By Colin Barr
July 16, 2010

The credit rating agencies are on the verge of downgrading one another for the same reason.

Moody’s

said Friday it is considering downgrading the parent of its archrival, citing the legal ramifications of the financial regulation overhaul. The move comes just weeks after S&P announced its own review of Moody’s rating.

Moody’s, which rates S&P parent McGraw-Hill

A2, said its review will weigh “heightened uncertainties and potential negative long-term effects on McGraw-Hill from the Financial Overhaul Legislation and increased global scrutiny of credit rating agencies.”

The big issue is whether the credit raters will face more lawsuits as a result of changes that would allow investors to sue in cases when they “knowingly or recklessly” fail to conduct reasonable investigations. The agencies fear new rules will make it easier to sue them.

Investors have been keeping an eye on the legal defenses available to the rating agencies in the wake of the financial meltdown of 2007-2009. In numerous instances the firms placed their top ratings on mortgage-related bonds that quickly went sour, leading to massive losses for buyers.

Short-sellers including David Einhorn have bet against the companies, in part on the rationale that they will be swamped by legal challenges.

Moody’s, obviously, isn’t going that far, but it promised a study nonetheless.

“Moody’s will consider the potential effect on McGraw-Hill’s litigation exposure and defense costs if a larger volume of cases were to survive a motion to dismiss, enter discovery and proceed to trial,” the rating firm said.

McGraw-Hill fell 3% in midday trading, while Moody’s was off 1%.

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