IFR-ABS: Bill reversing rating agency liability advances

Wed Jul 20, 2011 1:39pm EDT

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by Adam Tempkin

NEW YORK, July 20 (IFR) - The House Financial Services Committee on Wednesday voted to approve legislation introduced by Representative Steve Stivers (R-Ohio) that would repeal a provision of the Dodd-Frank legislation from last year which made credit rating agencies liable for increased lawsuit exposure.

The Asset-Backed Market Stabilization Act of 2011 (H.R. 1539), introduced early this year, would restore Rule 436(g) of The Securities Act of 1933, which exempted rating agencies from "expert" liability when they issue credit ratings on asset-backed securities.

The Dodd-Frank Act had repealed 436(g) and the ABS market froze in the summer of 2010 until the SEC issued a temporary no-action letter effectively exempting the rating agencies from liability.

With the exemption for credit ratings removed, rating agencies had feared exposure to the same degree of expert liability under the Securities Act of 1933 as accountants and other parties that participate in bond sales, according to Dechert LLP.

Therefore, in July 2010, Standard & Poor's, Moody's and Fitch refused to give their consent to allow their ratings from appearing in prospectuses and registration statements.

The SEC no-action letter was meant to last for six months, but the SEC later extended the disclosure exemption indefinitely, avoiding a potential shutdown of the securitization market.

Some market participants and state attorneys general were disconcerted by the SEC's lack of enforcement on the 436(g) matter, and were vocal about the regulator's inaction and coddling of the credit rating agencies, who have had good luck so far in battling investor lawsuits related to undeserved AAA ratings given in the run-up to the financial crisis.

A group of Republican Representatives known as the Financial Services Working Group, which Mr. Stivers is a member of, claim that Dodd-Frank's removal of 436(g) "would raise the cost of rating bonds from approximately $100,000 per rating to approximately $1 million, and it could result in some bonds not getting a rating, which would prevent those bonds from coming to market."

The Group claims that "this provision has a devastating effect on auto manufacturers and other who use asset-backed bonds to finance their business."

The provision threatens the 8 million automotive-related jobs in the United States, according to Congressman Stivers.

However, a lobby of hundreds of organizations called Americans for Financial Reform, which includes groups such as the AARP, AFL-CIO, Center for Responsible Lending, and Center for Economic Progress, has vigorously fought the Asset-Backed Market Stabilization Act of 2011 for months.

The group says that the bill, HR 1539, would reinstate the special exemption from expert liability for credit rating agencies, "just months after Congress passed it.

"It simply gives in to the tactics of the rating agencies and helps restore the pre-Dodd Frank status quo that gave Nationally Recognized Statistical Rating Organizations (NRSROs) the ability to mislead the public about the risks of asset-backed securities," the group wrote in a May letter to members of the House of Representatives.

The group also said that "this drastic step is unnecessary", as the SEC has taken steps to ensure that rating agencies cannot hold up the issuance of asset-backed securities.

The SEC has indicated in the past that the "no action" letter and the indefinite extension of the disclosure exemption for rating agencies was meant to give time to Federal regulators to completely remove references to ratings in their laws and regulations.

Interestingly, the repeal of 436(g) was inserted into the Dodd-Frank Act late in the process in 2010 by Stivers' predecessor Mary Jo Kilroy, a Democrat from Ohio who was trying to increase the potential liability for credit rating agencies.

Her amendment to the last version of the bill that became Dodd-Frank was passed on June 16, 2010, while the House and Senate versions were being reconciled.

The American Securitization Forum (ASF), a trade group for the securitization markets, were pleased by today's House Financial Services Committee vote.

"The ASF applauds the House Financial Services Committee for approving Representative Stivers' legislation," said Tom Deutsch, the Executive Director of the ASF, in a prepared statement. "The ABS markets need certainty in order to operate in a sound and robust manner, providing critical credit to car buyers, students, and business.

"...It is now crucial for the full House of Representatives and Senate to pass Stiver's bill to ensure permanent stability for the ABS markets. We strongly encourage lawmakers to act decisively on this critical matter."

(Adam Tempkin is a senior IFR structured finance analyst)

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