[Congressional Record Volume 155, Number 77 (Tuesday, May 19, 2009)]
[Senate]
[Pages S5617-S5620]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. REED:
  S. 1073. A bill to provide for credit rating reforms, and for other 
purposes; to the Committee on Banking, Housing, and Urban Affairs.
  Mr. REED. Mr. President, I rise to introduce the Rating 
Accountability and Transparency Enhancement, RATE, Act to strengthen 
the Securities and Exchange Commission's, SEC's, oversight of credit 
rating agencies and improve the accountability and accuracy of credit 
ratings.
  Credit ratings have taken on systemic importance in our financial 
system, and have become critical to capital formation, investor 
confidence, and the efficient performance of the U.S. economy. However, 
in recent months we have witnessed a significant amount of market 
instability stemming in part from the failure of these agencies to 
accurately measure the risks associated with mortgage-backed securities 
and other more complex products.
  As the Chairman of the Securities, Insurance, and Investment 
Subcommittee of the Senate Banking, Housing, and Urban Affairs 
Committee, I chaired a hearing in September of 2007 to examine the role 
of credit rating agencies in the mortgage crisis, and these issues were 
also addressed at a hearing by the full Committee last year. From these 
hearings, it is clear that problems at credit rating agencies 
contributed to the significant financial sector instability our country 
has been experiencing. In fact, an SEC investigation last summer found 
that credit rating agencies such as Moody's, Standard & Poor's, and 
Fitch Ratings conducted weak analyses and failed to maintain 
appropriate independence from the issuers whose securities they rated.
  Credit rating agencies 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 us be 
clear: not every rating is suspect and these firms provide crucial 
information for investors and the marketplace, but credit rating 
agencies like any other industry should be held accountable if they 
knowingly or recklessly mislead investors.
  According to a mortgage industry trade publication, the three major 
credit rating agencies have each downgraded more than half of the 
subprime mortgage-backed securities they originally rated between 2005 
and 2007. Ratings agencies made these mistakes in part because of 
conflicts of interest and other problems with internal controls, 
underscoring the need for enhanced oversight of this industry.
  The bill I introduce today gives the SEC strong new authority to 
oversee and hold rating agencies accountable for conflicts of interest 
and other internal control deficiencies that have weakened ratings in 
the past. The bill includes a carefully crafted liability provision 
that allows investors to take action when a rating agency knowingly or 
recklessly fails to review key information in developing the rating.
  It also enhances disclosure requirements to allow investors and 
others to learn about the methodologies, assumptions, fees, and amount 
of due diligence associated with ratings. It requires rating agencies 
to notify users and promptly update ratings when model or methodology 
changes occur. Finally, the bill requires ratings agencies to have 
independent compliance officers, and to take other actions, to prevent 
potential conflicts of interest.
  I hope my colleagues will join me in helping improve the 
accountability and transparency of credit ratings that are so critical 
to the functioning of our financial markets.
  Mr. President, I ask unanimous consent that the text of the bill be 
printed in the Record.
  There being no objection, the text of the bill was ordered to be 
printed in the Record, as follows:

                                S. 1073

       Be it enacted by the Senate and House of Representatives of 
     the United States of America in Congress assembled,

     SECTION 1. SHORT TITLE.

       This Act may be cited as the ``Rating Accountability and 
     Transparency Enhancement Act of 2009'' or the ``RATE Act''.

     SEC. 2. FINDINGS.

       Congress finds that--
       (1) because of the systemic importance of credit ratings 
     and the reliance placed on them by individual and 
     institutional investors and financial regulators, the 
     activities and performances of credit rating agencies, 
     including nationally recognized statistical rating 
     organizations, are the subject of national public interest, 
     as they are central to capital formation, investor 
     confidence, and the efficient performance of the United 
     States economy;
       (2) credit rating agencies, including nationally recognized 
     statistical rating organizations, play a critical 
     ``gatekeeper'' role

