Thursday, March 17, 2011

House Bill Reinstating SEC Rule 436(g) for Rating Agencies Could Contain Franken Amendment

The sponsor of a House bill repealing Section 939G of Dodd-Frank, which nullified SEC Rule 436(g) and thereby imposed Securities Act Section 11 liability on rating agencies if their ratings were determined to be inaccurate, said that he would consider putting the Franken Amendment in the legislation at hearings on the legislation, After listening to a plea from Rep. Sherman to include the Franken Amendment in the bill, Rep. Steve Stivers (R-OH) said that he was not adverse to putting the Amendment in the Asset-Backed Market Stabilization Act

Authored by Senator Al Franken (D-MN), the Amendment was a frontal attack on the conflict of interest problem with rating agencies. It would have added a new Exchange Act Sec. 15E(w) to create an SRO overseen by the SEC that would assign credit rating agencies to provide initial ratings for asset-backed securities and structured financial products on a rotating basis. There was no comparable provision in the legislation the House passed on December 11, 2009. The House-Senate conference committee that produced the Dodd-Frank Act reached a compromise that directed the SEC to conduct a study within two years on the feasibility of assigning a rating agency to issue ratings on structured products and, if no better method is found, implement the Sec. 15E(w) as authored by Senator Franken. (Sec. 939F of the Dodd-Frank Act).

Rep. Brad Sherman (D-CA) said that waiting two years for the SEC study is not option. The conflict of interest in the current system must be remedied much sooner. Congress must legislate the Franken Amendment so that issuers do not get to pick their rating agencies.

In the week preceding the effective date of Section 939G, the major rating agencies issued public statements refusing to allow their ratings to be included in registration statements. SEC Regulation AB, however, requires that a prospectus for an asset-backed offering disclose ratings whenever an issuance or sale is conditioned on the assignment of a rating. Thus, the public asset-backed securitization markets froze on July 22, 2010, forcing the SEC to step in and issue a temporary no-action letter on July 22, 2010. On November 23, 2010, the SEC issued a permanent no-action letter. The Asset-Backed Market Stabilization Act provides certainty to the issuers of asset-backed securities by repealing the liability provision.

The Act is supported by the American Securitization Forum. Testifying before the Financial Services Committee, Executive Director Tom Deutsch said that the
ASF believes that the appropriate action is a legislative fix to permanently remedy the issue so as to avoid the potential long-term shutdown of the public securitization market. This issue is of great concern, not only to the securitization market, he noted, but to the credit markets generally, and to consumers in particular. If such a permanent remedy does not ultimately occur, consumers and businesses may ultimately face a more constricted credit market, resulting in fewer financing options and higher costs.

Rule 436(g) specifically provided that credit ratings issued by NRSROs on debt securities, convertible debt securities and preferred stock were not considered part of the registration statement prepared or certified by a person within the meaning of Section 11 of the Securities Act, which imposes liability over and above that which would apply under common law or under Rule 10b-5 on those who are involved in the preparation of the registration statement With Dodd-Frank’s nullification of Rule 436(g), rating agencies remain concerned with the scope and magnitude of Section 11 strict liability attached to their being considered an expert. Also, a withdrawal of the SEC no-action letters giving relief would likely freeze the securitization markets again.