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House-Senate Conferees Reach Compromise on Franken Amendment

By Jim Hamilton

The House-Senate conference on the financial reform legislation has reached a compromise on the Franken Amendment mandating a new SRO within the SEC to randomly assign initial credit ratings for structured products. Under the compromise, the Franken Amendment, codified as Section 939D of the Senate bill , would take effect after an SEC study and report to Congress. The compromise provides that the SEC must implement the Franken Amendment after completion of the study unless the SEC determines that an alternative method would be better for investor protection. According to Senator Dodd, the SEC would have to proceed with the Franken provisions unless it is impossible to implement them and the study reveals a better way to implement this type of reform of the conflict of interest inherent in issuer-pays credit rating agency system. While he generally supports the Franken Amendment, Senator Dodd has consistently had concerns about how these provisions would be practically implemented.

Authored by Senator Al Franken, the Amendment would create a Credit Rating Agency Board, a self-regulatory organization, tasked with developing a system in which the Board randomly assigns a credit rating agency to provide a structured product?s initial rating. Requiring an initial credit rating by an agency not of the issuer?s choosing, but randomly selected by the Board, will put a check on the accuracy of ratings and end forum shopping, in the Senator?s view. The provision does not prohibit an issuer from then seeking a second or third or fourth rating from an agency of their choosing. The provision leaves flexibility to the Board to determine the assignment process. Thus, the new 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 its initial rating agency. This should eliminate the current incentive for a rating agency to give an inflated rating in the hope of getting repeat business. Cong. Record, May 10, 2010, S3465.

Full post as published by Jim Hamilton's World of Securities Regulation on June 16, 2010 (boomark / email).