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Rating Agency Liability for Current Financial Crisis
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Rating Agency Liability for Current Financial Crisis


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The liability of the bond rating agencies for the credit meltdown is analyzed by attorney Mark Anchor Albert

The liability of the bond rating agencies for the credit meltdown is analyzed by attorney Mark Anchor Albert

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  • 1. by Mark Anchor Albert Ratings wars The lawsuit filed by Calpers may be able to overcome the ratings agencies’ traditional First Amendment defense According to Thomas Friedman, a New York Poor’s7 for negligent misrepresentation in • Taken together, these circumstances show Times columnist, “There are two superpow- their ratings of $1.3 billion in “structured that either privity or “near privity” exists ers in the world today….There’s the United investment vehicles.” between the rating agencies and the limited States and there’s Moody’s Bond Rating There is some hope for the Calpers law- group of plaintiffs to whom the securities Service.”1 As if to prove this point, claims suit. An emerging trend in the law invali- were marketed and sold.8 against rating agencies arising from their dates the credit rating agencies’ First The role of rating agencies in the struc- credit rating activities have historically been Amendment defenses and related journalist turing, marketing, sale, and compensation unsuccessful against the defense that credit shield law defenses. The leading cases in this schemes of many of the financial products and ratings are opinions protected under the First line suggest that four key elements need to be derivatives that were a key factor in last Amendment.2 Under the standard articulated present to successfully assert rating agency lia- year’s financial collapse went far beyond the in New York Times v. Sullivan,3 opinions bility in cases not involving misrepresentation bounds of traditionally protected journalis- cannot serve as a basis for liability unless or outright fraud: tic analysis or opinion making. Rather, the rat- the plaintiffs can establish actual malice by the • The rating agencies are paid for their credit ing agencies were active participants in the credit rating agencies. These agencies have ratings by the issuer or underwriter of the structuring of toxic mortgage-based debt also won some early cases on the basis of the securities. instruments, from which they profited hand- journalist’s privilege and related shield laws, • The ratings are provided to a limited group somely. Their complicity in these debt secu- which provide a First Amendment-based of recipients to whom the securities are mar- rity arrangements may be enough to overcome defense to discovery requests seeking the keted and sold, rather than to a larger pub- existing rating agency protections, a possibility AMANE KANEKO basis for credit ratings.4 Nevertheless, in June lic audience. that is finding increasing favor in govern- 2009, the California Public Employees • The rating agencies actively participate in Retirement System filed suit in San Francisco the structuring of the securities transactions Mark Anchor Albert is a business litigator and against Moody’s,5 Fitch,6 and Standard & for which the ratings are provided. appellate lawyer in Los Angeles. 38 Los Angeles Lawyer October 2009
  • 2. ment and the judiciary, unless another crisis- tain the specific ratings given to the various intended to meet investment guidelines and driven government bailout provides a “get out CDO tranches. Through this process, the risk tolerances for institutional purchasers of jail free” card in their favor. rating agencies maintained an ongoing of the securities. These ratings were not vague, involvement in the CDO, creating an interface unspecific opinions but instead were touted Collateralized Debt Obligation with the collateral manager to ensure regular as scientifically and empirically based and There is no doubt that the so-called toxic asset composition compliance. objective—with AAA ratings for the top assets held by financial institutions have In fact, the collateral manager also typi- tranche of super-senior notes supposedly cor- played a significant role in the financial and cally was required to purchase a significant responding to a very low risk of default. credit crisis still affecting the country. These proportion of synthetic CDS contracts—a Not only were the rating agencies com- toxic assets consist in large part of collater- hedge against defaults in the underlying mort- plicit in structuring CDOs to achieve desired alized debt obligations (CDOs). A CDO typ- gage pools—from the investment bank spon- ratings, but the structure of the transaction ically is built from traditional debt and secu- sor, in which the investment bank would be assured that the rating agencies were paid