Bloomberg is reporting that new efforts are being made in Congress to rein in the dominant rating agencies… specifically it looks like legislation would remove the First Amendment protections that raters have stood behind when deflecting liabilities for their opinions… this would be a substantive change in the business and welcome…
By Jesse Westbrook
April 1 (Bloomberg) — U.S. Senator Jack Reed has circulated a draft bill that would open the door for investors to seek legal damages from credit-rating companies after the firms drew criticism for giving top grades to asset-backed debt.
Investors could sue companies including Moody’s Investors Service and Standard & Poor’s when the firms don’t conduct “reasonable” examinations of banks’ assurances of the debt before issuing a grade, according to a copy of the bill obtained by Bloomberg News. The companies would avoid litigation by doing the reviews, or by obtaining assessments from independent firms.
Credit-rating companies have come under fire after pension funds and other investors bought AAA-rated securities that were backed by mortgages on which delinquency rates soared. Reed, a Rhode Island Democrat, may be betting that the risk of legal costs will lead the companies to improve their accuracy, said Adam Pritchard, a law professor at the University of Michigan.
“It’s trying to punish ratings agencies for having missed the subprime crisis,” said Pritchard, a former U.S. Securities and Exchange Commission lawyer. Litigation “changes corporate behavior in situations where there is a cost-effective way of reducing the incidence of bad behavior.”
Reed’s draft follows efforts by the SEC, which oversees credit-rating companies in the U.S., and European regulators to reduce industry conflicts. The U.S. House also is considering legislation to impose limits on the industry.
Jennifer Berlin, a spokeswoman for Reed, declined to comment on the draft legislation because the bill hasn’t been introduced. S&P spokesman Edward Sweeney also declined to comment and spokesmen for New York-based Moody’s and Fitch didn’t return e-mails and telephone calls seeking comment.
Moody’s fell $1.38, or 6 percent, to $21.54 at 4:15 p.m. in New York Stock Exchange composite trading, and McGraw-Hill Cos., parent of Standard & Poor’s, rose 12 cents to $22.99, and earlier today slumped as much as 1.8 percent.
Credit-rating companies have fought lawsuits by arguing that the letter grades they assign to bonds to identify the risk of default, with AAA considered least likely to fail, are opinions protected by the First Amendment of the U.S. Constitution.
Reed’s measure seeks “to get rid of that protection for ratings,” said Joseph Mason, a banking professor at Louisiana State University who helped write a 2007 study on ratings companies. “When experts begin charging for their opinions there is, in my view, at least a little bit of liability for those opinions.”
Reed’s legislation would allow investors to seek monetary damages if credit-rating companies “knowingly or recklessly” failed to evaluate the mortgages, credit-card debt and other loans that make up asset-backed securities.
U.S. Representative Gary Ackerman, a New York Democrat, proposed legislation in February that would prohibit companies from issuing SEC-recognized rankings on debt securities without a “documented history” showing how the “pool of assets” would likely perform. Ackerman’s House measure doesn’t include a provision on legal liability.
Since the collapse of the U.S. subprime mortgage market in 2007, demand for debt packaged into securities has declined. Private securitization volumes fell 40 percent to $1.3 trillion last year, according to newsletter Asset-Backed Alert. The total includes $856 billion of debt created by banks to swap for overseas central bank loans, or two-thirds of the total.
Reed’s legislation also would restrict employees from leaving Moody’s, S&P and Fitch for a job at an underwriter. Specifically, the companies would be barred from grading debt sold by a securities firm if the underwriter employed anyone who assessed bonds at the same rating company in the past year.
Ratings companies would be required by the legislation to appoint compliance officers to make sure rankings are free from conflicts. It would also establish an office within the SEC that is responsible for overseeing debt raters.
The SEC in December prohibited those who assess debt from discussing compensation with bankers seeking a letter grade on bonds they intend to sell. The agency also restricted gifts from underwriters to rating-company employees.
The SEC is seeking public comment on a proposal that would force credit-rating companies to disclose the data that goes into rankings. The agency says that change would encourage unsolicited ratings by letting companies grade bonds even if they weren’t paid by those trying to sell the securities.
SEC Chairman Mary Schapiro is considering further reforms, saying in a February speech that she would “address the inherent conflicts of interest credit-rating agencies face as a result of their compensation models.” Lawmakers including U.S. Senator Richard Shelby, an Alabama Republican, have said ratings companies are compromised because the same banks that sell bonds pay Moody’s, S&P and Fitch Ratings to grade them.
Reed’s legislation asks the SEC to design a payment structure that creates “incentives for accurate ratings” and requires ratings companies to monitor grades to make sure their assessments on creditworthiness hold up over time.”~~~~