May 4, 2010 -- Sen. Al Franken has written an amendment to financial overhaul legislation that would seek to prevent securities underwriters from hiring rating agencies based on which ones proved most willing to give their deals the highest possible ratings.
The three largest rating agencies, Fitch Ratings, Moody's Investors Service and Standard & Poor's, have all come under fire of late for their role in the financial crisis of 2008, and would be most affected by the proposal.
"If a failing student paid their teacher to turn their F into an A, everyone would agree that what the teacher had done was unethical," the Minnesota Democrat told ABCNews.com. "But right now, investors are being sold a phony bill of goods. We need to protect consumers from the pay-to-play system that rewards Wall Street players at the expense of Main Street."
Senators Bill Nelson, D-Fla., and Charles Schumer, D-N.Y., have agreed to cosponsor the amendment, according to a spokesman for Franken. The amendment is expected to be formally introduced later this week.
Meanwhile, Nelson is also preparing his own possible amendment that would seek to hold rating agencies more accountable once their ratings, akin to Good Housekeeping seals of approval, are handed out.
Currently, agencies continue to monitor credit ratings only if they are paid to do so. Nelson's proposal would mandate ongoing surveillance.
Spokesmen at Moody's, S&P and Fitch all declined comment.
The Obama administration has pushed hard for financial reform, which has passed the House and is set to be debated in the Senate. The centerpiece of the reform effort is a package sponsored by Sen. Chris Dodd, D-Conn., but which thus far has failed to generate any Republican support.
Senate Probe Singled Out Raters
Last month, the Senate's Permanent Subcommittee on Investigations, chaired by Sen. Carl Levin, D-Mich., issued a scathing assessment of the role of rating agencies in the mortgage market meltdown and subsequent financial crisis, which in turn prompted one of the worst U.S. recessions in generations.
The Senate probe assigned raters a sizable amount of blame while accusing them of compromising the ratings process in pursuit of increasingly outsized fee revenue from Wall Street underwriters.
Banks paid rating agencies hundreds of millions during the mortgage bubble, allowing for an explosion of subprime-mortgage-tied instruments such as the Abacus 2007-1 collateralized debt obligation (CDO) that was at the heart of the Securities and Exchange Commission's fraud case brought recently against powerhouse investment bank Goldman Sachs.
Some 91 percent of the triple-A rated subprime residential mortgage-backed securities issued in 2007 have since been downgraded to junk status.
One of the major findings of the Senate subcommittee, tasked with identifying the root causes of the financial meltdown, was the appearance of collusion between Wall Street banks, such as Goldman, and the raters. In some cases, banks shopped deals around, deals which could earn raters hundreds of thousands of dollars in fees.
Banks routinely selected the raters most willing to hand out the coveted triple-A rating, according to Levin.
Franken said his amendment, titled "Restore Integrity to Credit Ratings," would lay the groundwork for a new regulatory entity that would include members of the investment community and would be in charge of objectively and independently selecting the agency that provides initial ratings to newly minted securities, so as to reduce the potential for "ratings shopping" or other conflicts of interest.
Measure Could Stir Competition
"[The measure] would increase competition by enabling smaller credit rating agencies to finally have an opportunity to compete against the largest three agencies that have abused the issuer-pays model," a written summary of the Franken amendment said.
Levin, who chaired the Senate subcommittee that over the past year and a half has examined the financial crisis -- and who made considerable headlines after at times profanity-laced marathon grilling of Goldman Sachs executives last week -- has said the Senate probe found evidence, including emails, pointing to some questionable practices within the rating agencies as the credit bubble was building.
Levin primarily questioned the issuing of triple-A ratings to derivative securities, such as CDOs, that were laced with toxic subprime mortgages.
A slew of particularly damning emails sent by ratings agency executives reveal a culture in which analysts were often at odds with revenue generation agendas.
In one email from August 2004, an S&P executive asks a colleague whether the firm might discuss adjusting criteria for rating certain issuances "because of the ongoing threat of losing deals."
In another email, from April 2006, a Moody's executive laments to another he is "getting serious push back from Goldman on a deal they want to go to market with today."
"For a hundred years, Main Street investors trusted U.S. credit-rating agencies to guide them toward safe investments," Levin said in explaining why the ratings agencies were being singled out. "But now that trust has been broken."