Make Credit Rating Agencies Collectively Liable for Inaccuracies, Proposes Lawmaker

House Financial Services subcommittee chair Paul Kanjorski introduced a new draft bill that proposes making credit ratings agencies collectively liable for inaccuracies. The agencies received a lot of heat when they failed to properly warn investors about the risks associated with subprime mortgage securities before the market fell.

One problem with the current system is that the firms issuing the securities are the ones paying the credit ratings agencies for rating the securities. Kanjorski’s draft bill lets investors pursue lawsuits against credit rating agencies that recklessly or intentionally did not examine key data to determine the ratings. He says that collective liability could compel the ratings agencies to provide reliable, quality ratings while providing the proper incentive for them to monitor each other.

Critics of the plan, including Republicans and industry executives, warned that collective liability could result in a slew of expensive complaints while decreasing competition even more in an industry that Fitch Ratings, Moody’s Investors Services, and Standard and Poor’s already dominate.

Kanjorski said that his proposal was a “start,” which comes as Congress intensifies its watch over the credit ratings agency industry and the Obama administration calls for stricter government oversight.

Credit ratings agencies are charged with issuing the creditworthiness ratings of securities and public companies. The ratings can impact a company’s ability to borrow or raise funds and determine how much mutual funds, banks, local governments, and state pension funds will pay for securities.

When home-loan delinquencies went up last year, the investments’ value dropped and the credit ratings agencies were forced to downgrade the ratings they gave to thousands of securities. Large banks and investment firms sustained hundreds of billions of dollars in losses because of the downgrades.

Meantime, two former Moody’s employees, former analyst Eric Kolchinsky and former senior vice president for compliance Scott McCleskey, are accusing Moody’s of misconduct, including engaging in conflicts of interest, knowingly inflating ratings, and failing to implement “meaningful surveillance of municipal securities” despite the credit ratings agency’s statements to the contrary. Moody’s acknowledges misjudging the magnitude of the subprime mortgage collapse but says the allegations are “unsupported.”

Recently, the SEC proposed rules that would put a stop to conflicts of interest and allow for greater transparency for credit ratings agencies.

When the subprime mortgage market collapsed, many investor sustained massive financial losses. Our securities fraud law firm is dedicated to helping our clients recover those losses. Contact Shepherd Smith Edwards & Kantas LTD LLP today.

Related Web Resources:
Lawmaker seeks group liability for rating agencies, Business Week, September 30, 2009
The Role and Impact of Credit Rating Agencies on the Subprime Credit Markets, SEC.gov, September 26, 2009
House Committee on Financial Services