[[Page S5618]]

     that is functionally similar to that of securities analysts, 
     who evaluate the quality of securities, and auditors, who 
     review the financial statements of firms, and such role 
     justifies a similar level of public oversight and 
     accountability;
       (3) because credit rating agencies perform evaluative and 
     analytical services on behalf of clients, their activities 
     are fundamentally commercial in character and should be 
     subject to the same standards of liability and oversight as 
     apply to auditors and securities analysts;
       (4) in certain of their roles, particularly in advising 
     arrangers of structured financial products on potential 
     ratings of such products, credit rating agencies face 
     conflicts of interest that need to be carefully monitored and 
     that therefore should be addressed explicitly in legislation 
     in order to give clear authority to the Securities and 
     Exchange Commission;
       (5) in the recent credit crisis, the ratings of structured 
     financial products have proven to be inaccurate, and have 
     contributed to the mismanagement of risks by financial 
     institutions and investors, which impacts the health of the 
     economy in the United States and around the world; and
       (6) credit rating agencies should determine their ratings 
     independently, without regulatory approval of methodologies, 
     in order to avoid overreliance on ratings and to ensure that 
     the rating agencies, rather than the Securities and Exchange 
     Commission, are accountable for such methodologies, except 
     that regulators should have strong authority to ensure that 
     all other aspects of rating agency activities are designed to 
     ensure the highest quality ratings and accountability for 
     those creating them.

     SEC. 3. ENHANCED REGULATION OF NATIONALLY RECOGNIZED 
                   STATISTICAL RATING ORGANIZATIONS.

