WASHINGTON, DC - In an effort to reform the credit rating industry and improve the accountability and accuracy of credit ratings, U.S. Senator Jack Reed (D-RI) today introduced the Rating Accountability and Transparency Enhancement (RATE) Act of 2009.

Reed's legislation would give the Securities and Exchange Commission (SEC) strong new authority to oversee credit rating firms and hold them accountable for conflicts of interest and other internal control deficiencies that have weakened ratings in the past. The bill also includes a narrowly tailored provision that would allow investors to take legal action against rating firms that "knowingly or recklessly" fail to review key information in developing ratings. Credit rating firms could avoid litigation by conducting thorough reviews or by obtaining assessments from independent firms.

"Credit rating firms are in the business of providing investors with unbiased analysis, but the current incentive structure gives them too much leeway to hand out unjustifiably favorable ratings. Let's be clear: not every rating is suspect and these firms provide crucial information for investors and the marketplace, but credit rating firms like any other industry should be held accountable if they knowingly or recklessly mislead investors," said Reed, Chairman of the Banking Subcommittee on Securities, Insurance, and Investment. "Just as we need to regulate hedge funds and derivatives, we need to start the process of restoring balance to the system by providing stronger oversight and added incentives for rating agencies to be more impartial and independent."

In September of 2007, Senator Reed chaired a hearing examining the role of credit rating firms in the mortgage crises. During that hearing Reed asked Christopher Cox, then-Chairman of the SEC, if his agency had enough authority to oversee the credit raters. Cox replied: "We have ample authority."

However, an investigation last summer by the SEC found that credit rating firms such as Moody's, Standard & Poor's, and Fitch Ratings contributed to the financial crisis by conducting weak analyses and failing to maintain appropriate independence from the issuers whose securities they rate. The SEC report quoted from emails written by unnamed employees at credit rating firms complaining that the agency's methodology didn't capture "half" of the risk of a particular security, noting, "It could be structured by cows, and we would rate it." A manager at the same firm wrote that his company was "creating an even bigger monster, the CDO [Collateralized Debt Obligations] market. Let's hope we are all retired and wealthy before this house of cards falters."

"Credit rating reform will address one of the systemic failures that caused the financial crisis. This legislation will help improve the accountability and transparency of credit ratings which are critical to the health and productivity of our financial markets," concluded Reed.

Reed's RATE Act of 2009 will also:

• Enhance disclosure requirements to allow investors and others to learn about the methodologies, assumptions, fees, and amount of due diligence associated with ratings.

• Require rating firms to notify users and promptly update ratings when model or methodology changes occur.

• Require rating firms to have independent compliance officers, and to take other actions to prevent potential conflicts of interest.


SUMMARY: The Rating Accountability and Transparency Enhancement (RATE) Act of 2009

The bill strengthens the Securities and Exchange Commission's (SEC) oversight of Nationally Recognized Statistical Rating Organizations (NRSROs) through enhanced disclosure and improved oversight of conflicts of interest, and makes credit rating firms more accountable through greater legal liability.

Accountability of NRSROs

• Holds NRSROs liable when it can be proved that they knowingly failed to review factual elements for determining a rating based on their methodology or failed to reasonably verify that factual information.

• Requires the SEC to explore alternative means of NRSRO compensation, and requires a Government Accountability Office study on payment methods, in order to create incentives for greater accuracy.

SEC Authority

• Establishes an office in the SEC to coordinate activities for regulating NRSROs.

• Directs the SEC to ensure that NRSRO methodologies follow internal NRSRO guidelines and requirements for accuracy and freedom from conflicts of interest.

Due Diligence Certification

• Requires certification if due diligence services are used to ensure that appropriate and comprehensive information was received by the NRSRO for an accurate rating.

Ratings Disclosures

• Requires NRSROs to notify users when model or methodology changes occur that could impact the rating, and to apply the changes to the rating promptly.

• Requires the SEC to establish a form for NRSROs to provide disclosures on ratings, including methodological assumptions, fees collected from the issuer, and factors that could change the rating.

• Requires NRSROs to provide rating performance information, such as information on the frequency of rating changes over time.

Conflicts of Interests

• Requires NRSROs to have an independent compliance officer to manage conflicts of interest and independently review policies and procedures governing ratings so they are free from conflicts.

• Requires the SEC to regularly review NRSRO conflict of interest guidelines.

• Creates a look-back provision requiring that if an NRSRO employee later becomes employed by an issuer, the NRSRO must review any ratings that the employee participated in over the previous year to identify and remedy any conflicts of interest; and provides for SEC reviews of NRSRO look-back policies and their implementation.