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The Dodd-Frank Act: A \'Nip and Tuck\' Approach to Credit Rating Agency Liability

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Presentation at the Dodd-Frank Wall Street Reform & Consumer Protection Act Symposium, November 4, 2011

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The Dodd-Frank Act: A \'Nip and Tuck\' Approach to Credit Rating Agency Liability

  1. 1. The Dodd-Frank Act: A “Nip and Tuck” Approach to Credit Rating Agency Liability Wendy CoutureThe Dodd-Frank Wall Street Reform & Consumer Protection Act Symposium Gonzaga University School of Law November 4, 2011
  2. 2. Increases liability exposure Excepts Excludes CRAs fromNullifies CRA PSLRA’sSEC Rule statements scienter 436(g) from 21E pleading safe harbor standardStalemate Strawman So what?
  3. 3. Financial Crisis Inquiry CommissionReport, Conclusions, p.xxv“We conclude the failures of credit rating agencies wereessential cogs in the wheel of financial destruction. Thethree credit rating agencies were key enablers of thefinancial meltdown...”
  4. 4. Dodd-Frank Act § 931(5) Findings• “In the recent financial crisis, the ratings onstructured financial products have proven tobe inaccurate.”• “This inaccuracy contributed significantly tothe mismanagement of risks by financialinstitutions and investors, which in turnadversely impacted the health of the economyin the United States and around the world.”• “Such inaccuracy necessitates increasedaccountability on the part of credit ratingagencies.”
  5. 5. Reduces reliance on Requires credit CRAs to ratings considerAddresses info fromconflicts of non-issuers interest CRAs Prevents issuers Creates from Office of “shopping” Increases Credit for rating liability Ratings exposure
  6. 6. § 11 of the Securities Act – Civil § 10(b) of the Securities Liability on Account of False Exchange Act – Registration Statement Manipulative and Deceptive DevicesImposes strict liability for materialmisrepresentations in the registration Imposes liability for materialstatement on the following parties: misrepresentations in connection with the purchase• every signatory or sale of any security. The key• every director of issuer elements of a claim are:• every expert who gives consent to benamed as having prepared or certified • materialityexpertised portion • falsity• every underwriter with respect to • scientersecurity • reliance • loss causation*Potential due diligence defenseavailable to non-issuers.
  7. 7. Increases liability exposure Excepts Excludes CRAs fromNullifies CRA PSLRA’sSEC Rule statements scienter 436(g) from 21E pleading safe harbor standardStalemate
  8. 8. § 11 of the Securities Act – Civil Liability on Account of FalseNullifies Registration Statement SEC Imposes strict liability for material misrepresentations in the Rule registration statement on the following parties: 436(g) • every signatory • every director of issuer • every expert who gives consent to be named as having prepared or certified expertised portion • every underwriter with respect to security
  9. 9. § 11 of the Securities Act – Civil Liability on Account of False Nullifies Registration Statement SEC Imposes strict liability for material misrepresentations in the Rule registration statement on the following parties: 436(g) • every signatory • every director of issuer • every expert who gives consent to be named as having prepared or certified expertised portion • every underwriter with respect to securityRule 436(g) – NRSRO credit ratings “shall not be considered a part of the registrationstatement prepared or certified by a person within the meaning of §§ 7 and 11 of the Act.”
  10. 10. § 11 of the Securities Act – Civil Liability on Account of False Nullifies Registration Statement SEC Imposes strict liability for material misrepresentations in the Rule registration statement on the following parties: 436(g) • every signatory • every director of issuer • every expert who gives consent to be named as having prepared or certified expertised portion • every underwriter with respect to security XRule 436(g) – NRSRO credit ratings “shall not be considered a part of the registrationstatement prepared or certified by a person within the meaning of §§ 7 and 11 of the Act.”Dodd-Frank § 939G – “Rule 436(g) . . . shall have no effect.”