       Section 15E of the Securities Exchange Act of 1934 (15 
     U.S.C. 78o-7) is amended--
       (1) in subsection (c)--
       (A) in the second sentence of paragraph (2), by inserting 
     ``including the requirements of this section,'' after 
     ``Notwithstanding any other provision of law,''; and
       (B) by adding at the end the following:
       ``(3) Review of internal controls for determining credit 
     ratings.--
       ``(A) In general.--Credit ratings by, and the policies, 
     procedures, and methodologies employed by, each nationally 
     recognized statistical rating organization shall be reviewed 
     by the Commission to ensure that--
       ``(i) the nationally recognized statistical rating 
     organization has established and documented a system of 
     internal controls for determining credit ratings, taking into 
     consideration such factors as the Commission may prescribe by 
     rule; and
       ``(ii) the nationally recognized statistical rating 
     organization adheres to such system; and
       ``(iii) the public disclosures of the nationally recognized 
     statistical rating organization required under this section 
     about its ratings, methodologies, and procedures are 
     consistent with such system.
       ``(B) Scope of reviews.--The Commission shall conduct the 
     reviews required by this paragraph--
       ``(i) for all types of credit ratings; and
       ``(ii) for new credit ratings, in a timely manner.
       ``(C) Manner and frequency.--The Commission shall conduct 
     reviews required by this paragraph in a manner and with a 
     frequency to be determined by the Commission.
       ``(4) Provision of information to the commission.--Each 
     nationally recognized statistical rating organization shall 
     make available and maintain such records and information, for 
     such a period of time, as the Commission may prescribe, by 
     rule, as necessary for the Commission to conduct the reviews 
     under this subsection;'';
       (2) in subsection (d)--
       (A) by inserting ``fine,'' after ``censure,'' each place 
     that term appears;
       (B) in the subsection heading, by inserting ``Fine,'' after 
     ``Censure,'';
       (C) in paragraph (4), by striking ``or'' at the end;
       (D) in paragraph (5), by striking the period at the end and 
     inserting ``; or''; and
       (E) by adding at the end the following:
       ``(6) fails to conduct sufficient surveillance to ensure 
     that credit ratings remain current, accurate, and 
     reliable.'';
       (3) by amending subsection (h) to read as follows:
       ``(h) Management of Conflicts of Interest.--
       ``(1) Organization policies and procedures.--Each 
     nationally recognized statistical rating organization shall 
     establish, maintain, and enforce written policies and 
     procedures reasonably designed, taking into consideration the 
     nature of the business of such nationally recognized 
     statistical rating organization and affiliated persons and 
     affiliated companies thereof, to address, manage, and 
     disclose any conflicts of interest that can arise from such 
     business.
       ``(2) Governance improvements at nrsro.--Each nationally 
     recognized statistical rating organization shall establish 
     governance procedures to manage conflicts of interest, 
     consistent with the protection of users of credit ratings, in 
     accordance with rules issued by the Commission pursuant to 
     paragraph (3).
       ``(3) Commission authority.--The Commission shall issue 
     final rules to prohibit, or require the management and 
     disclosure of, any conflicts of interest relating to the 
     issuance of credit ratings by a nationally recognized 
     statistical rating organization, including--
       ``(A) conflicts of interest relating to the manner in which 
     a nationally recognized statistical rating organization is 
     compensated by the obligor, or any affiliate of the obligor, 
     for issuing credit ratings or providing related services;
       ``(B) conflicts of interest relating to the provision of 
     consulting, advisory, or other services by a nationally 
     recognized statistical rating organization, or any person 
     associated with such nationally recognized statistical rating 
     organization, and the obligor, or any affiliate of the 
     obligor;
       ``(C) disclosure of business relationships, ownership 
     interests, affiliations of nationally recognized statistical 
     rating organization board members with obligors, or any other 
     financial or personal interests between a nationally 
     recognized statistical rating organization, or any person 
     associated with such nationally recognized statistical rating 
     organization, and the obligor, or any affiliate of the 
     obligor;
       ``(D) disclosure of any affiliation of a nationally 
     recognized statistical rating organization, or any person 
     associated with such nationally recognized statistical rating 
     organization, with any person that underwrites securities, 
     entities, or other instruments that are the subject of a 
     credit rating; and
       ``(E) any other potential conflict of interest, as the 
     Commission deems necessary or appropriate in the public 
     interest or for the protection of users of credit ratings.
       ``(4) Commission rules.--The rules issued by the Commission 
     under paragraph (3) shall include--
       ``(A) the establishment of a system of payment for each 
     nationally recognized statistical rating organization that 
     requires that payments are structured to ensure that the 
     nationally recognized statistical rating organization 
     conducts accurate and reliable surveillance of ratings over 
     time, and that incentives for accurate ratings are in place;
       ``(B) a prohibition on providing credit ratings for 
     structured products that it advised on, in the form of 
     assistance, advice, consultation, or other aid that preceded 
     its retention by any issuer, underwriter, or placement agent 
     to provide a rating for the securities in question (or any 
     assistance provided after such point for which additional 
     compensation is paid directly or indirectly);
       ``(C) requirements that a nationally recognized statistical 
     rating organization disclose any relationship or affiliation 
     described in subparagraphs (C) and (D) of paragraph (3);
       ``(D) a requirement that, in each credit rating report 
     issued to the public, a nationally recognized statistical 
     rating organization disclose the type and number of ratings 
     it has provided to the obligor or affiliates of the obligor, 
     including the fees it has billed for the credit rating and 
     aggregate amount of fees in the preceding 2 years that it has 
     billed to the particular obligor or its affiliates; and
       ``(E) any other requirement as the Commission deems 
     necessary or appropriate in the public interest, or for the 
     protection of users of credit ratings.
       ``(5) Look-back requirement.--
       ``(A) Review by nrsro.--In any case in which an employee of 
     an obligor or an issuer or underwriter of a security or money 
     market instrument was employed by a nationally recognized 
     statistical rating organization and participated in any 
     capacity in determining credit ratings for the obligor or the 
     securities or money market instruments of the issuer during 
     the 1-year period preceding the date of the issuance of the 
     credit rating, the nationally recognized statistical rating 
     organization shall--
       ``(i) conduct a review to determine whether any conflicts 
     of interest of such employee influenced the credit rating; 
     and
       ``(ii) take action to revise the rating if appropriate, in 
     accordance with such rules as the Commission shall prescribe.
       ``(B) Review by commission.--The Commission shall conduct 
     periodic reviews of the look-back policies described in 
     subparagraph (A) and the implementation of such policies at 
     each nationally recognized statistical rating organization to 
     ensure they are appropriately designed and implemented to 
     most effectively eliminate conflicts of interest in this 
     area.
       ``(6) Periodic reviews.--
       ``(A) Reviews required.--The Commission shall conduct 
     periodic reviews of governance and conflict of interest 
     procedures established under this subsection to determine the 
     effectiveness of such procedures.
       ``(B) Timing of reviews.--The Commission shall review and 
     make available to the public the code of ethics and conflict 
     of interest policy of each nationally recognized statistical 
     rating organization--
       ``(i) not less frequently than once every 3 years; and
       ``(ii) whenever such policies are materially modified or 
     amended.'';
       (4) by amending subsection (j) to read as follows:
       ``(j) Designation of Compliance Officer.--
       ``(1) In general.--Each nationally recognized statistical 
     rating organization shall designate an individual to serve as 
     a compliance officer.
       ``(2) Duties.--The compliance officer shall--
       ``(A) report directly to the board of the nationally 
     recognized statistical rating organization (or the equivalent 
     thereof) or to the senior officer of the nationally 
     recognized statistical rating organization; and
       ``(B) shall--

