Credit rating agencies Moody's and Standard & Poor's have nebulous legal status where they are officially sanctioned raters of creditworthiness among businesses and municipalities but also publishers of opinions. That status could change, according to a Fortune article by Ken Stier .
In Congress, the draft financial reform bills could increase liability, unless agencies can show adequate due diligence. Lowering their liability standard to gross negligence -- as Barney Frank's bill currently does -- "could well drive credit agencies out of structured finance," warns John Coffee Jr., a Columbia Law professor and expert in this area. Any new congressional-set liability on agencies' speech could be fought all the way up to the Supreme Court, which is where the industry has promised to go if necessary.
The agencies are currently targets of investor lawsuits claiming they fraudulently or negligently gave high ratings to about-to-fail financial products prior to the meltdown. The agencies' defense has been that their products are First Amendment-protected opinion.
That official sanction, however, is complicating matters legally as Stier reports.
The investor lawsuits claim the actual fraud occurred in the wildly unreasonable assumptions made in ratings, particularly about default rates and correlations, explains Patrick Daniels, an attorney with Robbins Geller Rudman & Dowd, which is representing the plaintiffs in the so-called Rhinebridge case, the one which Judge Shira Scheindlin allowed to go forward. Daniels argues Moody's and S&P colluded with investment banks by blessing their bonds with inaccurate and undeserving ratings, without which the banks had no chance of selling those securities.
The free ride may be coming to a close as frustrations with the state of the financial system rise. Moody's and S&P spokespeople have almost no visibility in the article - basically bunkered behind their lawyers.
When I represented Moody's back in the 1990s, I asked my contact there why they rated municipal bonds when there had only been two defaults in U.S. history, both to AAA rated debt. I was asked not to ask that question. Seems like someone who matters finally is.
Ken Stier wrote in to (very) politely ask that I spell his name correctly. I have updated the post.
Posted by: Sean Dougherty | 05/19/2010 at 11:45 AM