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Congress Agrees on Rater Liability Standard

Source: WSJ

Posted on 17 Jun 2010

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House and Senate lawmakers have agreed to a liability standard for credit-rating firms, saying that investors can sue them if their views of financial products are deemed "grossly negligent."

But negotiators on a broad financial-overhaul bill dropped a broader liability standard that the ratings firms had deemed problematic.

Lawmakers also agreed to establish a new quasi-government entity designed to address conflicts of interest inherent in the credit-ratings business after the Securities and Exchange Commission studies the matter.

The liability standard is a win for credit-rating agencies, which had protested against the Senate's liability provision, fearing that it would increase their chances of being sued. Senate lawmakers agreed to accept the House version.

House Financial Services Committee Chairman Barney Frank (D., Mass.) said the agreed-upon language removes exemptions for ratings firms. "There will be no carve-outs for them," he said.

Credit-rating firms said they would produce fewer analyses of financial products under the Senate's standard because they could be sued if plaintiffs believe the firms knowingly and recklessly failed to conduct a reasonable investigation.

That "reasonable" standard is lower than the one to which auditors or equity analysts are subjected, and ratings firms believe it discriminates against credit raters.

The liability accepted by the House and Senate lawmakers, by contrast, would allow an investor in a rated security to sue if a rating is "deemed grossly negligent and a substantial factor in the economic loss of the investor."

The deal comes after members of the conference committee working out the final version of the financial-overhaul bill voted to replace the proposed new regulatory body with a study. Conferees were at an impasse on liability standards.

Senate Banking Committee Chairman Christopher Dodd (D., Conn.) said that he had worried about mandating a new credit-rating clearinghouse without some analysis of whether such an entity was feasible.

Under the new agreement, the SEC will be required to implement the proposed new clearinghouse after it studies the issue, unless it determines that an alternate mechanism is more appropriate.

Credit-rating agencies have warned that the proposed new regulatory body would have unintended consequences.

But the credit-rating industry has come under fire in the wake of the 2008 economic meltdown. Policy makers say they failed to detect the weakness of securities based on risky mortgages and other loans.

The proposed new regulatory body for credit-rating agencies was an amendment offered by Sen. Al Franken (D., Minn.). Its intent is to limit conflicts in the existing system in which Wall Street firms pay for ratings and can shop around for the best score.