[[Page S5619]]

       ``(i) review compliance with policies and procedures to 
     manage conflicts of interest and assess the risk that such 
     compliance (or lack of such compliance) may compromise the 
     integrity of the credit rating process;
       ``(ii) review compliance with internal controls with 
     respect to the procedures and methodologies for determining 
     credit ratings, including quantitative and qualitative models 
     used in the rating process, and assess the risk that such 
     compliance with the internal controls (or lack of such 
     compliance) may compromise the integrity and quality of the 
     credit rating process;
       ``(iii) in consultation with the board of the nationally 
     recognized statistical rating organization, a body performing 
     a function similar to that of a board, or the senior officer 
     of the nationally recognized statistical rating organization, 
     resolve any conflicts of interest that may arise;
       ``(C) be responsible for administering the policies and 
     procedures required to be established pursuant to this 
     section; and
       ``(D) ensure compliance with securities laws and the rules 
     and regulations issued thereunder, including rules 
     promulgated by the Commission pursuant to this section.
       ``(3) Limitations.--No compliance officer designated under 
     paragraph (1), may, while serving in such capacity--
       ``(A) perform credit ratings;
       ``(B) participate in the development of rating 
     methodologies or models;
       ``(C) perform marketing or sales functions; or
       ``(D) participate in establishing compensation levels, 
     other than for employees working for such officer.
       ``(4) Other duties.--The compliance officer shall establish 
     procedures for the receipt, retention, and treatment of--
       ``(A) complaints regarding credit ratings, models, 
     methodologies, and compliance with the securities laws and 
     the policies and procedures required under this section; and
       ``(B) confidential, anonymous complaints by employees or 
     users of credit ratings.
       ``(5) Annual reports required.--The compliance officer 
     shall annually prepare and sign a report on the compliance of 
     the nationally recognized statistical rating organization 
     with the securities laws and its policies and procedures, 
     including its code of ethics and conflict of interest 
     policies, in accordance with rules prescribed by the 
     Commission. Such compliance report shall accompany the 
     financial reports of the nationally recognized statistical 
     rating organization that are required to be furnished to the 
     Commission pursuant to this section.'';
       (5) in subsection (k)--
       (A) by striking ``, on a confidential basis,'';
       (B) by striking ``Each nationally'' and inserting the 
     following:
       ``(1) In general.--Each nationally''; and
       (C) by adding at the end the following:
       ``(2) Exception.--The Commission may treat as confidential 
     any item furnished to the Commission under paragraph (1), the 
     publication of which the Commission determines may have a 
     harmful effect on a nationally recognized statistical rating 
     organization.'';
       (6) by amending subsection (p) to read as follows:
       ``(p) NRSRO Regulation.--
       ``(1) In general.--The Commission shall establish an office 
     that administers the rules of the Commission with respect to 
     the practices of nationally recognized statistical rating 
     organizations in determining ratings, for the protection of 
     users of credit ratings and in the public interest, and to 
     ensure that credit ratings issued by such registrants are 
     accurate and not unduly influenced by conflicts of interest.
       ``(2) Staffing.--The office of the Commission established 
     under this subsection shall be staffed sufficiently to carry 
     out fully the requirements of this section.
       ``(3) Rulemaking authority.--The Commission shall--
       ``(A) establish by rule fines and other penalties for any 
     nationally recognized statistical rating organization that 
     violates the applicable requirements of this title; and
       ``(B) issue such rules as may be necessary to carry out 
     this section with respect to nationally recognized 
     statistical rating organizations.
       ``(q) Transparency of Ratings Performance.--
       ``(1) Rulemaking required.--The Commission shall, by rule, 
     require that each nationally recognized statistical rating 
     organization shall disclose publicly information on initial 
     ratings and subsequent changes to such ratings for the 
     purpose of providing a gauge of the accuracy of ratings and 
     allowing users of credit ratings to compare performance of 
     ratings by different nationally recognized statistical rating 
     organizations.
       ``(2) Content.--The rules of the Commission under this 
     subsection shall require, at a minimum, disclosures that--
       ``(A) are comparable among nationally recognized 
     statistical rating organizations, so that users can compare 
     rating performance across rating organizations;
       ``(B) are clear and informative for a wide range of 
     investor sophistication;
       ``(C) include performance information over a range of years 
     and for a variety of classes of credit ratings, as determined 
     by the Commission; and
       ``(D) are published and made freely available by the 
     nationally recognized statistical rating organization, on an 
