The Dodd-Frank Act: A “Nip and Tuck” Approach
to Credit Rating Agency Liability
Wendy CoutureThe Dodd-Frank Wall Street Reform & Consumer Protection Act
SymposiumGonzaga University School of Law
November 4, 2011
Increases liability exposure
Nullifies SEC Rule
436(g)
Excludes CRA
statements from § 21E safe harbor
Excepts CRAs from PSLRA’s scienter pleading standard
Stalemate Strawman So what?
Financial Crisis Inquiry Commission Report, Conclusions, p.xxv“We conclude the failures of credit rating agencies were essential cogs in the wheel of financial destruction. The three credit rating agencies were key enablers of the financial meltdown...”
Dodd-Frank Act § 931(5) Findings• “In the recent financial crisis, the ratings on structured financial products have proven to be inaccurate.” • “This inaccuracy contributed significantly to the mismanagement of risks by financial institutions and investors, which in turn adversely impacted the health of the economy in the United States and around the world.” • “Such inaccuracy necessitates increased accountability on the part of credit rating agencies.”
CRAs
Creates Office of
Credit Ratings
Addresses conflicts of
interest
Reduces reliance on
credit ratings
Requires CRAs to consider info from
non-issuers
Prevents issuers from
“shopping” for ratingIncreases
liability exposure
§ 11 of the Securities Act – Civil Liability on Account of False
Registration Statement
Imposes strict liability for material misrepresentations in the registration statement on the following parties:
• 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
*Potential due diligence defense available to non-issuers.
§ 10(b) of the Securities Exchange Act –
Manipulative and Deceptive Devices
Imposes liability for material misrepresentations in connection with the purchase or sale of any security. The key elements of a claim are:
• materiality• falsity• scienter• reliance• loss causation
Increases liability exposure
Nullifies SEC Rule
436(g)
Excludes CRA
statements from § 21E safe harbor
Excepts CRAs from PSLRA’s scienter pleading standard
Stalemate
Nullifies SEC Rule
436(g)
§ 11 of the Securities Act – Civil Liability on Account of False Registration Statement
Imposes strict liability for material misrepresentations in the registration statement on the following parties:
• 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
Nullifies SEC Rule
436(g)
§ 11 of the Securities Act – Civil Liability on Account of False Registration Statement
Imposes strict liability for material misrepresentations in the registration statement on the following parties:
• 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
Rule 436(g) – NRSRO credit ratings “shall not be considered a part of the registration statement prepared or certified by a person within the meaning of §§ 7 and 11 of the Act.”
Nullifies SEC Rule
436(g)
§ 11 of the Securities Act – Civil Liability on Account of False Registration Statement
Imposes strict liability for material misrepresentations in the registration statement on the following parties:
• 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
Rule 436(g) – NRSRO credit ratings “shall not be considered a part of the registration statement 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.”
X
Nullifies SEC Rule
436(g)
§ 11 of the Securities Act – Civil Liability on Account of False Registration Statement
Imposes strict liability for material misrepresentations in the registration statement on the following parties:
• 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
Rule 436(g) – NRSRO credit ratings “shall not be considered a part of the registration statement 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.”
XNRSROs are withholding their consent!
Nullifies SEC Rule
436(g)
§ 11 of the Securities Act – Civil Liability on Account of False Registration Statement
Imposes strict liability for material misrepresentations in the registration statement on the following parties:
• 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
Rule 436(g) – NRSRO credit ratings “shall not be considered a part of the registration statement 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.”
XNRSROs 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
Increases liability exposure
Nullifies SEC Rule
436(g)
Excludes CRA
statements from § 21E safe harbor
Excepts CRAs from PSLRA’s scienter pleading standard
Stalemate Strawman
Excludes CRA statements from § 21E safe harbor
§ 10(b) of the Securities Exchange Act – Manipulative and Deceptive Devices
Imposes liability for material misrepresentations in connection with the purchase or sale of any security. The key elements of a claim are:
• materiality• falsity• scienter• reliance• loss causation
Excludes CRA statements from § 21E safe harbor
§ 10(b) of the Securities Exchange Act – Manipulative and Deceptive Devices
Imposes liability for material misrepresentations in connection with the purchase or sale of any security. The key elements of a claim are:
• materiality• falsity• scienter• reliance• loss causation
Sec. 21E – Statutory safe harbor for issuers and persons “acting on behalf of” such issuers from liability for “forward-looking statements,” if identified as such and accompanied by meaningful cautionary language.
