House Financial Services Committee passes rating agency bill

Controversial measures to hold rating agencies jointly liable in any securities fraud action have been dropped from a bill designed to curb the "inappropriate and irresponsible actions" of rating firms, which passed the US House Committee on Financial Services last month.

In a 49-14 vote on October 28, the committee passed the Accountability and Transparency in Rating Agencies Act, which will compel the Securities and Exchange Commission to review the methodologies and procedures of nationally recognised statistical rating agencies (NRSROs), mandate that at least one third of a rating agency's board of directors are independent, and require NRSROs to designate a compliance officer to address potential conflicts of interest.

The bill was based on a discussion draft introduced on October 16 by Paul Kanjorski, chairman of the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises. However, this draft contained few of the controversial proposals included in an earlier version, published by Kanjorski on September 25.

The September draft included a requirement for rating agencies to share information with each other, and conduct due diligence on ratings assigned or revised by rival firms. This obligation would have formed the basis of an even more contentious clause, which would have made NRSROs jointly liable in securities fraud actions against one agency, if that firm was unable to meet the full cost of any damages itself.

This version of the bill sparked strong protest from senior rating agency officials, who claimed the information-sharing and collective liability clauses were unjust and would damage their business. Meanwhile, some lawyers speculated the more controversial elements were part of a political ploy to force concessions from rating agencies. "This is obviously a case of a shot across the bow, but what is different on this case is that a shot across the bow is not normally done with a nuclear missile," says Dan Crowley, a partner at law firm K&L Gates in Washington, DC, speaking before the passing of the final draft on October 28.

While many of the most controversial elements were removed in the October 16 version, there remain some clauses aimed at increasing accountability of rating agencies. Specifically, the final draft clarifies the ability of individuals to sue rating agencies and lowers the pleading standard for legal actions. Under the new rules, it will be sufficient for a complaint to state facts that give rise to a "strong inference that the nationally recognised statistical rating organisation knowingly or recklessly violated the securities laws".

"This legislation builds on the administration's proposal and takes strong steps to reduce conflicts of interest, stem market reliance on credit rating agencies, and impose a liability standard on the agencies. As gatekeepers to our markets, credit rating agencies must be held to higher standards. We need to incentivise them to do their jobs correctly and effectively, and there must be repercussions if they fall short. This bill will take such steps," said Kanjorski.