     easily accessible portion of its website and in written form 
     when requested by users.
       ``(r) Credit Ratings Methodologies.--The Commission shall 
     promulgate rules, for the protection of users of credit 
     ratings and in the public interest, with respect to the 
     procedures and methodologies, including qualitative and 
     quantitative models, used by nationally recognized 
     statistical rating organizations that require each nationally 
     recognized statistical rating organization to--
       ``(1) ensure that credit ratings are determined using 
     procedures and methodologies, including qualitative and 
     quantitative models, that are approved by the board of the 
     nationally recognized statistical rating organization, a body 
     performing a function similar to that of a board, or the 
     senior officer of the nationally recognized statistical 
     rating organization, and in accordance with the policies and 
     procedures of the nationally recognized statistical rating 
     organization for developing and modifying credit rating 
     procedures and methodologies;
       ``(2) ensure that when major changes to credit rating 
     procedures and methodologies, including to qualitative and 
     quantitative models, are made, that the changes are applied 
     consistently to all credit ratings to which such changed 
     procedures and methodologies apply and, to the extent the 
     changes are made to credit rating surveillance procedures and 
     methodologies, they are applied to current credit ratings 
     within a time period to be determined by the Commission by 
     rule, and that the reason for the change is disclosed 
     publicly;
       ``(3) notify users of credit ratings of the version of a 
     procedure or methodology, including a qualitative or 
     quantitative model, used with respect to a particular credit 
     rating; and
       ``(4) notify users of credit ratings when a change is made 
     to a procedure or methodology, including to a qualitative or 
     quantitative model, or an error is identified in a procedure 
     or methodology that may result in credit rating actions, and 
     the likelihood of the change resulting in current credit 
     ratings being subject to rating actions.
       ``(s) Transparency of Credit Rating Methodologies and 
     Information Reviewed.--
       ``(1) In general.--The Commission shall establish a form, 
     to accompany each rating issued by a nationally recognized 
     statistical rating organization--
       ``(A) to disclose information about assumptions underlying 
     credit rating procedures and methodologies, the data that was 
     relied on to determine the credit rating and, where 
     applicable, how the nationally recognized statistical rating 
     organization used servicer or remittance reports, and with 
     what frequency, to conduct surveillance of the credit rating; 
     and
       ``(B) that can be made public and used by investors and 
     other users to better understand credit ratings issued in 
     each class of credit rating issued by the nationally 
     recognized statistical rating organization.
       ``(2) Format.--The Commission shall ensure that the form 
     established under paragraph (1)--
       ``(A) is designed in a user-friendly and helpful manner for 
     users of credit ratings to understand the information 
     contained in the report; and
       ``(B) requires the nationally recognized statistical rating 
     organization to provide the appropriate content, as required 
     by paragraph (3).
       ``(3) Content.--Each nationally recognized statistical 
     rating organization shall include on the form established 
     under this subsection, along with its ratings--
       ``(A) the main assumptions included in constructing 
     procedures and methodologies, including qualitative and 
     quantitative models;
       ``(B) the potential shortcomings of the credit ratings, and 
     the types of risks excluded from the credit ratings that the 
     registrant is not commenting on (such as liquidity, market, 
     and other risks);
       ``(C) information on the reliability, accuracy, and quality 
     of the data relied on in determining the ultimate credit 
     rating and a statement on the extent to which key data inputs 
     for the credit rating were reliable or limited (including, 
     any limits on the reach of historical data, limits in 
     accessibility to certain documents or other forms of 
     information that would have better informed the credit 
     rating, and the completeness of certain information 
     considered);
       ``(D) whether and to what extent third party due diligence 
     services have been utilized, and a description of the 
     information that such third party reviewed in conducting due 
     diligence services;
       ``(E) a description of relevant data about any obligor, 
     issuer, security, or money market instrument that was used 
     and relied on for the purpose of determining the credit 
     rating;
       ``(F) an explanation or measure of the potential volatility 
     for the rating, including any factors that might lead to a 
     change in the rating, and the extent of the change that might 
     be anticipated under different conditions; and
       ``(G) additional information, including conflict of 
     interest information, as may be required by the Commission.
       ``(4) Due diligence services.--
       ``(A) Certification required.--In any case in which third 
     party due diligence services are employed by a nationally 
     recognized statistical rating organization or an issuer or

