Of DOW JONES NEWSWIRES
~~~~ “WASHINGTON (Dow Jones)–Credit-rating agencies could become more susceptible to class-action lawsuits if they knowingly or recklessly misrepresent the risks of the securities they rate under a pending Senate proposal.
Sen. Jack Reed, D-R.I., who chairs the Senate Banking Securities Subcommittee, included that provision in his new draft bill, which aims to expand regulation over credit-rating agencies such as Standard & Poor’s, Moody’s (MCO) and Fitch Ratings.
The bill’s section on private actions would represent a major change in the law for credit-rating firms. They now enjoy the same kinds of protections against securities class-action cases that all publicly companies were granted in the Private Securities Litigation Reform Act of 1995.
“This is clearly an effort to get them to act right,” said Todd Cranford, an attorney at Patton Boggs who formerly worked for House Financial Services Chairman Barney Frank, D-Mass. “The fear of litigation has often been used as a disinfectant.”
The draft bill essentially carves out rating firms from those litigation protections and subjects them to possible suits if plaintiffs can produce facts showing the rating agencies “knowingly or recklessly failed” to conduct a “reasonable investigation” of a rated security either using their own methodology or in relying on information from third parties.
Stephen J. Crimmins, a partner at Mayer Brown, said he suspects most people would not disagree that credit-rating firms should conduct “reasonable investigations” before issuing ratings. But singling out credit-rating firms with this legislation would likely provoke strong debate.
“The question is whether credit-rating agencies should be treated differently from all other defendants in securities class-actions,” Crimmins said.
At this point the bill has not yet been introduced and it remains unclear if the provision on securities legislation will remain. A spokesman for Reed declined to comment because it is still in draft form.
But as written, the bill would go beyond just making it easier to sue rating agencies by also drastically expanding the regulations, which were imposed on credit-rating firms in a 2006 bill.
Unlike that legislation, which sought to minimize conflicts of interest, promote competition and bolster disclosures, this version would require the Securities and Exchange Commission to take a much more direct role in overseeing how firms rate securities.
It would require the SEC to promulgate more rules on conflicts of interest and also create a special office to oversee how ratings are determined to ensure they are “informative, accurate and free from conflicts of interest.”
“It puts the bureaucracy of the SEC in charge of how to do ratings, which assumes they could somehow do ratings better than somebody else,” said Alex Pollock, a fellow at the American Enterprise Institute. “I don’t think there is any evidence anywhere to suggest that would be true.”
Credit-rating firms have been under attack since the financial crisis began by critics who say they exacerbated the problems by providing overly-generous ratings to debt.
Moreover, some are concerned about the business models of certain rating firms in which issuers of securities pay the firms to rate them – a model critics say creates an inherent conflict.
SEC Chairman Mary Schapiro has hinted to lawmakers she may ask for additional regulatory over the firms beyond the scope of the 2006 bill. She has also expressed interest in exploring potential changes to compensation models, and has organized a roundtable event April 15 to discuss the oversight of credit-rating agencies.
Sean Egan, whose credit-rating firm Egan-Jones has an investor-paid model, said he thinks the bill fails to address the conflicts surrounding the issuer-paid business model.
“I think it’s laudable [Reed] is trying to address the problem because the current situation is unsustainable,” Egan said. “But this is not a preferred solution. In my mind it will in fact silence timely and accurate rating firms such as Egan-Jones.”
Spokesmen from Standard & Poor’s and Moody’s declined to comment. Representatives from Fitch Ratings could not be immediately reached.
Despite the current political climate, Cranford said he is not confident this credit-rating bill will move right away.
“I’m still not sure how quickly something like this will move given they are trying to coordinate their efforts to modernize the financial system,” Cranford said. “The desire to take a holistic view of the regulatory scheme may caution them and slow down particular pieces of legislation like this right now.”~~~~
-By Sarah N. Lynch, Dow Jones Newswires; 202-862-6634; email@example.com