38 Pages Posted: 16 Sep 2011
Date Written: September 15, 2011
“Below Investment Grade and Above the Law: A Past, Present and Future Look at the Accountability of Credit Rating Agencies” by Professor Marilyn Blumberg Cane, co-authored with Adam Shamir and Tomas Jodar is a timely and comprehensive article focusing on the responsibility, and lack thereof, of the credit rating agencies. The article is titled “below investment grade” due to the shoddy performance of the credit rating agencies (hereinafter “CRAs”) for their key role in the financial crisis of 2007-08. It is also titled “above the law” because of the CRAs’ lack of accountability due to regulatory sleight of hand and the CRAs’ almost totally successful defense against liability to bondholders through the invocation of the Freedom of Speech under the First Amendment.
This article covers the evolution of the credit rating industry, in particular, the noteworthy shift from purchaser-subscriber to issuer pay model. It then describes the history of SEC CRA regulatory measures, most notably the adoption of SEC Rule 436(g), adopted in 1982, which specifically eliminated liability for the big CRAs (Moody’s, Standard & Poor’s, Fitch’s and Duff and Phelps) as “experts” under Sections 7 and 11 of the Securities Act of 1933. The article then covers the Credit Rating Agency Reform Act of 2006 and the adoption of SEC Rule 17g-5 in an attempt to control conflicts of interest within CRAs. We next turn to the freedom of speech as a defense effectively used by CRAs, although the United States Supreme Court has yet to address this issue directly. The thrust of the CRAs’ argument is that their ratings are simply their expression of their opinion, akin to a review of a restaurant or editorial column. There is much irony in this as many regulated financial players, such as banks and insurance companies, are required to comply with governmental rules that mandate them to invest in “investment grade securities” a “blessing” conferred only by the privately owned CRAs.
We then dissect provisions regarding CRAs in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which among many other things, reads “Rule 436(g), promulgated by the Securities and Exchange Commission under the Securities Act of 1933 shall have no force or effect.” As the reader will see, this provision has not been enforced by the SEC in what could only be seen as a game of hard ball wherein the CRAs won notwithstanding the Act. For completeness, we then turn to the European approach of CRA regulation, including the creation of the European Securities and Markets Authority in January, 2011.
We conclude by suggesting, at a minimum, that CRAs be subject to accountability and that some formal, financially neutral body conduct a periodic assessment rating the performance of the CRAs.
Keywords: credit rating agencies, financial crisis, freedom of speech, first amendment, SEC, Securities and Exchange Commission, Securities Act of 1933, Credit Rating Agency Reform Act of 2006, Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, European Securities and Markets Authority
JEL Classification: G18, K10, K22, K23
Suggested Citation: Suggested Citation
Cane, Marilyn Blumberg and Shamir, Adam and Jodar, Tomas, Below Investment Grade and Above the Law: A Past, Present and Future Look at the Accountability of Credit Rating Agencies (September 15, 2011). Fordham Journal of Corporate and Financial Law, Forthcoming; NSU Shepard Broad Law Center Research Paper No. 11-005. Available at SSRN: https://ssrn.com/abstract=1927907