WASHINGTON - The Treasury Department yesterday sent Congress draft legislation designed to strengthen federal oversight of credit rating agencies, mitigate conflicts of interest, increase the transparency of the ratings process and reduce investor reliance on ratings.

Sources said House Financial Services Committee chairman Barney Frank, D-Mass., will consider adding to the measure legislation he introduced earlier this year that would require the rating agencies to rate municipal bonds more similarly to corporate debt, based only on the likelihood of timely repayment to investors.

Michael Barr, Treasury assistant secretary for financial institutions, told reporters during a briefing that the department consulted extensively with the Securities and Exchange Commission on the draft legislation and that the Obama administration also strongly supports pending SEC rule changes for the rating agencies.

The administration's bill would require all credit rating agencies to register with the SEC and would establish a dedicated office within the commission to supervise the agencies. It calls for the SEC to require each rating agency to document its policies and procedures for determining ratings and mandates the commission to examine each rating agency's internal controls, due diligence and implementation of rating methodologies.

To minimize conflicts of interest, the legislation would bar rating agencies from consulting with any company they rate and would prohibit or require the disclosure and management of conflicts resulting from fees paid, business relationships, or affiliations.

Each rating agency would have to disclose the fees paid by an issuer for a rating as well as the total amount of fees the issuer paid to the agency during the previous two years. In addition, under a draft "look-back" provision, if a rating agency employee was hired by an issuer the rater would have to review all of its ratings for the issuer to ensure there was no undue influence on them.

Asked if the Treasury considered other models than the one where the issuer pays, Barr said yes, but that the department found each had potential conflicts of interest. If an investor paid for ratings, it would not want the rating agencies to lower the ratings of any securities it had purchased, he said.

The draft legislation would try to deter issuers from shopping for preferred ratings by requiring them to disclose all preliminary ratings they obtain from different rating agencies. In addition, the legislation would require rating agencies to issue reports with ratings assessing the reliability of the data, the probability of default, the estimated severity of loss in the event of default, and the sensitivity of the rating to changes in assumptions. Raters also would have to come up with different symbols for structured products that would distinguish them from other securities, such as corporate bonds.

Barr stressed that the administration is not proposing to change the substantive methodology of the ratings process, only increase its transparency.

To reduce reliance on the rating agencies, the legislation would require the Treasury, SEC and President's Working Group on Financial Markets to determine where references to ratings can be removed from federal regulations. The draft bill also would require the Government Accountability Office to study and issue a report on the reliance on ratings in federal and state regulations.

Barr noted that the SEC's proposed changes to money market fund rules asks for public comments on how to reduce the reliance on ratings in the rules.

Asked why the administration did not propose allowing investors to sue the rating agencies, Barr said it did not want to "overly inflate the role of the credit rating agencies" and encourage "blind faith" in their ratings.

Andrew Ackerman contributed to this story.

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