Credit ratings agencies caught off guard with repeal of Rule 436(g) of Securities Act of 1933

[ProSense]

From Yves Smith at Naked Capitalism, who never has anything nice to say about the bill: Caught napping, sorry folks…

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Well, I’ll be damned, something got watered up in the final version! Here’s the timeline:

Konczal in May bemoans the absence of the stiff 436(g) language (present in the House Bill), from the Senate Bill.

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

And some time after that, the stiff House language (or something like it, because I still can’t find the final version of the words) gets reinstated: and here we are with the sulking RAs.

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WSJ:

Bond Sale? Don't Quote Us, Request Credit Firms

By ANUSHA SHRIVASTAVA

The nation's three dominant credit-ratings providers have made an urgent new request of their clients: Please don't use our credit ratings.

The odd plea is emerging as the first consequence of the financial overhaul that is to be signed into law by President Obama on Wednesday. And it already is creating havoc in the bond markets, parts of which are shutting down in response to the request.

Standard & Poor's, Moody's Investors Service and Fitch Ratings are all refusing to allow their ratings to be used in documentation for new bond sales, each said in statements in recent days. Each says it fears being exposed to new legal liability created by the landmark Dodd-Frank financial reform law.

The new law will make ratings firms liable for the quality of their ratings decisions, effective immediately. The companies say that, until they get a better understanding of their legal exposure, they are refusing to let bond issuers use their ratings.

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The change caught the ratings agencies by surprise. The original Senate version of the bill didn't include the provision. It was only on June 30, when the Dodd-Frank bill was passed, that the exemption was removed. The Senate passed the amended version on July 15. The offices of Sen. Christopher Dodd (D-Conn.) and Rep. Barney Frank (D-Mass.) didn't immediately respond to a request for comment.

more

Repealed by Wall Street Reform:

SEC. 939G. EFFECT OF RULE 436(G).
Rule 436(g), promulgated by the Securities and Exchange Commission under the Securities Act of 1933, shall have no force or effect.

PDF

Fitch Comments on U.S. Financial Reform Act's Implication for Credit Rating Agencies

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Historically, credit rating agencies have never been treated as experts under the Securities Act, appropriately so since ratings are inherently forward-looking and embody assumptions and predictions about future events that by their nature cannot be verified as facts. While Fitch continues to believe that it is not an expert under the plain meaning of sections 7 and 11 of the Securities Act, it is Fitch's understanding that, absent clarification by the U.S. Securities and Exchange Commission (SEC), immediately after the Dodd-Frank Bill is signed into law an issuer will need to obtain Fitch's written consent to include a Fitch credit rating in a Securities Act registration statement and any related prospectuses. If Fitch provides its consent for ratings to be included into Securities Act registration statements or prospectuses, Fitch will be potentially exposed to 'expert' liability under section 11 of the Securities Act, liability to which Fitch is not currently exposed. Fitch is not willing to take on such liability without a complete understanding of the ramifications of that liability to Fitch's business and the means by which Fitch may be able to effectively mitigate the risks associated therewith. While Fitch will continue to publish credit ratings and research, given the potential consequences, Fitch cannot consent to including Fitch credit ratings in prospectuses and registration statements at this time.

In addition, the Dodd-Frank Act directs the SEC to remove the exemption for credit rating agencies from the SEC's Fair Disclosure Rule (Regulation FD) within 90 days of the enactment of the Dodd-Frank Act. The exemption for credit rating agencies from Regulation FD permits issuers to provide the credit rating agencies with material non-public information without requiring public disclosure of such information. To the greatest extent possible, Fitch will work with the issuer community to put in place appropriate mechanisms so that Fitch can continue to receive confidential information as part of the rating process.

Issuers should consult their legal counsel with respect to the effect of these issues on the issuer and any planned securities offerings.

[Uben]

1. MAkes one think.....

...that maybe these ratings agencies might have been selling their ratings to the highest bidder, something that now might land them in legal trouble. TAlk about a scam! Somehow I figure they'll find a way to get around the new legislation. They always do.

[dkf]

2. Lol I love this! Wow I didn't think I would be very impressed by this bill but I'm beginning to

Like this part a lot.

