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WASHINGTON – Sen. Al Franken said Thursday that he will push the Securities and Exchange Commission in the coming months to remove conflicts of interest between securities rating agencies and the companies that pay them to rate financial products.
Franken, a Minnesota Democrat, discussed his plans barely a week after the Justice Department charged the Standard & Poor's rating agency with fraud for blessing what the rating agency allegedly knew were dangerously risky securities and derivatives backed by subprime mortgages.
Defaults on those mortgages eventually helped sink the global economy and plunged the United States into the biggest financial crisis since the Great Depression.
"Our nation's financial meltdown happened in no small part because of conflicts of interest in the credit rating industry," Franken told reporters in a conference call. "The agencies gave Triple-A ratings to junk that they knew was junk."
Franken and Sen. Roger Wicker, R-Miss., co-sponsored an amendment to Wall Street reform to force a study of conflicts of interest caused by companies directly hiring and paying rating agencies to grade their products.
In December, the SEC reported that those conflicts do exist and contributed to the recession. Now, Franken and Wicker say they want the commission to quickly make new rules to eliminate them.
"We gave the SEC authority to end the conflict-of-interest problem," Franken said. "And it is time for them to use it."
Franken and Wicker said they want the SEC to convene a roundtable of interested parties to discuss new rules within the next three months and to produce a written plan and timetable for putting new rules in place. Along with Sen. Charles Schumer, D-N.Y., they wrote a letter to the SEC Thursday calling for action.
Franken and Wicker have proposed an independent committee to select rating agencies used for initial review of financial products.
But some in the banking and brokerage community oppose the changes, including the Financial Services Roundtable, an industry lobbying group.
"Setting up a board to randomly select a rating agency will create mismatches between the agency's capability and expertise and the financial product it is asked to rate," said Scott Talbott, senior vice president of public policy.
A Franken spokesman called the objection "factually inaccurate" and said the senator's proposal requires the independent committee to consider "capacity, expertise and history of accuracy" in ratings before appointing an agency.
Ann Graham, founder of Hamline University's Business Law Institute and a banking law expert, said the dilemma for regulators will be finding a way to avoid conflicts of interest while preserving expertise in the ratings process.
Graham, a former regional counsel for the Federal Deposit Insurance Corp., said, "You have a [securities rating] system that has evolved over time to become rife with conflicts of interest."
Letting an independent group pick rating agencies for financial products "might take care of conflicts of interest. But it might not take care of the quality issue."
Among the worst practices in the current system, according to Franken, is the rating agencies' financial dependence on the companies offering securities. These firms hire the rating agencies, creating an expectation of high ratings that propel sales while reducing the percentage return the companies must pay investors.
Rating agencies that do not rate products highly risk losing critically large shares of their future business from the major financial institutions that sell securities.
Franken said that is what happened in the Standard & Poor's fraud case.