  11. 11. § 11 of the Securities Act – Civil Liability on Account of False Nullifies Registration Statement SEC Imposes strict liability for material misrepresentations in the Rule registration statement on the following parties: 436(g) • every signatory • every director of issuer • every expert who gives consent to be named as having prepared or certified expertised portion • every underwriter with respect to security XRule 436(g) – NRSRO credit ratings “shall not be considered a part of the registrationstatement prepared or certified by a person within the meaning of §§ 7 and 11 of the Act.”Dodd-Frank § 939G – “Rule 436(g) . . . shall have no effect.”NRSROs are withholding their consent!
  12. 12. § 11 of the Securities Act – Civil Liability on Account of False Nullifies Registration Statement SEC Imposes strict liability for material misrepresentations in the Rule registration statement on the following parties: 436(g) • every signatory • every director of issuer • every expert who gives consent to be named as having prepared or certified expertised portion • every underwriter with respect to security XRule 436(g) – NRSRO credit ratings “shall not be considered a part of the registrationstatement prepared or certified by a person within the meaning of §§ 7 and 11 of the Act.”Dodd-Frank § 939G – “Rule 436(g) . . . shall have no effect.”NRSROs are withholding their consent!• SEC No-Action Letter granting open-ended reprieve to asset-backed issuers• H.R. 1539 – Asset-Backed Market Stabilization Act of 2011
  13. 13. Increases liability exposure Excepts Excludes CRAs fromNullifies CRA PSLRA’sSEC Rule statements scienter 436(g) from 21E pleading safe harbor standardStalemate Strawman
  14. 14. § 10(b) of the Securities Exchange Act – Manipulative andExcludes CRA Deceptive Devices statements from 21E Imposes liability for material misrepresentations in connection with the purchase or sale of any security. The safe harbor key elements of a claim are: • materiality • falsity • scienter • reliance • loss causation
  15. 15. § 10(b) of the Securities Exchange Act – Manipulative and Excludes CRA Deceptive Devices statements from 21E Imposes liability for material misrepresentations in connection with the purchase or sale of any security. The safe harbor key elements of a claim are: • materiality • falsity • scienter • reliance • loss causationSec. 21E – Statutory safe harbor for issuers and persons “acting on behalf of” such issuersfrom liability for “forward-looking statements,” if identified as such and accompanied bymeaningful cautionary language.
  16. 16. § 10(b) of the Securities Exchange Act – Manipulative and Excludes CRA Deceptive Devices statements from 21E Imposes liability for material misrepresentations in connection with the purchase or sale of any security. The safe harbor key elements of a claim are: • materiality • falsity • scienter • reliance • loss causation XSec. 21E – Statutory safe harbor for issuers and persons “acting on behalf of” such issuersfrom liability for “forward-looking statements,” if identified as such and accompanied bymeaningful cautionary language.
  17. 17. § 10(b) of the Securities Exchange Act – Manipulative and Excludes CRA Deceptive Devices statements from 21E Imposes liability for material misrepresentations in connection with the purchase or sale of any security. The safe harbor key elements of a claim are: • materiality • falsity • scienter • reliance • loss causation XSec. 21E – Statutory safe harbor for issuers and persons “acting on behalf of” such issuersfrom liability for “forward-looking statements,” if identified as such and accompanied bymeaningful cautionary language. Not excluded from § 27A safe harbor in Securities Act!
  18. 18. Increases liability exposure Excepts Excludes CRAs fromNullifies CRA PSLRA’sSEC Rule statements scienter 436(g) from 21E pleading safe harbor standardStalemate Strawman So what?
  19. 19. § 10(b) of the Securities Exchange Act – Manipulative andExcepts CRAs Deceptive Devicesfrom PSLRA’s scienter Imposes liability for material misrepresentations in connection with the purchase or sale of any security. The pleading key elements of a claim are: standard • materiality, falsity, scienter, reliance, loss causation
