Below Investment Grade and Above the Law: A Past, Present and Future Look at the Accountability of Credit Rating Agencies

“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 credit rating agencies (“CRAs”). The Article is titled “below investment grade” due to the shoddy performance of the CRAs in light of 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 completely 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 the purchaser-subscriber to issuer-pays 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. This Article then covers the Credit Rating Agency Reform Act of 2006 and the adoption of SEC Rule 17g-5, in so far as they attempted to control conflicts of interest within CRAs. This Article next turns 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. Next, this Article dissects 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, whereas in what could only be seen as a game of hard ball, the CRAs won notwithstanding the Act. For completeness, this Article then turns to the European approach of CRA regulation, including the creation of the European Securities and Markets Authority in January 2011. This Article concludes 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