4.2. First amendment protection from liability
4.2.3. Protection and compensation
The Oklahoma Court of Appeals held in Hennessee v. Mathis (1987) that statements made as mere opinions, and not as statements of fact, were incapable of being false.425 In the decision in Commercial Financial Services,426 the Oklahoma Civil Appeals court ruled that solicited bond ratings of investments rated in exchange for compensation were not
the Role and Function of Credit Rating Agencies in the Operation of the Securities Markets, 5-8 (Jan. 2003) available at http://www.sec.gov/news/studies/creditratingreport0103.pdf); American Savings Bank v. UBS Financial Services, 347 F.3d 436 (2d Cir., 2003); Compuware Corp. v. Moody’s Investors Services, 324 F.Supp.2d 860, 862 (E.D. Mich., S.D. 2004) (discussed under 4.2.2 and 4.3); Abu Dhabi Commercial Bank v. Morgan Stanley & Co. 651 F.Supp.2d 155, 166, n.12 (S.D.N.Y. 2009) (discussed under 4.2.1 – 4.3.4.);
and Baker v. Goldman Sachs & Co., 669 F.3d 105, 108, 112 (2d Cir., 2012) (Affirming that qualified privilege for journalists is recognized with regard to news that is both unpublished and not obtained under a promise of confidentiality).
424 In the 330 F. 3d 104 - Fitch Inc., FSB v. UBS Paine Webber, 2nd.Cir. 2003) (the Second Circuit Appeal Court at note 31 cited correspondence highlighting the active role on the part of a Fitch employee commenting on proposed transactions and offering suggestions about how to model the transactions to reach the desired ratings as not improper, but guiding in their decision. See also, e.g., Freeman, supra note70, at 602 supra (active participation by CRAs in structuring process to maximize final rating valuations)).
425 See, Hennessee v. Mathis, 737 P.2d 958, 962 (1987). See also, John Patrick Hunt, Credit Rating Agencies and the Worldwide Credit Crisis, 2009 COLUM.BUS.L.REV.,(1)109, 162 (2009) (arguing that CRA opinions, although untestable, cannot be equated to truly unprovable assertions like “dogs are better than cats”.).
426 Commercial Fin. Servs., v. Arthur Andersen LLP, 94 P.3d 106, 109 (Okla. Civ. App. 2004). (CRA ratings
“fall somewhere between those opinions which receive constitutional protection and those that do not”).
protected by the First Amendment,427 even as it recognized that the CRA had the duty of rating the securities accurately.428 However, the same court also ruled that unsolicited ratings produced by a CRA – which by definition would exclude participation of the latter in the structuring of the structured financial products – owed no such duty to issuers and thereto qualified for First Amendment protection.429
Subsequent court decisions have regularly reached divergent outcomes when ruling on the question of whether journalistic protection should be extended to CRAs. For instance; compare, In re Fitch, 330 F.3d 104430 where the Second Circuit court ruled that a CRA that takes an active role in the structuring of the transactions431 that it rates and
“only covers its own clients”432 was unlike a journalist, with the ruling in Compuware v.
Moody’s Investors Services, (affirmed on appeal by the Sixth Circuit Court of Appeal, on
427 Commercial Fin. Servs., 94 P.3d at 110-11 (Court distinguishes that a journalist writing an article for a newspaper about the bonds would (presumably) receive First Amendment, unlike a journalist hired by [CFS]
to write a company report as the latter would be considered to be in privity and thereby reflecting a relationship akin to that between a client and the client's certified public accountant. See Stroud v. Arthur Andersen & Co. OK 76, 37 P.3d 783 (2001).
428Commercial Fin. Servs., 94 P.3d, at113. (CRAs owed CFS a duty to issue the [accurate] rating which the securities deserved.)
429 Commercial Fin. Servs., 94 P.3d, at 111. (The court did not accept the argument that “having agreed to rate the bonds for a fee, the [CRAs] owed no duty of care to ... the entity paying for the rating”). Contrast, Jefferson County School District. v. Moody’s Investor Services, 175 F.3d. 848, 850-51 (10th Cir. 1999) (lawsuit arising out of unsolicited public ratings deemed “inaccurately low”). See also Jefferson County School District. v. Moody’s Investor Services, Inc., 175 F.3d. 848, 850-51 (10th Cir. 1999) (a case claiming inaccurately low and unsolicited “public” ratings by Moody’s where court ruled that the CRA “owed the plaintiffs no duty”).