for rities instruments9 that are packaged together the swap counterparty. In other words, the their services from the transaction itself, not and sold to investors who, in return for peri- CDO was required to “sell protection” to the from an independent fee or subscription. The odic payments of interest, bear the losses investment bank, which provided a “pre- CDO’s trust indenture agreement almost that occur if instruments in the portfolio mium” in return to the CDO, with respect to invariably contained so-called waterfall pro- default. Many of the CDOs upon which the a reference basket of securities. The invest- visions that determined the priority of inter- current credit and financial crisis turns con- ment bank was entitled to choose the secu- est and principal payments. Simply put, the tained large quantities of subprime and so- rities that were in the synthetic reference bas- waterfall provisions described how the cash called Alt-A residential loans. (Alt-A loans ket and could change the composition, flow from a CDO was distributed to the were made to borrowers whose credit qual- without notice to or control by the collateral tranches. A typical priority of payments sched- ity was in between prime and subprime.) manager or others. ule, or waterfall, worked together with ongo- These residential mortgage CDOs were also The rating agencies played an integral ing rating agency coverage tests to ensure known as residential mortgage-backed secu- and ongoing role in this process, because the that senior tranche debt holders would be paid rities, or subprime RMBS. collateral eligibility criteria and the purchase even if equity and lower tranches received In forming a CDO, a sponsor—usually an or sale of CDS protection were designed to nothing. For example, in a typical waterfall investment bank—would create a trust to ensure that the rating agencies would be able arrangement, the CDO trust used interest hold the CDO’s assets, and the investment to assign specific ratings to the various CDO (and principal) payments from the underly- bank would issue securities representing tranches offered for sale—from AAA super- ing assets to pay first the fees and expenses of interests in the CDO asset pool. In a sub- senior notes in the top tranche, to BB notes the CDO, including trustee, custodian, and prime RMBS CDO pool, residential mort- in the mezzanine tranches, all the way down paying agent fees, and the fees of the rating gages would make up the bulk of the under- to the unrated equity tranche at the bottom. agencies; second, the net periodic coupon lying assets, but the trust might also hold The credit rating for each rated tranche was payment owed to any swap counterparty; other assets either to create a credit enhance- supposed to reflect the rating agency’s third, the periodic asset manager fees; and ment (for example, a holding of bonds could informed assessment of the creditworthiness finally, interest on senior tranches. Lower provide some income stability to a CDO, the of the securities issued from the tranche, tranches were only paid if the foregoing pay- assets of which were made of variable rate based in part on the likelihood that the CDO ments were already satisfied. Equity received loans) or to “park” cash received from early issuer would default on its obligations to no payments until all tranches above it and payoffs or other unexpected events. The make interest and principal payments in full related administrative costs (and rating agency CDO trust would then obtain interest and and on time. In fact, rather than indepen- fees) had been paid. principal payments from the underlying dently evaluate a CDO investment after the In creating this multitiered payment struc- mortgagee obligors, which it would use to fact, the rating agencies worked directly with ture, the investment banks made sure that the make interest and principal payments to the the investment bank sponsor to produce the rating agencies also would be paid before CDO investors. The trust would be struc- rating the sponsor wanted in order to better nearly everyone else. The rating agencies also tured to provide differing levels of credit sell the CDOs to investors. enjoyed a top-priority position to recover enhancement to the securities issued in var- In particular, the collateral manager was their fees for rating the various tranches and ious CDO tranches. Credit enhancement supposed to apply what are commonly called the RMBS supporting those tranches in the would be provided through different mech- collateral quality tests to assess whether the interest proceeds waterfall provisions of the anisms, such as subordination of lower debt securities forming the vast bulk of the trust indentures for the trusts that held the tranches to higher tranches, overcollateral- assets for the CDOs met the collateral eligi- underlying assets. Moreover, the rating agen- ization, excess spread, bond insurance, and bility criteria. All these tests and criteria