When Dodd-Frank passed, I said that the legislation was not a bill but a plan to write a bill later. Dodd-Frank had dozens of studies and rules that would be written and implemented by regulators. The legislation would offer a rough guideline, but ultimately it would be up to the regulators to actually determine whether or not it would make a difference.

We have some preliminary results on that front and they’re not great. But I want to focus on the credit rating agencies and their conduct, because that’s a crucial piece of the puzzle in understanding the financial crisis. The rating agencies, as you know, have an issuer-pays model on its structured finance products. In other words, they rate the products of companies who pay them for the rating, and the more favorable they are toward those companies, presumably the more business they get. This is a massive conflict of interest in the rating agency model, and it has been exposed by rating agency insider accounts and through the work of Carl Levin’s Permanent Subcommittee on Investigations. And it continues to this day. Nothing has really changed at the rating agencies; we learned yesterday that they are still giving triple-A ratings to subprime mortgage backed securities.

Sen. Al Franken wrote an amendment to Dodd-Frank that would change the issuer-pays model, creating a rating agency board that would assign structured finance products to rating agencies at random (UPDATE: it’s not quite random, it would be based on a criteria set by the rating agency board), and which over time would take into account the accuracy of the rating agency’s work in determining how much business they would get. “This would eliminate the model of pay-for-play, and institute a model of pay-for-performance,” said Franken on a conference call today to update the status of rating agency regulation in Dodd-Frank.

Unfortunately, despite passing, Franken’s rating agency overhaul amendment was “downgraded,” as he put it, into a study. However, the study, once it is carried out, must come up with a structure to change the issuer-pays model if the conflict of interest is found to still be evident in the way rating agencies do business. Franken said today that the rating agencies remain “fundamentally flawed,” and that the conflict of interest is still readily apparent. “Dangers still persist,” Franken said. “I’d be kind of amazed if the study didn’t conclude that and lead to a change in the law.” Franken didn’t even know what there is to study. “It’s like asking, did Barry Bonds hit over 70 home runs in a season because he used steroids? Well, yeah!”

Outside of the study, the only rules in place for the rating agencies have been proposed by the SEC. And they fall woefully short of what’s needed to reverse the fundamental design flaw. Rating agencies already rebelled at the SEC for attempting to increase liability on them for bad ratings, threatening to essentially shut down the entire asset-backed securities market. The SEC relented, and while the rest of their rules are OK on transparency, none of them address the fundamental conflict of interest. The Office of Credit Rating Agencies mandated by Dodd-Frank hasn’t even been set up, because the House has not authorized the funding. The rules were written by the division of trading and markets, which may not have the necessary expertise or independence in this area.

Franken said that he is waiting for the outcome of his study; public comment on the study closes September 13. After that, if the SEC fails to address the conflict of interest, he plans to “hold their feet to the fire,” including potentially creating a standalone bill modeled on his amendment.

The Franken amendment would not deal with how rating agencies address sovereign debt, which S&P dealt with when they downgraded US Treasuries. But Franken did say that his legislation would reduce the power of the “oligopoly” of the three big rating agencies, power which may have played a role in the debt downgrade. “I’m not big on conspiracy theories, but there’s a case to be made that S&P was saying to Treasury and the SEC, ‘if you implement the Franken amendment, watch out,’” Franken said. He added that the immediate $2 trillion error found by Treasury in S&P’s debt downgrade analysis shows the “culture of incompetence” that has sprouted up at the rating agencies, and if the agencies have to compete on performance and quality, that would change.

The SEC will have trouble just funding themselves for ongoing operations, let alone taking on increased responsibility with the rating agencies or establishing new divisions. But the rating agencies were at the heart of the crisis, and they have not been touched so far by the reform legislation.