430 In re Fitch, 330 F.3d 104 (2d Cir. 2003).
431 In re Fitch, 330 F.3d 104 at 111 (Court finds (from what the sealed documents provided) evidence alleging Fitch’s active role in structuring the transaction to be “extremely credible”).
432 In re Fitch, 330 F.3d 104 at 110.
August 23, 2007)433 where because it was found not to have “participate[d] in the structuring of the debt it was rating” … “[and had therefore not stepped] outside its role as information gatherer”,434 journalistic protection was extended to the CRA.
One commentator has posited that by taking compensation from their ‘research subjects’, participating in the transactions’ structuring process, as well as due to the general acceptance of ratings as “certifications”435 and “benchmarks”436 by financial market participants constitutes the distinctions upon which CRAs so significantly differ from journalists so as to render them ineligible for First Amendment protection.
Based on the aforementioned observations, a recommendation for the use of a
“three-pronged test”437 when assessing CRA liability was proposed. The test requires that the CRA meets three criteria in order to be eligible for First Amendment protection, namely: (i) It must not have received compensation in order to rate the transaction at issue;
(ii) It must demonstrate that it did not take an active role in the planning, structuring and construction of the transaction at issue, and; (iii) It must show that its ratings are more characteristic of an opinion than of a “certification” or “benchmark.” Hence, only where a CRA is not paid to rate the transaction; does not participate in the structuring process;
and can adequately demonstrate that its reports are more like opinions and less like certifications or benchmarks would it then be deemed to qualify for First Amendment protection under the conditions of the proposed three-pronged test.
433 Compuware Corp. v. Moody’s Investors Services, Inc., 499 F.3d 520, 2007 Fed.App. 0336P. (Aff’d on appeal from E.D. Michigan, No. 03-70247, Feikens, District J.).
434 Compuware v. Moody’s Investors Services, at 862.
435 Certification refers to the distinction drawn from CRA ratings between “investment” and “non-investment “grade securities.
436 Benchmark refers to the reliance on a ratings trigger in contract documents or regulation guidelines, e.g.
for mutual fund portfolio holdings.
437 Theresa Nagy, Credit Rating Agencies and the First Amendment 94 MINN.L.REV. 140, 163-64 (2009).
And yet, even if one accepts the proposal’s contention that the third prong helps to
“account for the substantial market value the market places on the ratings”438 as being fundamentally sound, the supporting argumentation put forth by the aforementioned commentator remains unconvincing. The huge profits earned by CRAs notwithstanding,439 more convincing is the argument that the use of and reliance on certifications and benchmarks is one that legislators, regulators and investors have over time collectively adopted or defaulted to because it allowed them to simplify their own due diligence process and thereby reduce the transaction costs440 that would otherwise have arisen from more engaged investment decision-making processes.
Moreover, it is also apparent that although CRAs provide ratings of relative risk on a scale ranging from AAA to BBB-441 for “investment grade” securities, risk profiles and risk appetites among investors differ significantly. This is in part exemplified by the existence of an active market even for “non-investment” grade-rated bonds, including those that are rated “D” and are in default.442 Under the proposed three-pronged test
438 Id., Nagy, at 164.
439 Id., Nagy, at 165. (“The rating agencies have made huge profits from the financial market’s dependence on their certifications of quality…”).
440 Frank Partnoy, Barbarians at the Gatekeepers? 79 WASH. U.L. Q. 5, (2001) (positing reputable gatekeepers to bridge gap between investors and issuers who otherwise find evaluating securities too expensive). See also, Nagy, 94 MINN.L.REV.140,143 (2009) (Ratings have been described as ‘“an efficient interface between investors and issuers” that reduces the cost of securities research for individual investors) citing Amy K. Rhodes, The Role of the SEC in the Regulation of the Rating Agencies: Well-Placed Reliance or Free market Interference? 20SETON HALL LEGIS.J. 293-94 (1996).
441 From AAA to BBB- for S&P and Fitch; AAA to Baa3 for Moody’s. See, http://www.standardandpoors.com/aboutcreditratings/;
http://www.fitchratings.com/creditdesk/public/ratings_defintions/index.cfm?rd_file=intro#primary_sum;
and http://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004 (last accessed Apr.
1, 2015).
