Financial Reform Act Includes New Rules for Ratings Agencies

November 5, 2010 by · Leave a Comment
Filed under: Financial Reform, SEC, The Rating Agencies 

The Dodd-Frank Wall Street Reform and Consumer Protection Act has passed into law. It immediately subjects ratings agencies to greater liability and limits their protection under the First Amendment that they had historically used to defend themselves from investors angry about highly rated securities that later turned sour.  Specifically, rating agencies can now be sued if the plaintiff can prove that an agency “recklessly” neglected to review key information when creating a rating.

The Securities and Exchange Commission (SEC) was also directed to find a way to alleviate the risk of conflict of interest at rating agencies who are paid by the issuers whose debt they rate. If after two years the SEC does not find a solution, they are required to implement the Franken amendment and to create a board that assigns a rating agency to a debt issuer. The issuer would still be free to hire their own rating agency in addition to the one it was assigned; however, the rating provided by the assigned agency must be made available to investors.

Eventually, federal regulators will be required to remove all credit rating references from their rules to reduce reliance on the credit rating agencies. Congress will hold hearings in 12 months to review this action.

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