[[Page S5620]]

     underwriter, the firm providing the due diligence services 
     shall provide to the nationally recognized statistical rating 
     organization written certification of such due diligence, 
     which shall be subject to review by the Commission.
       ``(B) Format and content.--The nationally recognized 
     statistical rating organizations shall establish the 
     appropriate format and content for written certifications 
     required under subparagraph (A), to ensure that providers of 
     due diligence services have conducted a thorough review of 
     data, documentation, and other relevant information necessary 
     for the nationally recognized statistical rating organization 
     to provide an accurate rating.''; and
       (7) by amending subsection (m) to read as follows:
       ``(m) Accountability.--
       ``(1) In general.--The enforcement and penalty provisions 
     of this title shall apply to a nationally recognized 
     statistical rating organization in the same manner and to the 
     same extent as such provisions apply to a registered public 
     accounting firm or a securities analyst under the Federal 
     securities laws for statements made by them, and such 
     statements shall not be deemed forward-looking statements for 
     purposes of section 21E.
       ``(2) Rulemaking.--The Commission shall issue such rules as 
     may be necessary to carry out this subsection.''.

     SEC. 4. STATE OF MIND IN PRIVATE ACTIONS.

       Section 21D(b)(2) of the Securities Exchange Act of 1934 
     (15 U.S.C. 78u-4(b)(2)) is amended by inserting before the 
     period at the end the following: ``, except that in the case 
     of an action brought under this title for money damages 
     against a nationally recognized statistical rating 
     organization, it shall be sufficient, for purposes of 
     pleading any required state of mind for purposes of such 
     action, that the complaint shall state with particularity 
     facts giving rise to a strong inference that the nationally 
     recognized statistical rating organization knowingly or 
     recklessly failed either to conduct a reasonable 
     investigation of the rated security with respect to the 
     factual elements relied upon by its own methodology for 
     evaluating credit risk, or to obtain reasonable verification 
     of such factual elements (which verification may be based on 
     a sampling technique that does not amount to an audit) from 
     other sources that it considered to be competent and that 
     were independent of the issuer and underwriter''.

     SEC. 5. REGULATIONS.

       The Securities and Exchange Commission shall issue final 
     rules and regulations, as required by the amendments made by 
     this Act, not later than 365 days after the date of enactment 
     of this Act.

     SEC. 6. STUDY AND REPORT.

       (a) Study.--The Comptroller General of the United States 
     shall undertake a study of--
       (1) the extent to which rulemaking the Securities and 
     Exchange Commission has carried out the provisions of this 
     Act;
       (2) the appropriateness of relying on ratings for use in 
     Federal, State, and local securities and banking regulations, 
     including for determining capital requirements;
       (3) the effect of liability in private actions arising 
     under the Securities Exchange Act of 1934 and the exception 
     added by section 4 of this Act; and
       (4) alternative means for compensating credit rating 
     agencies that would create incentives for accurate credit 
     ratings and what, if any, statutory changes would be required 
     to permit or facilitate the use of such alternative means of 
     compensation.
       (b) Report.--Not later than 30 months after the date of 
     enactment of this Act, the Comptroller General shall submit 
     to Congress and the Securities Exchange Commission, a report 
     containing the findings under the study required by 
     subsection (a).
                                 ______