The Liability of Credit Rating Agencies to Investors: A Review of the Current Liability Regime and Recent SEC Proposals

Abstract

The article attempts to provide a comprehensive review of the current common law and statutory liability of credit rating agencies to investors. In the course of this analysis the authors discuss potential causes of action against credit rating agencies by investors, considering contract law (third-party beneficiary claims), tort law (negligent misrepresentation, product liability. and tortious interference), as well as securities law claims for fraud (Rule 10b-5 under the Securities Exchange Act) and negligence (including potential claims against rating agencies as underwriters and experts engaged in the public offering process of securities). While credit rating agencies before the global financial crisis of 2008 regularly avoided being held liable for their ratings—seeking protection from negligence claims under the First Amendment—growing criticism over the consistency and reliability of their ratings and the independence of credit rating agencies has led to a shift in evaluation of their role as gatekeepers in the securities markets. As a result, in 2009 the SEC proposed to abolish Rule 436(g) under the Securities Act and thereby reclassified credit rating agencies as experts under Section 11 of the Securities Act. Congress, in an attempt to overhaul major parts of the financial system, in 2010 passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which repealed Rule 436(g) as well as lowered the pleading requirements in securities law actions for fraud under Rule 10b-5 against credit rating agencies. This article reviews these changes while rethinking the current liability scheme. Due to the inherent complexity of a review of credit ratings under the different negligence standards of tort law or the liability instruments of the securities laws, finding an answer to the question of what standard of due care should apply will be decisive for the rating agencies’ daily business practices. Even though, in the authors’ view, the creation of a consistent liability system for rating agencies could be an achievable goal in the near future, the debate on this controversial subject is likely to continue.