In the aftermath of the economic meltdown, the credit rating agencies have evaded liability as successfully as Superman dodges speeding bullets. Just a handful of surviving cases blame the credit rating agencies for conferring rosy ratings on mortgage-backed securities that turned out to be drek. There’s a CalPERS California state court negligence suit against Moody’s, Standard & Poor’s, and Fitch Ratings that squeaked by the agencies’ motion to dismiss last May; and a pair of Robbins Geller Rudman & Dowd cases—one for Abu Dhabi Commercial Bank and the other for Kings County and the Iowa Student Loan Liquidity Corporation—that are proceeding before U.S. district court judge Shira Scheindlin in the Southern District of New York.
And that’s about it. In courtroom after courtroom, the agencies and their lawyers have successfully argued that credit ratings are protected opinions under the First Amendment. Plaintiffs have tried to get around the agencies’ First Amendment defense by asserting that Moody’s, S&P, and Fitch were so involved in structuring mortgage-backed securities to receive AAA ratings that they were de facto underwriters, but courts aren’t buying it. Last week, the U.S. Court of Appeals for the Second Circuit affirmed the dismissal of a class action that asserted the underwriter argument against the big credit rating agencies.
Congress felt investors’ pain. Last year’s Dodd-Frank legislation, enacted after hearings on the role of rating agencies in the subprime debacle, called for the Securities and Exchange Commission to impose new regulations on the agencies.
On Wednesday, as Sarah Lynch reports for Reuters, the SEC voted unanimously to issue its 500-page proposal for implementing the Dodd-Frank regulations on credit rating agencies. The SEC proposal, Lynch writes, calls mostly for the rating agencies to govern themselves. It attempts to minimize the possibility of rating agencies’ conflicts of interest by requiring agencies to establish firewalls between their marketing and analytical departments. The proposed rules also call for the rating agencies to make more substantive disclosures about their rating methodology and about the performance of the securities they rate. If credit rating agencies break the rules, the SEC would have the ability to impose fines in certain circumstances.
So will the proposed new regulations finally make the credit rating agencies accountable to investors? Michael Hausfeld of Hausfeld LLP, who was class counsel in the Second Circuit’s recent rating agencies case, said they’ll help. “Anything that makes the agencies report more accurately is necessary,” he said. “It will enable individuals to make a better connection between ratings and reality…as investors. Then they can see if they need to be plaintiffs.”
But Patrick Daniels of Robbins Geller, who is leading the Abu Dhabi and Kings County suits against the rating agencies, is a lot less sanguine. “As long as the credit rating agencies face no real threat of sanction for their conflicts of interest and compromised ratings—not just the occasional fine—any attempts at reform will be toothless,” he said in an e-mail.
Marcus Stanley, policy director of Americans for Financial Reform, was also cautious about the impact of the newly proposed rules. “There are some sensible steps in this proposal,” he said. “But one has to doubt whether they’re really going to solve the problem.”
Both Daniels and Stanley said a different Dodd-Frank provision, which imposes a lower standard of civil liability on the credit rating agencies than the tough standard investors have previously had to meet, is likelier to improve the odds of successfully suing the rating agencies. The agencies, however, forced the SEC to suspend enforcement of the provision by refusing to permit the disclosure of their ratings on asset-backed securities until the agency issued a no-action letter on new liability standard.
The SEC is asking for public comment on its new proposal. That should make for interesting reading.
(Reporting by Alison Frankel)