“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  

Category: Credit, Legal, Regulation

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14 Responses to “Time for Legal Liability for Rating Agencies”

  1. Barry,

    I know MH didn’t publish your book, but you are far better off without them.

    That aside, I do agree. But ratings agencies are just typical of business as usual. the banks cheat their customers, the oil companies lie about safety and clean-up procedures. Why should ratings agencies be any different?

    My true, and totally naive questions are:

    Why has integrity disappeared from American life?
    Why are people unwilling to give an honest day’s work for the money they earn?
    Why the shortcuts?

  2. Transor Z says:

    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.

    The author’s observation cuts both ways. Sometimes the courts giveth and sometimes they take away. For folks who don’t know how corporate compliance works (most here probably do), after new laws and implementing regulations come into play, a company gets a legal opinion from outside counsel. Using this opinion the companies tweak their policies. Sometimes they even have to modify their business model (what we want to see here).

    As always, companies will vary in their appetite for risk in “pushing the envelope” jockeying for competitive advantage (l/t and s/t). Courts hopefully clarify the envelope over time. It may turn out to be more or less restrictive than originally thought. It always comes back to corporate culture and appetite for risk in the face of the unknown.

  3. dave says:

    I second the motion, the behavior of these firms was criminal and they should be held accountable.

  4. “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.””–from the Quote, above..

    speaking of naive..

    “You mean the ‘Ratings ‘Problem’” was gifted, to us, by the same “Gov’t” that, now, is proposing a “Fix”?

    “That’s some mighty fine Windowdressing..”

  5. JustinTheSkeptic says:

    Warren, owns/owned them so they will get a pass. OK, they’ll get the all too familier Washington tongue lashing, so that the masses can be hoodwinked again, but not much else.

    Side Note: has anyone else noticed how the headline news – AP, Bloomberg, etc., are trying to only see the glass as half full lately. I mean overly so…things must really be at their boiling point. How about Obama’s letter to the G-20? Ponzi would be proud of these people. Keynes is dead.

  6. Ole Drippy says:

    Why should this be a new thing? Is negligence not negligence?

    Negligence: “The failure to use reasonable care. The doing of something which a reasonably prudent person would not do, or the failure to do something which a reasonably prudent person would do under like circumstances. A departure from what an ordinary reasonable member of the community would do in the same community.”

  7. peter north says:

    Hey Barry –

    Instead of trying to reform a fatally flawed model, why can’t we just admit the rating agencies have become harmful and unnecessary relics?

    It seems to me there is already a better way… All we have to do is standardize credit default swaps and mandate that they be traded over an exchange, with a clearinghouse intermediary (like puts and calls). I presume we would just pay the fee to get the real time data (until Google figured out a way to give it away), and viola! We have a better (pros betting real money) barometer for default risk, minus the conflicts of the current model, and best of all, it is in real time!

    Wouldn’t that make the rating agencies obsolete? Their ratings are too late, and of dubious value, so why try to salvage them?

    Sure, pension funds, etc. would have to move away from the rating agency letter grade parameters (e.g., can only buy AAA paper), but that seems easy… just put the parameters in CDS spread bps terms (e.g., can only buy paper 100 bps riskier than the comparable US debt).

    If this is naive, I apologize. But this seems like a total no-brainer from where I’m sitting, so I can’t understand why we are trying to “fix” these damn things…

  8. [...] liability and scrutiny for most of the post-crisis period,” FusionIQ CEO Barry Ritholtz writes. But that may be coming to an [...]

  9. erb2 says:

    From the Office of Senator Cantwell: “I am proud that the Senate unanimously passed my amendment to fight manipulation in futures and derivatives markets by giving the Commodity Futures Trading Commission strong authority to combat fraudulent or deceptive market practices. The Senate also passed two other amendments I co-sponsored. The first would remove the federal government’s “seal of approval” from investment rating agencies and force federal regulators to develop more diverse and accurate measures of credit worthiness. The second provides strong protections for “angel investors,” while promoting small business startups vital to job creation.”

    Did that die stillborn?

  10. dsawy says:

    I’m guessing not much will happen.

    Think about the consequences of what would happen if we were able to tell these clowns “tell the truth or else!”

    1. Muni bonds would have lower ratings than they now do. State/city/county borrowing costs would go up as the ratings went down. Huge political fracas would erupt from the states/cities/counties towards DC, telling them to “do something!” and we’d see the same sort of thing happen as happened with Mark to Market: suspension to allow the states/cities/counties “to get their houses in order.”

    2. Corporate borrowing costs would go up too. And that would suck money out of the Real Economy, which would cause a further downward pressure on the small uptick in positive private sector data we’ve seen. Complaints would ensue, see (1) above. Lather, rinse repeat.

  11. philipat says:

    It’s a business model that has always had inherent conflicts. These surfaced with the crisis of morality in the US, lead by Washington. The problem is that a better model is not immediately obvious, which suggests that we should probably find a way to live without ratings in their present form.

    In the meantime, nobody would take seriously a restaurant review paid for by the restaurants involved, so why would ratings be any different?

  12. Fred C Dobbs says:

    The rating of a rating agency is only as good as the future assets the rating agency may have to satisfy a judgment against the rating agency for a negligent or fraudulent judgment, other wise the rating is worth nothing. It always has, and always will be. Nothing changes.

  13. DeDude says:

    Force them to sell CDS at a rate that correspond to their ratings. There is noting that could shape them up better than forcing them to put their money where their mouth is. As a matter of fact we don’t need ratings if we had a fully regulated open market for CDS.

  14. [...] Ritholtz spots some late tightening fiddling with this part of the Bill in mid-June. [...]