Sept. 2 (Bloomberg) -- Moody’s Corp. will discontinue its use of language seeking to have taxpayers indemnify it against lawsuits related to municipal-bond ratings after states including California and New Jersey complained.
“As Moody’s began introducing rating applications to the municipal market earlier this year, we heard from issuers, in isolated instances, that our standard indemnification language raised concerns unique to their market,” Michael Adler, a spokesman for New York-based Moody’s Investors Service, said yesterday. “We have decided to suspend our use of this indemnification language in this sector.”
The move followed a protest by California, said Tom Dresslar, a spokesman for state Treasurer Bill Lockyer, in a telephone interview from Sacramento before Moody’s made its decision public. “We told them to take it out,” he said. “So they took it out.”
Moody’s announcement came about two-and-a-half hours after Bloomberg News reported that issuers in the $2.8 trillion municipal-bond market, led by California and New Jersey, were objecting to the wording. Officials in the California treasurer’s office first learned of Moody’s attempt to add the indemnification clause to its ratings contracts when they were asked to sign an agreement earlier this year, Dresslar said.
The language was “an attempt to have the taxpayers foot the bill for their negligence,” Dresslar said.
Issuers have said Moody’s was 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. Underwriters and interest-rate swap providers in the municipal bond market have reworded contracts in recent years to escape potential liability.
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 company’s ratings of mortgage securities.
Municipal issuers 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 indemnification clause faced a 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,” he said.
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 SEC 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.
Bond ratings companies have taken other steps to limit their exposure to lawsuits after passage of the Dodd-Frank Act in July.
The new financial-regulation led Moody’s, S&P, Fitch and others to tell Wall Street that they will no longer let underwriters use their ratings in asset-backed bond-registration statements because of increased risk of being sued. The new rules eliminated credit-rating companies’ shield from lawsuits when underwriters include their assessments in documents used to sell debt.
The SEC responded by allowing the companies to omit ratings from regulatory documents for six months to give market participants a transition period to comply with new laws.
Congress intended the change to increase due diligence at the ratings companies in the face of increased legal liability, according to Piper Jaffray analyst Peter Appert.
Moody’s Not Alone
Moody’s isn’t the only rating company to have sought types of indemnification.
S&P has entered into “revised agreements with many issuers over the last several months,” said spokesman Edward Sweeney in New York.
“Fitch has long included indemnification language in some of its general business agreements,” said Daniel Noonan, spokesman for the company in New York. “However, Fitch has not included indemnification language in its issuer agreements.”
Moody’s included the language releasing it from liability in a January 2009 fee schedule. The wording said the company wouldn’t be liable to the issuer or any third party “for any loss, injury or cost,” according to a copy of the schedule.
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.
“This type of language is common in other business services agreements,” said Adler of Moody’s.