In order to better appreciate the challenge faced by regulators to legislate assigning liability to CRAs, it is imperative to briefly review the evolution of S&P, Moody’s and Fitch from their origins as publishers to institutions of unparalleled influence, if not, power.357 While it is commonly accepted that the rating of securities by CRAs originated in the late 19th century, some scholarship contends that Louis Tappan’s mercantile credit rating agency business established in 1841 was the true origin of the rating enterprise.358 Tappan’s firm, acquired by Robert Dun in 1859, consolidated with John Bradstreet’s firm to establish Dun & Bradstreet, which in 1962 acquired Moody’s Investor Service before spinning off the latter as publicly listed company in 2000.
While working as the editor of the American Railway Journal which was owned by his younger brother John, Henry Varnum Poor wrote and published History of Railroads and Canals in the United States of America – Exhibiting their Progress, Cost, Revenue, Expenditures & Present Condition in 1860.359 Addressed to the American Geographical
& Statistical Society, this tome was a state-by-state360 financial analyst’s review of the
357 Thomas L. Friedman, (“There are two superpowers in the world today in my opinion. There's the United States and there's Moody's bond rating service. The United States can destroy you by dropping bombs, and Moody's can destroy you by downgrading your bonds. And believe me, it's not clear sometimes who's more powerful.”), PBS television broadcast, The News Hour with Jim Lehrer (1996).
358 See e.g., Richard Cantor, and Frank Packer, “The Credit Rating Industry.” Federal Reserve Bank of New York, Q. Rev., at 1-2 (1994).
359 Standard&Poors, available at https://www.spratings.com/about/who-we-are/what-we-do.html.
360 The 11 states covered in “History of Railroads & Canals” were: Maine, New Hampshire, Vermont, Massachusetts, Rhode Island, Connecticut, New Jersey, Pennsylvania, Delaware and Maryland.
then existing railroad and canal infrastructure in the United States. In 1868, Poor followed up this earlier publication with the Manual of the Railroads of the United States361 (hereafter, The Manual) wherein he opined on the quality of the bonds issued, observing that:
“[A] single statement, as experience has shown, is very unsafe ground upon which to base an opinion. A high degree of apparent prosperity that one report may show, has not unfrequently (sic) been followed by bankruptcy before the annual occasion for another.”362
The Manual was the forerunner for Henry Varnum Poor’s decision to regularly publish corporate railroad bond ratings.363 After merging with Standard Statistics in 1941, the H.V. & H.W. Poor364 publishing business evolved into the current Standard & Poor’s business, which was itself acquired by the McGraw-Hill group of companies in 1926.
Another American, John Moody, founded ‘John Moody & Co.’ in 1900. That same year he issued a seminal publication: Moody's Manual of Industrial and Miscellaneous Securities which was an agglomeration of information and statistical information on the property, capitalization, and management of companies; most notably on the “stocks and bonds of financial institutions, government agencies, manufacturing, mining, utilities, and food companies”.365 It reportedly sold out in two months and was nationally renowned by 1903. However, Moody’s early success turned out to be fleeting and he was forced to sell the firm during the financial market crash of 1907. John Moody’s forced ‘sabbatical’
361 Poor, H.V. Central Pacific Railroad Photographic Museum, (1868), available at http://cprr.org/Museum/Poors_1868.html (last accessed Mar. 30, 2015).
362 Id. Poor, (1868).
363 Id. Poor, (1868).
364 Henry Varnum and his son, Henry William Poor.
365 Moody's, About Us: Moody's History, available at http://www.moodys.com/Pages/atc001.aspx (last accessed Mar. 5, 2015).
lasted until 1909 when he returned to the market with a newly incorporated company registered simply as “Moody’s”. His new and improved product offering changed the ratings analysts’ landscape for all time. Rather than merely collating financial data and statistics of selected firms, Moody’s published Analyses of Railroad Investments, “a book about railroad securities, used letter grades to assess their risk”.366 The use of letter grades made Moody’s the first what? to rate public market securities on a quantifiable scale.367
Through Moody’s lettering classification system, the branch transitioned from merely reporting on the financial data and statistics to providing a calibrated scale for quantifying opinions on the data, hence creating what today is commonly referred to as a credit rating. With the incorporation of Moody’s Investors Service in July 1914, Moody’s proceeded to introduce the coverage of bonds issued by US cities and municipalities.
Moody’s US bond market coverage level was reaching close to 100 percent by 1924 while coverage of commercial paper and bank deposits was later introduced in the 1970s. Fitch Ratings, the smallest of the Big Three, was founded in New York City on December 24th, 1913, by John Knowles Fitch. Similar to Poor’s and Moody’s, the Fitch Publishing Company was also founded in the United States of America. Having also started out as a publisher of financial statistics, it later introduced the “AAA” to “D” ratings scale in 1924.368 In 1997, Fitch approached the French-owned (i.e. owned by Fimalac S.A.) but London-based rating agency, IBCA, with the intention of acquiring it and thus expanding its own European footprint. However, IBCA surprisingly turned the tables on its potential suitor and had by December of the same year, itself acquired the Fitch Publishing
366 Alec Klein, Smoothing the Way for Debt markets: Firms' Influence Has Grown Along With World's Reliance on Bonds, WASH.POST, Nov. 23, 2004, at A18.
367 Id., Klein, 2004 at A18.
368 Fitch Ratings, Fitch Ratings, About us (2011) available at www.fitchratings.com.
Company. Subsequently, Fitch Ratings, part of the Fitch Group, is today a majority-owned subsidiary of Paris-based Fimalac S.A.369
The fact that each of the Big Three was originally founded as a publishing house is important to note as it would later strongly influence the manner in which they perceived and interpreted their roles as CRAs, as well as the manner in which they would predominantly rely on the First Amendment defense when facing lawsuits charging flawed ratings.