House moves toward reinstating SEC rule on rating-agency liability

Under the SEC rule, credit ratings from a nationally recognized statistical rating organization (NRSRO) were not considered as an expert-certified part of a registration statement or prospectus, and thus the rating agencies were exempt from any liability arising from those statements.

In the wake of the financial crisis and criticisms of how the rating agencies overrated many financial products, the Dodd-Frank bill included language that struck this SEC rule, which made rating agencies liable for incorrect statements.

However, Republicans noted that as soon as this change took effect in 2010, NRSROs stopped including their ratings in prospectuses. This seriously affected the asset-backed securities (ABS) market, since SEC rules require ratings to be included.

The SEC immediately issued a six month "no-action" letter in order to ensure the continued functioning of the ABS market, and extended that decision in November. The GOP bill, sponsored by Rep. Steve Stivers (R-Ohio), would permanently terminate language in the Dodd-Frank law that repealed the SEC rule.

"The risk of greater liability as a result of subjecting NRSROs to [the law] could undermine competition if credit rating agencies decide that they are unable to bear the risk of liability and thus exit the ratings business," the report said. "In reinstating the rule, the bill would exempt NRSROs from liability if the information provided in the offering statement is found to be untrue."

Despite the disruption in the ABS market caused by this portion of Dodd-Frank, House Democrats opposed the bill when the Financial Services Committee approved it on July 20. The committee voted 31-19 in favor of the bill on a straight party-line vote.

"If ratings appear in a prospectus, investors today can hold rating agencies accountable to the same standards that apply to other experts, such as auditors, giving opinions in the legal documents of security offerings," Democrats wrote in a dissenting view in the House report.

"H.R. 1539 restores that exemption, which both makes it harder for a purchaser of a mis-rated security to get into court and requires the purchaser to meet a much higher standard to prevail — for example, blatant misstatements would not be sufficient," they added. "We believe that reducing the increased liability the act imposes on rating agencies is a grave error."

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