were cies had a critical, ongoing role in the pricing credit default swaps (CDS). linked to rating agency tests, such as Moody’s of the various tranches and in determining rat- The underlying assets of a subprime Asset Correlation Test, Moody’s Weighted ing-related events of default that triggered RMBS CDO often were changed during the Average Rating Factor Test, Moody’s the waterfall priorities, at the top of which sat life of the CDO. For this task, the invest- Minimum Weighted Average Recovery Test, the collateral managers and rating agencies. ment bank sponsor engaged a collateral or the Weighted Average Spread Test, the Accordingly, in a typical subprime RMBS asset management firm that was charged with Weighted Average Coupon Test, the Weighted CDO, the interest and principal payment pri- purchasing the securities that formed the sub- Average Life Test, the Standard & Poor’s orities for purpose of the waterfall provi- stance of the CDO. The collateral manager Minimum Recovery Rate Test, and the Fitch sions of the debt instruments were specifically could sell bonds or other portfolio enhance- Weighted Average Factor Test. Subprime tied to credit default tests that were linked to ments and purchase other ones, all in the RMBS CDOs offering circulars and prospec- the ratings provided by the rating agencies. name of complying with the CDO trust agree- tuses typically included default probability They used quantitative cash flow models that ment restrictions on holdings and the rating assessments that, based upon their tests and analyzed, under various stress scenarios, the agencies’ requirements necessary to main- linked to their corresponding ratings, were amount of principal and interest payments 40 Los Angeles Lawyer October 2009
  • 3. expected to be generated from the loan pool circumstances that appear to coincide in crit- “a level of involvement with the client’s trans- each month over the life of the RMBS tranche ical respects with the involvement of the actions that is not typical of the relationship securities. The output of this model was then agencies in the structuring of subprime RMBS between a journalist and the activities upon compared against the priority of payments CDOs. One of these cases—In re Fitch, which the journalist reports.”15 (the waterfall) to the RMBS tranches specified Inc.11—is particularly instructive. A bank In LaSalle National Bank v. Duff & in the CDO’s trust documents. purchased various CDOs structured by one Phelps Credit Rating Company,16 another Thus, far from providing a generic opin- of its brokers. The banking regulators con- New York case rejecting the rating agen- ion of creditworthiness to a broad-based cluded that the CDOs were not investment cy’s First Amendment defense, the court audience, the rating agencies were intricately grade and compelled the bank to sell them. denied the rating agency’s motion to dis- linked to the structuring and payment pro- The broker refused to accept the return of the miss claims based on its allegedly too-favor- visions of the assets they rated, did so specif- ically for the benefit of targeted investors (CDOs were generally marketed in private placements to qualified institutional buyers under Rule 144A—Private Resales of Securities to Institutions—promulgated under the 1933 Securities Act10), and were directly compensated for this effort. That these credit ratings were critical to the spread of CDOs in the financial markets is undeniable. Investors use credit ratings as a proxy for their own credit review and thus to support the level of credit risk they are will- ing to undertake with respect to particular debt securities. Fiduciary investors (such as pension funds, trustees, and insurance com- panies) typically may only acquire “invest- ment grade” assets, primarily as determined by credit ratings. Assets that are below invest- ment grade—speculative or junk bonds—are supposed to be excluded from the fiduciary investor’s pool of appropriate potential invest- ments. Higher-quality ratings directly affected the pricing and marketability of the subprime RMBS CDOs offered for sale. Through the financial alchemy of CDS contracts (which hedged the risk of underlying defaults) and associated higher-quality ratings, pools of low-quality residential mortgages could be marketed as high-grade investments. As a result, investors that would not buy individual subprime mortgages bought sub- prime RMBS aggregated into CDOs that CDOs. The bank sued the broker and sub- able rating. The dispositive factor in the sported high-quality ratings from the rating poenaed Fitch, having learned during dis- court’s decision to reject the rating agen- agencies. Subprime RMBS CDOs came to covery that Fitch and the broker “had exten- cy’s First Amendment defense was the rat- be held by pension funds, school districts, sive communications about the structure of ing agency’s “substantial influence in the charitable organizations, municipal treasuries, the