Moody's Bid for Rating-Lawsuit Protection Meets Challenge From U.S. States

Moody’s Investors Service’s demand that taxpayers indemnify it against lawsuits over ratings will be challenged by state and local governments that say the company is shunning legal responsibility for its work.

Underwriters and interest-rate swap providers in the $2.8 trillion municipal bond market have reworded contracts in recent years to escape liability. Now, issuers say Moody’s is asking them to absorb the cost the company and its executives may bear from lawsuits over ratings, except in cases of fraud or willful misconduct.

Rating companies have traditionally invoked the U.S. Constitution’s First Amendment to protect their opinions against lawsuits. Moody’s added the indemnity language last year after the worst financial crisis since the 1930s led to widespread criticism of the New York-based company’s ratings of mortgage securities. Municipal issuers have discovered the change in recent months. Language in the Dodd-Frank U.S. financial- regulation law enacted in July lowers the threshold for suing bond raters.

The Moody’s indemnification clause “appears to be an attempt to have the taxpayers foot the bill for their negligence,” Tom Dresslar, spokesman for California Treasurer Bill Lockyer, said in a telephone interview.

The indemnification clause faces potential backlash from municipal governments that rely on professional-services firms to prepare bond sales.

‘Shifts the Burden’

“If this shifts the burden onto the taxpayers, I’d be opposed,” Louisiana Treasurer John Neely Kennedy said in a phone interview.

“When you hire a professional to perform a service, you don’t expect to be held liable if they make a mistake,” Kennedy said. He said he is studying the wording.

Texas law also may prevent issuers from signing waivers.

“State law precludes the city from agreeing to indemnify Moody’s,” James Moncur, deputy director of Houston Mayor Annise Parker’s office, said in an e-mail. “If Moody’s made indemnification a requirement, we simply could not use them.”

Some financial advisers said they would urge their clients not to accept agreements exposing taxpayers to financial risk.

“I wouldn’t recommend that any of my clients sign it,” said Robert Doty, an adviser with American Government Financial Services in Sacramento. “The issuer might not be at fault but could still be liable.”

Moody’s, McGraw-Hill Cos.’ Standard & Poor’s unit and Fitch Ratings faced scrutiny from Congress and state regulators after they assigned top marks to U.S. subprime-mortgage bonds before that market collapsed in 2007. The ensuing credit crisis resulted in $1.8 trillion in writedowns from financial firms worldwide, according to data compiled by Bloomberg.

No Enforcement Action

After finding instances of potential wrongdoing, such as choosing not to downgrade inflated ratings on almost $1 billion of debt in 2007, the U.S. Securities and Exchange Commission said Aug. 31 that it declined to bring a fraud-enforcement action against Moody’s, according to an SEC report.

Moody’s isn’t the only rating company seeking indemnification. Fitch “has long included indemnification language in its agreements,” said Daniel Noonan, spokesman for the company in New York.

S&P has entered into “revised agreements with many issuers over the last several months,” said spokesman Edward Sweeney in New York.

Moody’s included the language releasing it from liability in a January 2009 fee schedule. The wording says the company won’t be liable to the issuer or any third party “for any loss, injury or cost,” according to a copy of the schedule.

Common Clauses

“These types of indemnification clauses are common in business services agreements,” said Moody’s spokesman Michael Adler. The company has been introducing standard ratings agreements for all its clients across all ratings categories, including the municipal sector, Adler said.

Other providers of municipal-bond services to issuers have changed wording to limit liability for their public finance work in recent years.

Two years ago, municipal-bond underwriters including Wall Street banks sought to disavow responsibility for advice given to issuers in a bond sale, according to a model contract prepared at the time by the Securities Industry and Financial Markets Association, a trade group. The wording made it clear that the underwriter wasn’t acting as a “fiduciary to the issuer,” according to the association’s suggested agreement.

State and local officials have also bought interest-rate swap agreements with waivers saying they’re not relying on the advice of their bankers when entering the deals.

New Jersey Objection

Moody’s first included the language seeking indemnification against lawsuits in documents it sent to Montgomery County, Maryland, in July, said Tim Firestine, the municipality’s chief administrative officer. The county has the highest possible bond rating.

New Jersey doesn’t sign such agreements with rating agencies or with vendors in general, Andy Pratt, spokesman for Treasurer Andrew P. Sidamon-Eristoff, said in an e-mail.

“There are risks inherent to practicing any profession,” he said. “The state believes that vendors are best equipped to manage this risk.”

In addition to Texas, waivers may also be illegal in states such as Ohio, according to David Goodman, a public-finance attorney with Squire Sanders in Cleveland.

“It can be viewed as a form of indebtedness,” he said. “You’re creating an open agreement to pay another party.”

To contact the reporters on this story: Darrell Preston in Dallas at dpreston@bloomberg.net. To contact the reporters on this story: Matthew Leising in New York at mleising@bloomberg.net;

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