As we wrote yesterday, Manhattan federal Judge Shira Scheindlin rejected a free-speech defence rating agencies have been trying to shield themselves with for quite some time.
Although this might not resolve all the problems inherent to the rating agency system, it is a step in the right direction.
By using the First Amendment as a defence, the agencies were aligning themselves with the press, saying they were merrily giving “opinions,” which is ludicrous. It’s like saying that the press and PR people are doing the same job.
The judge’s ruling importantly doesn’t turn on the much villainized “issuer-compensated model” model that many wrongly assume drove the ratings agencies to issue rosy ratings. Instead, it concentrates on the idea that the ratings are not statements of public opinion but private commercial communications with buyers. This makes them very different from, say, Barron’s taking a view on a company’s prospects.
From the judge’s opinion (via WSJ):
Under typical circumstances, the First Amendment protects rating agencies, subject to an “actual malice exception, from liability arising out of their issuance of ratings and reports because their ratings are considered matter of public concern. However, where a rating agency has disseminated their ratings to a select group of investors rather than to a public at large, the rating agency is not afforded the same protection. Thus the Rating agencies’ first amendment argument is rejected.
For the reasons discussed below, plaintiffs have sufficiently pleaded that the rating agencies did not genuinely or reasonably believe that the ratings they assigned to the rated notes were accurate and had a basis in fact, As a result, the rating agencies’ ratings were not mere opinions but rather actionable misrepresentations.
So the judge’s opinion is a first step. It shoots down one defence and opens the rating agencies up to major liabilities (which is why the stocks got crushed).
The decision doesn’t address the agencies’ other issues–includng the market distorting government created oligopoly, the lack of understanding of the securities they rate or the regulatory arbitrage opportunities created by applying different credit standards to different types of loans. But by forcing them to stand behind their conclusions rather than hiding behind the freedom to say stupid things, the ruling might help future ratings a bit.
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