House to Discuss Muni Rating Legislation

A House Financial Services Committee panel will hold a hearing today on draft legislation that would both ensure municipal bonds are rated the same way as other securities and expose the rating agencies to significant liability for issuing faulty ratings.

The hearing will be held by the House Financial Services subcommittee on capital markets, whose chairman, Rep. Paul Kanjorski, D-Pa., recently released a 43-page "discussion draft" of the legislation. The measure also would subject nationally recognized statistical rating organizations to a new "mutual liability standard" that would make them each responsible for one another's ratings.

Under the "mutual liability" concept, if a plaintiff sues an NRSRO and wins a monetary judgement but is unable to recover the full amount of money from the rating agency, all NRSROs would be jointly liable for the judgement.

Kanjorski's proposal appears to go far beyond a credit rating agency bill introduced in the Senate in May by Sen. Jack Reed, D-R.I., as well as an Obama administration's proposal for rating agency legislation that was released this summer.

The administration's bill is silent on liability. While Reed's bill would expose the rating agencies to greater liability to suits brought by private parties, the agencies would be exempted from the lawsuits if they performed due diligence on their ratings.

But securities law experts said yesterday that the discussion draft of the Kanjorski bill does not appear to include a "safe harbor" provision like the one in the Reed bill.

Currently, NRSROs are shielded from liability under the federal securities laws.

Securities experts panned the idea of mutual liability, which they said would only raise barriers for new rating agencies and would unfairly expose NRSROs to financial harm if a deficient competitor led a so-called "race to the bottom" in standards that others resisted.

John Coffee, a professor at Columbia University Law School, said the provision is "a mistake" that would effectively make NRSROs joint insurers of each other.

"We have not done that for any other gate-keeping industry," he said.

The Kanjorski bill also includes provisions from the Municipal Bond Fairness Act, which was introduced earlier this year by Massachusetts Democrat Michael Capuano, who also is a member of the House Financial Services Committee.

The measure is designed to pressure rating agencies to give municipalities higher ratings, which would allow some lower-rated issuers to forgo the expense of bond insurance to sell their debt.

Under the provisions, NRSROs would be required to rate "securities and money market instruments" based on the likelihood that investors "may not receive payment in accordance with the terms of issuance." The draft legislation also would require the rating agency to "define clearly any rating symbol" used by it and apply it consistently to "all types" of securities and money market instruments. The agencies could still provide "complimentary" ratings to measure volatility or other risks, however.

At least two of the agencies - Moody's Investors Service and Fitch Ratings - rate municipals on a separate, more rigorous scale than other bonds. Though they have both committed to switching to a "global" scale for muni credit, they have delayed these efforts, citing market turmoil created by the financial crisis. Standard & Poor's maintains that it already uses a single, global scale for its ratings.

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