Excludes CRA statements from § 21E safe harbor
§ 10(b) of the Securities Exchange Act – Manipulative and Deceptive Devices
Imposes liability for material misrepresentations in connection with the purchase or sale of any security. The key elements of a claim are:
• materiality• falsity• scienter• reliance• loss causation
Sec. 21E – Statutory safe harbor for issuers and persons “acting on behalf of” such issuers from liability for “forward-looking statements,” if identified as such and accompanied by meaningful cautionary language.X
Excludes CRA statements from § 21E safe harbor
§ 10(b) of the Securities Exchange Act – Manipulative and Deceptive Devices
Imposes liability for material misrepresentations in connection with the purchase or sale of any security. The key elements of a claim are:
• materiality• falsity• scienter• reliance• loss causation
Sec. 21E – Statutory safe harbor for issuers and persons “acting on behalf of” such issuers from liability for “forward-looking statements,” if identified as such and accompanied by meaningful cautionary language.X
Not excluded from § 27A safe harbor in Securities Act!
Increases liability exposure
Nullifies SEC Rule
436(g)
Excludes CRA
statements from § 21E safe harbor
Excepts CRAs from PSLRA’s scienter pleading standard
Stalemate Strawman So what?
Excepts CRAs from PSLRA’s
scienter pleading standard
§ 10(b) of the Securities Exchange Act – Manipulative and Deceptive Devices
Imposes liability for material misrepresentations in connection with the purchase or sale of any security. The key elements of a claim are:• materiality, falsity, scienter, reliance, loss causation
Excepts CRAs from PSLRA’s
scienter pleading standard
§ 10(b) of the Securities Exchange Act – Manipulative and Deceptive Devices
Imposes liability for material misrepresentations in connection with the purchase or sale of any security. The key elements of a claim are:• materiality, falsity, scienter, reliance, loss causation
PSLRA – requires a plaintiff who is seeking money damages in a private action to “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind”
Excepts CRAs from PSLRA’s
scienter pleading standard
§ 10(b) of the Securities Exchange Act – Manipulative and Deceptive Devices
Imposes liability for material misrepresentations in connection with the purchase or sale of any security. The key elements of a claim are:• materiality, falsity, scienter, reliance, loss causation
PSLRA – requires a plaintiff who is seeking money damages in a private action to “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind”
Dodd-Frank Act §933(b)(2)(B): “In the case of an action for money damages brought against a credit rating agency or a controlling person under this title, it shall be sufficient, for purposes of pleading any required state of mind in relation to such action, that the complaint state with particularity facts giving rise to a strong inference that the credit rating agency knowingly or recklessly failed –(i) to conduct a reasonable investigation of the rated security with respect to the factual elements relied upon by its own methodology for evaluating credit risk; or(ii) to obtain reasonable verification of such factual elements (which verification may be based on a sampling technique that does not amount to an audit) from other sources that the credit rating agency considered to be competent and that were independent of the issuer and underwriter.”
X
Excepts CRAs from PSLRA’s
scienter pleading standard
§ 10(b) of the Securities Exchange Act – Manipulative and Deceptive Devices
Imposes liability for material misrepresentations in connection with the purchase or sale of any security. The key elements of a claim are:• materiality, falsity, scienter, reliance, loss causation
PSLRA – requires a plaintiff who is seeking money damages in a private action to “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind”
Dodd-Frank Act §933(b)(2)(B) – lower scienter pleading standard
X
Excepts CRAs from PSLRA’s
scienter pleading standard
§ 10(b) of the Securities Exchange Act – Manipulative and Deceptive Devices
Imposes liability for material misrepresentations in connection with the purchase or sale of any security. The key elements of a claim are:• materiality, falsity, scienter, reliance, loss causation
PSLRA – requires a plaintiff who is seeking money damages in a private action to “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind”
Dodd-Frank Act §933(b)(2)(B) – lower scienter pleading standard
XPSLRA – still must plead falsity with particularity
Excepts CRAs from PSLRA’s
scienter pleading standard
§ 10(b) of the Securities Exchange Act – Manipulative and Deceptive Devices
Imposes liability for material misrepresentations in connection with the purchase or sale of any security. The key elements of a claim are:• materiality, falsity, scienter, reliance, loss causation
PSLRA – requires a plaintiff who is seeking money damages in a private action to “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind”
Dodd-Frank Act §933(b)(2)(B) – lower scienter pleading standard
XPSLRA – 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).
Increases liability exposure
Nullifies SEC Rule
436(g)
Excludes CRA
statements from § 21E safe harbor
Excepts CRAs from PSLRA’s scienter pleading standard
A “Nip and Tuck” Approach to Credit Rating Agency Liability
Stalemate Strawman So what?