Credit agencies are no longer a protected species
Bryan Frith | September 11, 2009
Article from: The Australian
IT is something of a mystery why the credit ratings agencies have come out relatively unscathed from the fallout of the sub-prime disaster that led to the global credit seizure and financial crisis.
Now the Australian Securities & Investments Commission has disclosed what was hitherto largely unknown -- that for decades it has treated the ratings agencies as a protected species, granting them immunity from prospectus liability simply because it was easier that way.
Now the ratings agencies are under increasing scrutiny overseas. In April the European Parliament legislated to regulate the agencies and the US District Court has ruled investors who participated in a structured debt raising can pursue a claim for damages against the promoters, including Morgan Stanley and the ratings agencies Moody's and Standard & Poor's.
The court dismissed an argument by the ratings agencies that they were entitled to immunity under the first amendment to the US constitution on the grounds that their ratings were publications and as such were entitled to the protection of free speech.
The court said that would be the case if the ratings were considered matters of public concern, but the protection did not apply where, as in this case, the ratings had been provided to a select group of investors.
The court also found that the plaintiffs had sufficiently proved that the ratings were not "non-actionable opinions" but actionable misrepresentations, on the grounds that the ratings agencies did not genuinely or reasonably believe their ratings were accurate and had a basis in fact.
The court noted that the plaintiffs had "painstakingly detailed" conflicts of interest that arose when the agencies rated entities in which they had a financial stake. In this instance, rather than being paid by investors, the agencies were paid more than three times their normal fees by Morgan Stanley and the issuer. Moreover, the fee was directly connected to the success of the issue and increased in tandem with the issuer's growth.
Back in Australia, ASIC is seeking comment on whether to withdraw a class order relief that allows issuers of a prospectus or product disclosure statements to cite credit ratings without obtaining the consent of credit agencies.
ASIC is planning, as of January 1, to require the credit agencies to obtain an Australian Financial Services licence, without which an issuer could not cite a credit rating even if it obtained consent.
Issuers of a prospectus or PDSs are required to obtain the consent of a person to cite a statement made by them, which means the party granting consent is generally liable for loss or damage caused by that statement.
It turns out, however, that ASIC had been giving case-by-case relief since the mid-1990s to citing credit ratings and in 2007 issued the class order, which meant credit ratings were immune to liability under the prospectus provisions.
ASIC said obtaining consent from the ratings agencies was "impractical" because it would require the agencies to look at each prospectus or PDS that cited a rating. That's a flimsy excuse, because in the wake of the GFC it's no longer considered impractical. ASIC is considering revoking the class order, which would mean issuers would have to obtain consent to cite ratings and, if it was obtained, the agencies would carry prospectus liability.
As to the proposed requirement for credit agencies to obtain an AFS licence, it's arguable that should always have applied.