442 David J. Ward & Gary L. Griepentrog, Risk and Return in Defaulted Bonds, 49FIN.ANALYSTS J. (3), 61, 61-65 (1993) (on the risk and returns from the defaulted bonds market). See e.g., Stefan Kueffner,
criteria, structured products – for which CRAs are typically actively involved in the structuring process and compensated by the issuer – would then only be decided based on the third prong; the similarities to an opinion as opposed to a certification or benchmark.
The proponent of the three-prong test criteria further asserts that where “investment-grade ratings [are] required by the [investor]”,443 then the third prong would influence the decision against CRAs. However, such a premise appears to only hold if one assumes CRA ratings to be equivalent to guarantees of investment performance of the various rated securities.444 CRAs have neither presumed nor professed the ability to provide such a level of certainty of expected returns, even for their AAA ratings.445 Instead, the literature confirms that CRAs have extensively highlighted the fact that their ratings are ordinal, and not cardinal, by issuing ratings based on relative credit risk as opposed to those explicitly stating a particular expected default.446
Ecuador buys back 91% of 2012, 2030 Bonds in Default, BLOOMBERG, June 11, 2009, available at http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aOqMjXvGDEK8 (last accessed, Apr. 1, 2015).
443 Theresa Nagy, 94 MINN.L.REV.140,166 (2009).
444 Steven L. Schwarcz, Protecting Financial Markets 93 MINN.L.REV.373,403-04 (2008), (ratings are judgment calls by humans, who by their nature, are fallible).
445 e.g. Moody’s defines its highest rated AAA what? for both long-term obligations and structured finance as those “judged to be of the highest quality, with minimal credit risk”, as opposed to zero credit risk, at 4, available at, http://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004 .
446 See e.g., StandardandPoors.com, “The Fundamentals of Structured Finance Ratings”, at 10 available at http:// www2.standardandpoors.com/spf/pdf/fixedincome/Fundamentals_SF_Ratings.pdf.
Deats (2010)447 extends the earlier argument developed by Nagy (2009)448 by citing several examples where First Amendment protection has been extended by courts to cover non-media related parties as evidence that the court decisions have been motivated more by the premise of ensuring protection for statements that infer a public concern rather than on the merit of characteristics that distinguish CRAs from traditional journalists. The number of lawsuits that have been decided by the courts so far is still statistically small449 giving credence to Kettering’s450 caution that because CRAs’’ First Amendment defence has not yet been litigated often enough, it therefore does not permit confident predictions to be made on what the courts will ultimately decide. Although a confident prediction may not yet be achievable, several lawsuits pre- and post- 2007 have given indication of the various courts’ leanings and an observable pattern has started to emerge.
A key area where in recent times CRAs have seemed to hold a divergent view to that of the SEC is on the legal interpretation of the rights, duties, obligations and protections accruing to and associated with the term “opinion”. Some lower US courts have ruled against the contention advanced by CRAs over several decades that ratings opinions are not provably false and should therefore not be avenues by which liability can be extended to them.451 Up until the 2007 GFC, whether on the basis of failing to meet an
447 Caleb M. Deats, Talk that Isn't Cheap, 110COLUM.L.REV.1818,1821 N.16(2010). See e.g. Bigelow v.
Virginia, 421 U.S. 809, 822-25 (1975) (protecting advertisements for abortion services in New York, which was published in Virginia, from regulation as it “conveyed information of potential interest and value to a diverse audience”).
448 Theresa Nagy, 94 MINN. L. REV. 140,166 (2009).
449 Frank Partnoy, Not Like Other Gatekeepers, at 95 (2006) (“[U]nfortunately, private litigation has not yet generated any decisive cases and it remains unclear what protections credit rating agencies should receive”).
450 Kenneth C. Kettering, Securitization and Its Discontents, 29 CARDOZO L.REV.,1553, 1690 (2008).
451 e.g., County of Orange v. McGraw Hill Co., Inc., 245 B.R. 151, 154-56 (1999) (“S&P again attempts to persuade the Court its ratings are opinions which are not provably false. The Court has rejected this argument in the past and does again today. See Order of March 18, 1997 at 21 fn. 7; Order of June 2, 1997”).
“actual malice” or a “misrepresentation” standard, almost all major US court decisions had been decided in favour of CRAs. The premise of the key court decisions in this regard will be reviewed in greater detail later in the dissertation.