transactions.”12 drafting” of the debt securities and the and a vast number of other public and private In response to an order to show cause requirement for high ratings as a condition trust fund investors that could ill afford the regarding contempt due to the failure of Fitch of the initial issuance of the bonds.17 Due to losses that were to come. to comply with the subpoena, the district the rating agency’s active involvement in However, even though both purchasers court rejected Fitch’s First Amendment defense structuring the transactions, the agency was and issuers of RMBS CDOs have suffered bil- under New York’s shield law. The Second in “near privity” to the purchasers of the pri- lions of dollars of losses resulting from the Circuit affirmed. “Unlike a business news- vately offered securities.18 acquisition of interests in securities that now paper or magazine, which would cover any The Duff & Phelps court also found priv- appear to have been wrongly labeled as invest- transactions deemed newsworthy, Fitch only ity under another theory. In the context of ment grade by rating agencies, these pur- ‘covers’ its own clients. We believe this prac- accountant liability to third parties, the New chasers and issuers typically have not sued the tice weighs against treating Fitch like a jour- York Court of Appeals previously had estab- rating agencies. These investors are likely nalist.”13 In addition, the Second Circuit lished in Credit Alliance Corporation v. daunted by the legal precedents that protect noted that an employee of Fitch took “a Arthur Andersen & Company that liability rating agencies. fairly active role…in commenting on pro- may be imposed when a professional or firm posed transactions and offering suggestions is aware that its work product is to be used Rating Agency Defenses about how to model the transactions to reach for a particular purpose in furtherance of Several recent cases, however, have been the desired ratings.”14 Fitch’s active role in which a known party was intended to rely, decided against credit rating agencies under helping to structure the CDOs demonstrated and the professional’s conduct connects to Los Angeles Lawyer October 2009 41
  • 4. that third party, thereby showing an under- benefit of subscribers and new services. “It Commercial Financial, the role of rating agen- standing of that party’s reliance on the pro- had not been asked to rate the bonds [by the cies in the structuring, marketing, and sale of fessional’s work.19 The Duff & Phelps court school district issuing them].”23 By contrast, subprime RMBS CDOs went far beyond the noted that although the Credit Alliance test in Commercial Financial the professional parameters of protected speech and analyti- initially applied only to accountants, it has role of the rating agencies went “beyond a cal opinion established under First subsequently been applied to other profes- relationship between a journalist and sub- Amendment-based journalist’s privilege or sionals—including attorneys, real estate ject, and [was] more analogous to that of a related statutory shield laws. In view of their appraisers, architects, and realtors. The court client and the client’s certified public accoun- central role in the structuring of subprime saw no reason why it should not also apply tant.”24 In such a case, the First Amendment RMBS CDOs, and their dynamic and ongo- the privity requirement to a securities rating does not shield the rating agencies from ing role in re-rating CDO tranches over time company.20 potential liability. after their initial issuance, a strong argument Finally, in Commercial Financial Services, The Commercial Financial court also held can be made that the rating agencies were pro- Inc. v. Arthur Andersen LLP, the court held that the facts of that case satisfied Section 552 viding professional services to issuers and that the First Amendment does not protect of the Restatement (Second) of Torts, titled investment banks, with a clear set of poten- rating agencies from liability if they were Information Negligently Supplied for the tial investors in mind—typically qualified asked to rate investment certificates by a debt Guidance of Others,25 which supported its institutional buyers in private (nonpublic) collecting company, rated the bonds based on analysis that liability may be imposed on a securities Rule 144A offerings—and were information furnished by that company, were professional information provider that neg- not engaged in any meaningful sense or degree paid a fee by that company, were therefore in ligently furnishes information for a fee that in news gathering, news analysis, or other privity with that company, and thus owed a it knows will be provided to and relied upon journalistic activities. duty of care to that company to provide by a limited group of persons. Because the rat- In summary, the structure of typical sub- accurate ratings.21 ings at issue in Commercial Financial were prime RMBS CDOs, and