Time for Legal Liability for Rating Agencies

“Ratings firms fear litigation more than they fear regulation because past regulation efforts haven’t “been that draconian.”

-Scott McCleskey, a former Moody’s compliance officer who has testified before Congress about the industry.


Of all the various contributors to the financial crisis and economic collapse, none loom larger than the Ratings Agencies. They were the prime enablers of the entire crisis, allowing global asset managers to purchase all manner of junk paper due to their triple AAA rating. Had these various securitized RMBS been rated properly, i.e., reflecting their true value and risk factors, most of the crisis would have been avoided.

The big 3 ratings agencies have escaped much blame, liability and scrutiny for most of the post-crisis period. As Columbia Law School professor John Coffee noted, the credit rating agencies have been “essentially liability proof and it’s not because they’re infallible.”

Until now.

There is a new move afoot to slap ordinary liability on rating agencies for the results of their ratings:

“Credit-rating firms are a big step closer to facing a harsher liability standard on their work. But it could take years for courts to decide what the planned rules mean.

A panel of Senate and House lawmakers negotiating final details of a financial-overhaul bill agreed this week to allow investors to bring legal action against credit-rating firms that “knowingly or recklessly” fail to “conduct a reasonable investigation of the rated security.”

The new standard, if passed into law, likely would make it easier for investors to sue the ratings companies, such as McGraw-Hill Cos.’ Standard & Poor’s and Moody Corp.’s Moody’s Investors Service, which for long have enjoyed near immunity from liability for ratings gone awry.”

Some of the problems of this legislation are obvious: Defining what is a “reasonable investigation” is far too ambiguous, and should be more clearly defined by Congress.

More importantly, the proposed rule changes do not impact the past actions crimes of the ratings agencies — namely, the charge of selling their ratings to the highest bidder. But for this legal Payola, most of the crisis would have been avoided.


Legal Fights Loom Over Ratings-Firm Liability Rule
WSJ, JUNE 18, 2010  

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