[Democrats_win]

3. Not standing behind their product, does this mean they're frauds?

[unblock]

5. they've always claimed that their ratings are merely their free speech opinions

their position has always been, if our ratings fail you, shrug, it was just our opinion, your fault for betting your life savings on it.

to be fair, they don't get paid nearly enough to tolerate liability for the massive deals they rate. a typical fee might be $75,000 for a $500,000,000 deal. that pays for the work and some decent profit, but it doesn't come close to paying for even a tiny percentage chance of getting sued for the loss of tens or hundreds of millions of dollars. if they got sued and had to pay $15,000,000 (a 3% loss for the investor) for one deal out of every 200, that would wipe out 100% of their fee revenue.

in practice, that means they would have to hike their fees, probably double them, to pay for some serious errors and omissions insurance. that, in turn, would make many worthwhile deals become prohibitively expensive. of course, the bigger deals would still get done, but the smaller deals wouldn't (because the fixed costs to do the deal are too great on a percentage basis), meaning that the smaller companies suffer but the bigger companies don't really suffer much. in an environment that already favors big companies too much, this is just more bad news for the economy.

[UpInArms]

4. the ratings agencies were part of the big swindle

and this is just beeee-uuuuu-ti-ful!

No more hiding in plain sight for these shysters!

Good on ya - Frank/Dodd!

[rucky]

6. They were the lynchpins.

It couldn't have happened without their help.

[uponit7771]

11. They were the root cause, not just a part of it. Without their ratings the MBS's can't sell and they

...told the banks they change their rating model for houses to some random shit.

[Hydra]

7. *laughs*

Good to see them running scared.

That said, maybe this industry will now disappear because they might be legally liable?

[davidpdx]

8. I think the title "Caught with their pants down" would have been much funnier

[ProSense]

9. Yeah, maybe the title isn't catchy enough.

:)

[uponit7771]

10. This itself is land mark "new law will make ratings firms liable for the quality of their ratings"

That means there's going to be either some real lobbying to get this repealed or the rating agencies will have to back up the ratings with facts or at least some real hit miss ratios

[ProSense]

13. Add this to the list of good things in the bill

including the:

• Kanjorski Amendment
  
  
• Collins Amendment
  
  
• Durbin Amendment
  
  
• Consumer Financial Protection Bureau

[uponit7771]

15. I get the feeling we wont get everything with any bill but we'll get net positive and that's

...a start.

I've really enjoyed voyouring ....er keeping up with the Obama presidency

[alcibiades_mystery]

14. They actually have to do the job they claim to be doing

Which is to review the underlying securities and the assets backing them (when the securities are packages), determine the quality of the collateral assets, and rate according to actual, real, grounded, like - y'know - fucking due diligence. What an extraordinary burden to place on companies that claim to, well, DO JUST FUCKING THAT.

And already, the landmark financial legislation massively changes the game for players who would otherwise skirt the spirit of their role in financial transactions. So much for the "industry-friendly" do-nothing law so many on these boards have been yqapping about endlessly.

Here's another effect of this, down the pipeline: if an issuer actually wants to price the bonds effectively, it will have to do it's own due diligence on the underlying assets, or risk a low rating and more expensive issue before closing. Duh. This is what they should have been doing all along, needless to say, and I say that as somebody that's done actual due diligence on ABS - to wit, thumbing through 1000 Mack truck loans to see which were paid-to-date and which were fucking trash. It takes all day, I'll tell you, but at the end of the day you actually, well, fucking know the value of the assets you're selling. And if issuers have to do that, so do underwriters. And if the issuers and underwriters are doing it, then that filters down to the people giving the loans in the first place, if they know they can't unload shit mortgages and loans on an issuer who won't take them.

This is a crucial element of the legislation because it forces changes in behavior all the way down. Specifically, it forces changes in precisely the type of behavior that caused the financial crisis in the first place. It's brilliant, which is why we're already seeing the resistance.

[depakid]

12. I'll drink to that-

Removing the inherent conflicts of interest which Barney Frank dispensed with after having "the 60 votes" would be that much better.