related CDS pro- The Commercial Financial court noted a done at the request of the plaintiff, for a fee, tection, provides a strong basis for liability “crucial distinction” between the suit before and were intended to be provided to the against the rating agencies involved in those it and Jefferson County School District No. plaintiff, who could be expected to rely upon transactions, for negligent misrepresentation, R-1 v. Moody’s Investor’s Services,22 which them, the Commercial Financial court held because 1) they were paid fees to structure the dismissed claims for tortious interference, that Section 552 applied to the credit rating transactions and had a direct financial incen- injurious falsehood, and antitrust violations agency.26 tive to be actively involved, in an ongoing, because Moody’s credit ratings are “pro- Based upon the reasoning and analyses dynamic manner, in the management of the tected expressions of opinion.” In Jefferson underlying the holdings in In re Fitch, Inc., ratings process (i.e., the collateral manager County, Moody’s published its opinion for the Duff & Phelps Credit Rating Company, and could replace securities with higher-rated securities as necessary to maintain the over- all rating of particular tranches, 2) the ratings of the subprime RMBS CDOs were provided to a limited group of recipients to whom the securities were marketed and sold, rather than to the larger public, at least with respect to the original purchases in the private place- ments (versus purchases made in the sec- ondary market), and with respect to the orig- inal sellers of CDS protection in the initial private placements, 3) the rating agencies had an active, central, interactive, and ongo- ing role in the structuring and rating of the subprime RMBS CDOs and their respective tranches, and 4) taken together, these cir- cumstances ought to be sufficient to show that either privity or near privity existed between the rating agencies, on the one hand, and the limited group of plaintiffs to whom the securities were marketed and sold, on the other.27 Negligence or Wrongful Acts Once the four elements are shown to be sat- isfied, it is still necessary to show that the rat- ing agencies acted negligently or wrongfully. In this regard, the question is whether the rat- ing agencies knew or should have known that their assigned ratings were less reliable than the rating agencies made them appear, knowing the reliance placed on the ratings. When rating subprime RMBS CDOs, the rat- ing agencies typically used indenture guide- 42 Los Angeles Lawyer October 2009
  • 5. lines as a template to run worst-case scenar- ios based on the underlying assets. The rat- SAVE ing agencies would apply their proprietary “Industry Specialists For Over 22 Years” YOUR computer models to the types of collateral CLIENTS pools permissible under the indenture guide- lines, placing the most emphasis on the weak- A t Witkin & Eisinger we specialize in the Non-Judicial Foreclosure of obligations secured by real property or real and personal property (mixed collateral). FROM THE JAWS OF est pools. Next they would compare the com- puter model results against the capital When your client needs a foreclosure done profession- ally and at the lowest possible cost, please call us at: BANKRUPTCY structure of the CDOs to assess whether the Bankruptcy litigator and strategist level of subordination, overcollateralization, with 30+ years experience and excess spread available to each rated helps law firms and their clients with all aspects of bankruptcy. tranche provides the necessary amount of “credit enhancement” to support a particu- • Bankruptcy Avoidance lar rating. • Strategic Pre-Bankruptcy Planning This sounds impressive, but the sad truth • Business & Personal Bankruptcies is that the rating agencies used computer • Debtor & Creditor Representation models that were inadequate, were based upon inadequate information and faulty • Adversary Proceedings & Appeals default assumptions, and were operated and Does LACBA have • Fraudulent & Preferential Transfers analyzed by rating analysts who did not under- your current • Nondischargeability Proceedings stand what they were doing and what the • Settlement & Judgment Protection data revealed. In particular, the rating agen- e-mail address? cies and the issuers and underwriters that UCLA Law Graduate The Los Angeles County Bar Phi Beta Kappa paid their fees relied almost universally on Association is your resource for information delivered via e-mail Magna Cum Laude Monte Carlo simulation-based approaches on a number of subjects that Balance the scales to assessing default probabilities, predicated in your clients’ favor. impact your practice. on a correlation model called the Gaussian Keep your clients in-house. copula formula, which was developed by for- Update your records online at mer J.P. Morgan quantitative analyst David X. or Li. Monte Carlo simulation-based approaches call Member Services at 