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Moody’s Escapes SEC Lawsuit, Now Moves to Shield Itself From Liability

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Current and former executives of credit rating agencies are sworn in during a hearing before the House Oversight and Government Reform Committee on Capitol Hill on Oct. 22, 2008. (Alex Wong/Getty Images)

Sept 2: This post has been updated.

Despite allegations that Moody’s Investors Service, one of the three major credit rating agencies, committed fraud when it failed to fix what it knew was an erroneous rating, the Securities and Exchange Commission announced on Tuesday that it wouldn’t sue the rating agency. It instead settled for a scolding, directed at ratings agencies generally.

Historically, rating agencies have argued with some success that the First Amendment protects their ratings, but much of the examination done after the financial meltdown has cast blame on the agencies for caving into pressure from investment banks and compromising standards in order to preserve market share. It has also brought a string of lawsuits from investors and issuers alike.

States and local governments have recently noticed, however, that Moody’s is including in its contracts what’s known as an “indemnification clause,” which helps protect the agency from lawsuits, according to Bloomberg.

The clauses, Bloomberg explained, push liability onto the issuers; in the municipal bond market, lawsuits that hold the issuer responsible for bad ratings could ultimately cost taxpayers.

Moody’s acknowledged the clauses, but said they’re not new.

“These types of indemnification clauses are common in business services agreements,” said Moody’s spokesman Michael Adler told Bloomberg.

And it seems Moody’s hasn’t been alone in seeking some measure of legal protection:

“Fitch has long included indemnification language in some of its general business agreements,” said Daniel Noonan, spokesman for the company in New York. “However, Fitch has not included indemnification language in its issuer agreements.”

S&P has entered into “revised agreements with many issuers over the last several months,” said spokesman Edward Sweeney in New York.

(S&P spokesman Ed Sweeney gave the following statement: ""For the capital markets to function properly, investors should receive from issuers information relevant to the performance of a security. Likewise, S&P's expects issuers to stand behind the accuracy and completeness of the information they provide as part of the rating process.")

As the Center for Public Integrity reported in June, ratings agencies fought hard against language in the Dodd-Frank financial reform bill that would expose them to more liability. From the official summary of the bill (PDF):

Liability: Investors can bring private rights of action against ratings agencies for a knowing or reckless failure to conduct a reasonable investigation of the facts or to obtain analysis from an independent source.

While this sounds straightforward enough, the effects of the final language are still unclear. The bill essentially requires issuers to get permission from the ratings agencies in order to include their ratings in offering documents for bond sales. If a rating agency agrees, it exposes the agency to liability if the ratings are wrong. Here’s Fitch reacting:

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.

The solution? Moody’s, Fitch, and S&P have all asked for their ratings not to be used in official documentation. (Ratings agencies would argue that ratings are essentially their best predictions of the future, and they shouldn't be held liable if those predictions don't pan out.) There’s a separate SEC rule, however, that requires ratings to be included in the offering documents for asset-backed securities in particular, but that rule has been temporarily suspended until Jan. 24, 2011.

After the rule suspension expires, rating agencies will likely be exposed to more liability for ratings of those securities, but it remains unclear whether that will be true for other bonds. One thing’s for sure — agencies are doing what they can to “mitigate the risks” and minimize the degree to which they can be held responsible for their own mistakes.

Update: Moody's announced it will discontinue the use of indemnification language in its contracts with muni-issuers. This post has also been updated with comment from S&P.

In the past, Moody’s has aggressively bought back stock, thereby ensuring that only a sliver of equity remains on the balance sheet, almost as if to immunize itself from lawsuits. Is there enough equity on the balance sheet to make a class action lawsuit worth the candle? In the light of this, I have always wondered about the efficacy of filing a lawsuit against against the company. Have you pursued this angle?

I guess no one was responsible…s**t happens?

Try listing all the people that got away with the crap that led to the financial meltdown. It is now a very long list and some of them are still getting millions in bonuses.

