Conventional wisdom is that credit reporting agencies like Moody's Corp., Standard and Poor's, and Fitch Ratings are immune from liability for their bond ratings because they are mere opinions about the future, rather than statements of fact amenable to being consider misrepresentations.
A federal trial judge in New York ruled yesterday, however, in a class action lawsuit against Moody's, Standard and Poor's and Morgan Stanley, regarding unduly optimist ratings assigned to subprime bonds that one of the claims in the suit should not be dismissed. A First Amendment defense had been asserted to the fraud claim.
The judge ruled that there can be liability for a bond rating opinions “if the speaker does not genuinely and reasonably believe it or if it is without basis in fact.” This allows the lawsuit to advance to the discovery stage on this single claim.
In response to the ruling the stock of the parent company of Standard and Poor's "tumbled $3.30, or 10 percent, to $29.01 in New York Stock Exchange composite trading, its steepest decline since Dec. 1. Moody’s declined $1.84, or 7.1 percent, to $24.26. Earlier the two stocks fell as much as 12 percent."
Credit reporting agency liability has been the subject of vigorous debate for years. Credit reporting agency ratings have massive economic impacts on the financial markets. A large share of the market, in practice, relies upon these credit ratings when making their bond investments in lieu of other forms of due diligence, credit reporting agency ratings largely determine the cost to corporations of obtaining financing with bonds, and historically, the SEC has allowed a good credit rating to put a public offering of corporate bonds on a fast track to regulatory approval.
Indeed, the main problem with credit reporting agency liability is that their economic impact grossly exceeds the amount of fees they collect to rate bonds. In contrast, certified public accounting firms that audit big companies make an allowance for potential liability if their mistakes cause a client to misreport their financial situation in their financial statements when they set their fees.
Wall Street "investment banks" relying upon Moody's for subprime ratings is like Bush relying on John Yoo for the legality of torture.
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