213.896.6560. Beverly Hills Westlake Village to assessing default probabilities rely on sev- 323.954.9144 805.557.7001 eral key assumptions regarding default fre- quencies, recovery rates, and correlations. The primary rating agencies used proprietary software tools to conduct these complex Monte Carlo simulations. During the time leading up to the beginning of the financial cri- sis in 2007 and 2008, Standard & Poor’s used CDO Evaluator 3.3, Moody’s used CDOROM, and Fitch used VECTOR 3.0. These computer models are only as reliable as the assumptions on which they are predi- cated and the people who operate and inter- pret the models. The assumptions were out- dated. Assessing future default risk in subprime mortgage loans based upon past performance was not and could not be a reli- able predictor when the fundamental under- writing criteria used in the past was not being used in connection with subprime RMBS that formed the core of the CDO tranches actually being rated. But the rating agencies ConfidenceAtThe Courthouse. Business litigation is increasingly complex. That is why we believe valuation evidently turned a blind eye to this problem, issues must be addressed with the same meticulous care relying on the Gaussian copula formula to as legal issues. Analysis must be clear. Opinions must be provide supposed added security to their defensible. Expert testimony must be thorough and probabilistic default assessments. articulate. HML has extensive trial experience and can Thus, to assess the myriad variables and provide legal counsel with a powerful resource for expert the range of different probabilistic outcomes testimony and litigation support. arising from multiple ever-changing variables, the rating agencies relied on the Gaussian For More Information Call 213-617-7775 copula formulation to simplify and quantify Or visit us on the web at RMBS default probabilities based upon com- plex and exceedingly variable correlations.28 BUSINESS VALUATION • LOSS OF GOODWILL • ECONOMIC DAMAGES • LOST PROFITS (In statistics, a copula is used to couple the Los Angeles Lawyer October 2009 43
  • 6. behavior of two or more variables.) The expert4law–The Legal Marketplace Gaussian copula soon became such a uni- versally accepted part of the world’s financial vocabulary that brokers started quoting prices Target Your Online Search for Experts Quickly, Easily for bond tranches based on their correla- tions. “Correlation trading has spread Need an Expert? Find one here. through the psyche of the financial markets The Los Angeles County Bar Association’s official online referral service for like a highly infectious thought virus,” wrote expert witnesses, legal consultants, litigation support, lawyer-to-lawyer referrals, derivatives guru Janet Tavakoli in 2006.29 and dispute resolution service providers. But this Gaussian copula formula was For more information, call 213.896.6470 or e-mail simplistic and flawed. The damage was fore- seeable and foreseen. In 1998, before Li had AVAILABLE 24 HOURS A DAY! even invented his copula function, Paul Wilmott wrote that “the correlations between financial quantities are notoriously unsta- ble.”30 Yet the rating agencies in rating sub- prime RMBS CDOs relied heavily on this copula correlation model that they did not really understand, even though they claimed that their ratings were based upon objective, thorough, and comprehensive analyses. Finally, in addition to turning a blind eye to the increasingly lax underwriting stan- dards used by loan originators and to the overly optimistic and reductionist formula used to quantify default risk, the rating agen- cies also mistakenly relied upon CDS to “insure” tranches that they were rating in order to buttress the ratings assigned to those tranches. A CDS typically acts—or rather, is supposed to act—like an insurance contract that protects the protection purchaser from the decline in value or other trigger event in a referenced entity or security in relation to which the CDS provides credit default insur- ance. In the case of subprime RMBS CDOs, “insurance” often was provided against default rates exceeding the predicted range for the asset type supporting a particular invest- ment grade by the rating agencies for partic- ular CDO tranches. The key problem with the use of CDS to support the creditworthiness of particular tranches of subprime RMBS CDOs—a prob- lem that should have been obvious to issuers, investors, and rating agencies alike—is that CDS contracts were freely tradable, usually without notice to CDO investors, and it was almost always difficult, if not impossible on an ongoing basis, to determine who the CDS counterparty was at any particular time and whether and to what extent that CDS coun- terparty was sufficiently solvent, creditwor- thy, and ready to fulfill its insurance obliga- tions in an event of default. In fact, the CDS became a financial product with a life of its own, and CDOs were often linked with syn- thetic credit default swaps and complex hedg- ing structures that in many cases were them- selves linked to yet other CDOs imbedded with credit default swaps and hedging struc- tures whose values and risk levels were not and could not be assessed accurately. This history should provide more than 44 Los Angeles Lawyer October 2009