“... still getting millions in bonuses.” Most of the millions came by way of stock option exercises.

Executives exercised stock options by the truckload. Fund managers (mainly of index funds who had to buy the crap the executives were peddling), using the cash entrusted to them through the hard-earned retirement savings of middle-class America’s 401(k) plans, were ready buyers of the avalanche of paper.

Mozilla of Countrywide cashed out $480 million. Lehman’s president cashed out $380 million, etc., etc. The top paid 25 CEO’s cashed out more than $13 billion during the past decade.

Stock option plans is the means by which a vast transfer of wealth has taken place and is still taking place, from hardworking Americans to the bank accounts of Corporate America’s elite.

Do not invest in companies that use and abuse stock options – go to “insider sales” and note the selling frenzy. Why are you buying the stock when insiders are disgorging themselves? Avoid index funds/ETFs. They have to buy the stock if it is part of the index. Index funds provide a convenient place for miscreants in the corner office to dump their stock. Radical thoughts, but most appropriate. It is a public issue – a scandal.

So, what else is new?  The rating agencies, carrying so much responsibility for this financial mess will get away without any penalties worth speaking of.  And, they will move forward doing their same job in the future and the final retort would be, “....sorry, we’re not responsible.”  Even after 200 page prospectuses their final fine print will absolve them of all indemnity…..
What a sad state of affairs for this country…a country that bleats, “responsibility” throughout its’ conversation with the public and just flaunts that theme when it comes to Wall Street and it’s affiliates…And, we wonder why so many people just “...walk away from their homes” when they loose their jobs and can’t continue to pay a mortgage that was sold to so many on false qualifications…...

It seems our government is having problems with keeping law and order.

Perhaps is these corporations blatanly murder people in front of millions of witnesses then they’ll be punished.

How about we just open the prison doors and let all criminals out? Oh yeah, they’re not rich enough.

It seems to me that all “rated” securities will have great risk of failure as long as no one involved in the process is paid to “question” investment underwriting assumptions.  Everyone is still paid for “completed transactions.”

You would think the rating agencies and bond insurers would have to bring critical thinking to the process…silly me!

Hard to believe we can’t even get this right.  Financial reform remains a joke.

I’m glad everyone seems to agree.  I can’t forget to mention the joke that is current campaign finance law.  In order to get the right people in office to do the right things, elections have to become about people and issues rather than the corporate controlled horse-race/beauty pageant we have today.  Until then, this country will continue to be the United States of Corporation, where they say they’re are 2 parties, when there is really only one.  The party for Big Money Interests.  Big money isn’t 250k a yr, btw, it’s the $23Billion a quarter bastards I refer to.

This (and countless other fraudulent business practices by ratings agencies) make those agencies null and void! What they report means NOTHING! They are not penalized by the SEC for lying to investors ether? If they are penalized, it will cost the tax payers? It already cost us tax payers because they lie causing bad investments! The SEC cost to this country for not doing their job of making sure no laws are being broken and making sure people don’t lose money due to fraud, which makes them just as responsible! They need to be eliminated NOW! Why are the same people ripping us off still in these positions? We the people want you out. You have ruined this country, and you still present yourselves like you are credible, for what? We are all paying for all the corruption you companies still dish out to America, yet you still go on business as usual, like you are worth anything? All we have seen is that no matter how much money you steal from us to make you feel important, you are all losers! Go away!

As long as there is no punishment, the crimes will continue. It really is that simple.
The men who have destroyed our economy have spent decades weaseling their way to the top, believing they made tremendous sacrifices to gain their success.
The last thing on earth they will ever do is risk their power and wealth by obeying any law.
The law is a ‘problem for legal,’ not a concern of top management. And they are dead right. They can obtain whatever they want from the courts and they know it.
Regulation is the only protection the American people have. The GOP and their owners have virtually destroyed regulation. That’s been their objective for at least three decades and they have succeeded.

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