inherent conflict of interest because the arranger has an economic interest in obtaining credit ratings that are demanded by investors and that lower the issuer's financing costs and the NRSRO has an economic interest in having the arranger hire it in the future;" and cites a study indicating that for a credit rating agency "the more revenue a product brings in, the lower the ratings standards are for that product." Does this finding reinforce the need for fundamental reforms to protect the public interest in the credit rating system? If not, why not?
During a roundtable on May 14, 2013, the Commission discussed assigning nationally recognized statistical rating organizations to determine the initial credit ratings of structured finance products in order to prevent conflicts of interest with a product's issuer, sponsor, or underwriter, as well as other alternative credit rating agency reform proposals as part of its efforts to consider approaches and appropriate responses to the study's findings. What analysis has the Commission undertaken as a result of the roundtable?
What further analysis does the Commission anticipate completing in order to make its determination of whether reforms are "necessary or appropriate in the public interest or for the protection of investors"?
What is the timeline for completing such analysis?
Thank you for your attention to this important matter. Please provide a response by February 8, 2014.