  • 7. enough to overcome the traditional defenses Servs., 175 F. 3d 848, 856 (10th Cir. 1999) (dismissing court adopted the magistrate judge’s opinion, with its of ratings agencies and expose them to lia- claims for tortious interference, injurious falsehood, recommendation regarding the critical First Amendment and antitrust violations because Moody’s credit ratings issue, in toto. bility. However, given the continuing central 17 Id. at 1076. are “protected expressions of opinion”); County of role that ratings agencies play in our financial Orange v. McGraw-Hill Cos., 245 B.R. 151, 157 (C.D. 18 Id. at 1092-93. and credit markets, it remains to be seen Cal. 1999) (“The First Amendment protects S&P’s 19 Credit Alliance Corp. v. Arthur Andersen & Co., 65 whether Congress, the Executive Branch, or preparation and publication of its ratings.”). N.Y. 2d 536 (1985). 4 See, e.g., In re Scott Paper Co. Sec. Litig., 145 F.R.D. 20 Duff & Phelps, 951 F. Supp. at 1093. the judiciary will be willing to address the 366 (E.D. Pa. 1992); In re Burnett, 269 N.J. Super. 493 21 Commercial Fin. Servs., Inc. v. Arthur Andersen massive liability that could face the rating (Super. Ct. 1993); In re Pan Am Corp., 161 B.R. 577 LLP, 2004 OK CIV APP 56, 94 P. 3d 106 (Okla. Civ. agencies as a result of their complicity in the (S.D. N.Y. 1993); Stephens v. American Home Assur. App. 2004). financial crisis. ■ Co., No. 91 Civ. 2898 (JSM) (KAR) (S.D. N.Y. Apr. 22 Jefferson County Sch. Dist. No. R-1 v. Moody’s 17, 1995). Investor’s Servs., 175 F. 3d 848, 856 (10th Cir. 1999). 1 PBS 5 Moody’s has been a stand-alone public company 23 Commercial Fin., 94 P. 3d at 110 (quoting Jefferson Online, Free Market Society, THE ONLINE NEWS HOUR, Feb. 13, 1996, available at since 2000, when it was spun off from Dun & County, 175 F. 3d at 850). Bradstreet. 24 Id. at 110. /newshour/gergen/friedman.html. 2 Credit reporting services (not credit rating agencies) 6 Fitch is owned by Fimalac, S.A., in France, which is 25 Id. at 112-14. controlled by Group Marc de Lachairière. 26 Id. at 113. lost the First Amendment issue in Dun & Bradstreet, 7 Standard & Poor’s is a division of the McGraw-Hill 27 Compare, e.g., In re Fitch, Inc., 330 F. 3d 104, 110- Inc. v. Greenmoss Builders, Inc., 472 U.S. 749 (1985); Oberman v. Dun & Bradstreet, Inc., 460 F. 2d 1381 Companies, Inc. 11 (2d Cir. 2003) (communications between rating 8 See infra notes 15-31 and accompanying text. agency and arranger “reveal a level of involvement with (7th Cir. 1972); and Grove v. Dun & Bradstreet, Inc., 9 A CDO can hold different types of loans, emerging the client’s transactions that is not typical of the rela- 438 F. 2d 433 (3d Cir. 1971), cert. denied, 404 U.S. 898 (1971). market debt, sovereign debt, high-yield corporate tionship between a journalist and the activities upon 3 New York Times v. Sullivan, 376 U.S. 254 (1964). See bonds, distressed securities (also junk bonds), asset which the journalist reports”) with Compuware Corp. also Compuware Corp. v. Moody’s Investors Servs., backed securities, commercial mortgage backed secu- v. Moody’s Investors Servs., Inc., 222 F.R.D. 124, Inc., 499 F. 3d 520 (6th Cir. 2007) (affirming grant of rities, and commercial and industrial loans. By means 131 (E.D. Mich. June 10, 2004). Cf. Compuware summary judgment in favor of rating agency sued by of credit default swaps and other vehicles, access to Corp. v. Moody’s Investors Servs., 324 F. Supp. 2d 860, issuer over an allegedly erroneous downgrade and rat- these assets also can be achieved synthetically. 862, and 904 n.7 (E.D. Mich. 2004). 10 17 C.F.R. §230.144A (2009). 28 On Default Correlation: A Copula Function Approach, ings report); Newby v. Enron Corp. (In re Enron Corp. 11 In re Fitch, Inc., 330 F. 3d 104 (2d Cir. 2003). 9 J. OF FIXED INCOME 43-54 (Mar. 2000). Sec. Derivative & ERISA Litig.), No. MDL-1446, 2005 12 Id. at 107. 29 Felix Salmon, Recipe for Disaster: The Formula That U.S. Dist. LEXIS 4494 (S.D. Tex. Feb. 16, 2005) (grant- 13 Id. at 109. Killed Wall Street, WIRED MAGAZINE, Feb. 23, 2009 ing motions by rating agencies to dismiss tort claims by 14 Id. at 110. (quoting Janet Tavakoli), available at http://www.wired Enron creditor grounded on their allegedly too-favorable 15 Id. at 111. .com/techbiz/it/magazine/1703/wp_quant?currentPage ratings of Enron debt), motion for reconsideration 16 LaSalle Nat’l Bank v. Duff & Phelps Credit Rating =all. denied, 2007 U.S. Dist. LEXIS 41091 (S.D. Tex. June 5, Co., 951 F. Supp. 1071 (S.D. N.Y. 1996). The district 30 Id. (quoting Paul Wilmott). 2007); Jefferson County Sch. Dist. v. Moody’s Investor’s Los Angeles Lawyer October 2009 45