A Justified 'Assault upon the Citadel of Privity' and the First Amendment: A Theory of Liability for Investors Seeking Recovery from Credit Rating Agencies
| Autor | Joseph G. Bunn |
| Páginas | 128-144 |
AJUSTIFIED “A SSAULT UPON THE CITADEL OF PRIVITY”AND THE
FIRST AMENDMENT:ATHEO RY OF LIABILITY FOR INVESTORS
SEEKING RECOV ERY FROM CREDIT RATI NG AGENCIES†
JOSEPH G.BUNN*
I. Introduction .......................................................................................................................................................... 128
II. Credit Rating Agencies’ Involvement in the Recent Financial Crisis.......................................... 129
A. The traditional credit rating business mo del.................................................................................. 130
B. Credit rating agencies ’ regulatory entanglement. ......................................................................... 130
C. The emergence of struc tured financial products. .......................................................................... 132
D. The structured financial product rating p rocess........................................................................... 134
E. Inherent flaws in the s tructured financial rating process. ......................................................... 135
F. Damage Caused By Inaccurate Structured Financial Product Ratings ................................. 136
III. An Approaching PrivityRelationship Exists Between Credit Ratin g Agencies and
Structured Financial Product Investors. ...................................................................................................... 137
IV. The First Amendment’s Lack of Protecti on for Structured Financial Product Ratings. ... 140
V. Conclusion ............................................................................................................................................................ 144
I.INTRODUCTION
The active involvement of credit rating agencies (hereinafter “CRAs”)
in therecent financial crises involving structured finance marketan adequate
basis fornegligent misrepresentation claims by investorsagainst CRAs.
Traditionally, CRAs have qualified for protection from suit by investors under
the privity doctrine and under the First Amendment. CRAs qualified for
protection under the privity doctrine because they are not typically in a
contractual relationship with investors who utilize their ratings. Moreover,
CRAs qualified for protection under the First Amendment because courts
viewed their ratings as speechregarding public matters. However, this dual
protectionshould not apply in the aforementioned circumstances.
Third party beneficiaries of a contract may have a cause of action
against a service-providing party when there is a relationship approaching
that of privity. Such a relationship exists when a contract party provides
services for a particular purpose in furtherance of which a known party or
parties are intended to rely, and the service-providing party provides those
services in a manner that constructively links the service provider to the
reliant party. The ratings of structured financial products (hereinafter
†1 Ultramares Corp v. Touche, 255 N.Y. 170, 174 N.E. 441, 445 (1931) (Cardozo, J.)
*Special thanks to C. Haley Cook, Esq. for l ove and inspiration, and Prof. Andre Douglas
Pond Cummings, West Virginia University Colleg e of Law for endless hours of editing and
comments
No. 1Assault upon the Citadel of Privity
129
“SFPs”) serve a particular purpose because those ratings provide issuers the
ability to offer SFPs to qualified institutional investors under Rule 144A of
theSecurities Act of 1933. Qualified institutional investors are known,
reliant parties of such ratings because many of them are required by law to
only purchase securities equal to or exceeding investment-grade. Finally,
CRAs provide these ratings in a manner that constructively links them to
investors because the process of providing SFP ratings is plagued by conflicts
of interest, improper management, and poor use of information. Thus, CRAs
and should be liable for losses incurred by investors who relied on their
inflated structured financial product ratings.
Furthermore, the First Amendment should not protect CRAs from this
liability because a structured financial product rating is speechthat is not of
public concern. First Amendment protection is extended only to matters of
public concern. A credit rating’s “content, form, and context . . . as revealed
by the whole record” indicates whether such rating is of public concern or
not. There are a variety of factors that indicate SFP ratings are not a matter
of public concern. First, SFP ratings are solely in the interests of CRAs and
their specific audience because they are the only parties who will financially
benefit from an SFP rating’s issuance. Second, SFP ratings are not typically
disseminated in a broad fashion. Third, the large profit margin that CRAs
derive from each SFP rating will encourage CRAs to continue providing SFP
ratings, despite additional regulation. Fourth, SFP ratings are more
objectively verifiable than other protected forms of speech. Because the
content, form, and context of a typical SFP rating indicates that such rating is
not a matter of public concern, the First Amendment should not protect SFP
ratings.
To fully explain the issues discussed above, the following analysis is
composed of three parts: (I) Credit rating agencies’ involvement in the
financial crisis, (II) An “approaching privity” relationship among credit rating
agencies and structured financial product investors, and (III) The First
Amendment’s lack of protection for structured financial product ratings.
II.CREDIT RATING AGENCIES’INVOLVEMENT IN THE RECENT FINANCIALCRISIS.
Prior to exploring CRAs’ potential liability to investors for inflated
credit ratings, an examination of many facts is necessary. First, it is
necessary to understand the CRAs’ origins because they give insight into the
limits of CRAs’ First Amendment protection. Additionally, examining the
CRAs’ influence and function in the structured finance market sheds light on
the special relationship that exists between CRAsand structured financial
product investors. Finally, the policing of imposing liability exposure upon
CRAs is strengthened by understandingthe losses suffered by investors in
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