  20. 20. § 10(b) of the Securities Exchange Act – Manipulative and Excepts CRAs Deceptive Devices from PSLRA’s scienter Imposes liability for material misrepresentations in connection with the purchase or sale of any security. The pleading key elements of a claim are: standard • materiality, falsity, scienter, reliance, loss causationPSLRA – requires a plaintiff who is seeking money damages in a private action to “state withparticularity facts giving rise to a strong inference that the defendant acted with therequired state of mind”
  21. 21. § 10(b) of the Securities Exchange Act – Manipulative and Excepts CRAs Deceptive Devices from PSLRA’s scienter Imposes liability for material misrepresentations in connection with the purchase or sale of any security. The pleading key elements of a claim are: standard • materiality, falsity, scienter, reliance, loss causation XPSLRA – requires a plaintiff who is seeking money damages in a private action to “state withparticularity facts giving rise to a strong inference that the defendant acted with therequired state of mind”Dodd-Frank Act §933(b)(2)(B): “In the case of an action for money damages brought againsta credit rating agency or a controlling person under this title, it shall be sufficient, forpurposes of pleading any required state of mind in relation to such action, that thecomplaint state with particularity facts giving rise to a strong inference that the credit ratingagency knowingly or recklessly failed –(i) to conduct a reasonable investigation of the rated security with respect to the factualelements relied upon by its own methodology for evaluating credit risk; or(ii) to obtain reasonable verification of such factual elements (which verification may bebased on a sampling technique that does not amount to an audit) from other sources thatthe credit rating agency considered to be competent and that were independent of theissuer and underwriter.”
  22. 22. § 10(b) of the Securities Exchange Act – Manipulative and Excepts CRAs Deceptive Devices from PSLRA’s scienter Imposes liability for material misrepresentations in connection with the purchase or sale of any security. The pleading key elements of a claim are: standard • materiality, falsity, scienter, reliance, loss causation XPSLRA – requires a plaintiff who is seeking money damages in a private action to “state withparticularity facts giving rise to a strong inference that the defendant acted with therequired state of mind”Dodd-Frank Act §933(b)(2)(B) – lower scienter pleading standard
  23. 23. § 10(b) of the Securities Exchange Act – Manipulative and Excepts CRAs Deceptive Devices from PSLRA’s scienter Imposes liability for material misrepresentations in connection with the purchase or sale of any security. The pleading key elements of a claim are: standard • materiality, falsity, scienter, reliance, loss causation XPSLRA – requires a plaintiff who is seeking money damages in a private action to “state withparticularity facts giving rise to a strong inference that the defendant acted with therequired state of mind”Dodd-Frank Act §933(b)(2)(B) – lower scienter pleading standardPSLRA – still must plead falsity with particularity
  24. 24. § 10(b) of the Securities Exchange Act – Manipulative and Excepts CRAs Deceptive Devices from PSLRA’s scienter Imposes liability for material misrepresentations in connection with the purchase or sale of any security. The pleading key elements of a claim are: standard • materiality, falsity, scienter, reliance, loss causation XPSLRA – requires a plaintiff who is seeking money damages in a private action to “state withparticularity facts giving rise to a strong inference that the defendant acted with therequired state of mind”Dodd-Frank Act §933(b)(2)(B) – lower scienter pleading standardPSLRA – still must plead falsity with particularity Case law – in order for an opinion to be false for purposes of securities fraud, it must be both disbelieved by its maker (subjectively false) and objectively unreasonable (objectively unreasonable).
  25. 25. Increases liability exposure Excepts Excludes CRAs fromNullifies CRA PSLRA’sSEC Rule statements scienter 436(g) from 21E pleading safe harbor standardStalemate Strawman So what? A “Nip and Tuck” Approach to Credit Rating Agency Liability

Presentation at the Dodd-Frank Wall Street Reform & Consumer Protection Act Symposium, November 4, 2011

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