Skip to main content
SearchLoginLogin or Signup

Credit Rating Agencies Dodge Investors’ Lawsuits

Published onSep 12, 2016
Credit Rating Agencies Dodge Investors’ Lawsuits

The “Big Three” credit rating agencies (CRAs)—Moody’s, Standard and Poor’s (S&P), and Fitch Ratings—have come under intense scrutiny in the wake of the global financial crisis.

Meant to provide investors and regulators with credit ratings which weigh the riskiness of various kinds of securities, companies, and governments, CRAs have instead exacerbated the financial crisis by skewing assessments to please their clients instead of providing accurate credit ratings.  In turn, these reckless credit ratings helped the financial system undertake far more risk than it could safely handle.

Traditionally, publically disseminated credit ratings enjoyed First Amendment protection as opinions, essentially shielding CRAs from all civil liability, except fraud.  Angry Investors wanting to hold CRAs liable for bad credit ratings needed to prove “actual malice,” showing that the CRA issued the credit rating with knowledge of the rating’s falsity or with reckless disregard of its truth.  The actual malice standard’s high threshold helps explain why up until the 2010 Dodd-Frank Act, the courts generally ruled in favor of CRAs in ratings related litigation.

In Congress’s attempt to stop CRAs from issuing bad credit ratings, Dodd-Frank repealed Rule 436(g), making it easier for investors to sue CRAs over bad ratings.  By repealing Rule 436(g), Congress subjected CRAs to “expert liability,” the same standard of liability applying to other financial “gatekeepers” like auditors, securities analysts, and investment bankers.  Now considered experts, CRAs could no longer use the First Amendment as a safe harbor for their reckless credit ratings.  Investors who relied on the bad credit ratings could now sue CRAs for knowingly or recklessly failing to conduct reasonable investigations of the rated security, a much lower threshold than the actual malice standard.

Repealing Rule 436(g) resulted in the big three refusing to issue ratings for certain new financial products, potentially stifling the financial system’s access to sources of creditworthiness.  The Securities and Exchange Commission (SEC) responded by issuing a no-action letter, indicating that it “will not recommend” bringing action against CRAs if financial products require a credit rating.  The SEC’s no-action position was set to expire on January 24, 2011, but was extended indefinitely, thus reestablishing the regulatory shield.  As a result, CRAs are still not subject to expert liability.

Courts have also shielded CRAs from liability for their misleading credit ratings.  Despite headline-grabbing settlements, like S&P’s $1.37 billion settlement with the Department of Justice, $80 million fraud case with the SEC, the actual malice standard remains a formidable obstacle for investors seeking responsibility for reckless credit ratings.

The problem is that credit ratings are not simply pure opinions entitled to heightened constitutional protection.  Rather, credit ratings are commercial speech, because experts are expressing their fact-based opinion as to creditworthiness.  In California Public Employees’ Retirement System (CalPERS) v.  Moody’s, a California court agreed, reasoning that because a CRA has superior knowledge or holds itself out as an expert, the CRA should be treated as an expert.  The decision resulted in S&P and Moody’s combined $255 million payment to CalPERS, the nation’s largest pension fund.

Accordingly, courts should follow CalPERS lead by holding CRAs liable for their reckless credit ratings.  Further, the SEC should also hold CRAs liable by following the intentions of Congress by rescinding its no-action position.

Brad Fleming is a second year law student at Wake Forest University School of Law.  He holds a Bachelor of Arts in Political Science from Georgia College & State University.  Upon graduation, he intends to practice in estate planning. 

No comments here
Why not start the discussion?