Rating Agency Liability for Current Financial Crisis

38 Los Angeles Lawyer October 2009

According to Thomas Friedman, a New YorkTimes columnist, “There are two superpow-ers in the world today….There’s the UnitedStates and there’s Moody’s Bond RatingService.”1 As if to prove this point, claimsagainst rating agencies arising from theircredit rating activities have historically beenunsuccessful against the defense that creditratings are opinions protected under the FirstAmendment.2 Under the standard articulatedin New York Times v. Sullivan,3 opinionscannot serve as a basis for liability unlessthe plaintiffs can establish actual malice by thecredit rating agencies. These agencies havealso won some early cases on the basis of thejournalist’s privilege and related shield laws,which provide a First Amendment-baseddefense to discovery requests seeking thebasis for credit ratings.4 Nevertheless, in June2009, the California Public EmployeesRetirement System filed suit in San Franciscoagainst Moody’s,5 Fitch,6 and Standard &

Poor’s7 for negligent misrepresentation intheir ratings of $1.3 billion in “structuredinvestment vehicles.”

There is some hope for the Calpers law-suit. An emerging trend in the law invali-dates the credit rating agencies’ FirstAmendment defenses and related journalistshield law defenses. The leading cases in thisline suggest that four key elements need to bepresent to successfully assert rating agency lia-bility in cases not involving misrepresentationor outright fraud:

• The rating agencies are paid for their creditratings by the issuer or underwriter of thesecurities.

• The ratings are provided to a limited groupof recipients to whom the securities are mar-keted and sold, rather than to a larger pub-lic audience.

• The rating agencies actively participate inthe structuring of the securities transactionsfor which the ratings are provided.

• Taken together, these circumstances showthat either privity or “near privity” existsbetween the rating agencies and the limitedgroup of plaintiffs to whom the securitieswere marketed and sold.8

The role of rating agencies in the struc-turing, marketing, sale, and compensationschemes of many of the financial products andderivatives that were a key factor in lastyear’s financial collapse went far beyond thebounds of traditionally protected journalis-tic analysis or opinion making. Rather, the rat-ing agencies were active participants in thestructuring of toxic mortgage-based debtinstruments, from which they profited hand-somely. Their complicity in these debt secu-rity arrangements may be enough to overcomeexisting rating agency protections, a possibilitythat is finding increasing favor in govern-

Mark Anchor Albert is a business litigator andappellate lawyer in Los Angeles.

Ratings warsThe lawsuit filed by Calpers may be able toovercome the ratings agencies’ traditional FirstAmendment defense

by Mark Anchor Albert

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ment and the judiciary, unless another crisis-driven government bailout provides a “get outof jail free” card in their favor.

Collateralized Debt Obligation

There is no doubt that the so-called toxicassets held by financial institutions haveplayed a significant role in the financial andcredit crisis still affecting the country. Thesetoxic assets consist in large part of collater-alized debt obligations (CDOs). A CDO typ-ically is built from traditional debt and secu-rities instruments9 that are packaged togetherand sold to investors who, in return for peri-odic payments of interest, bear the lossesthat occur if instruments in the portfoliodefault. Many of the CDOs upon which thecurrent credit and financial crisis turns con-tained large quantities of subprime and so-called Alt-A residential loans. (Alt-A loanswere made to borrowers whose credit qual-ity was in between prime and subprime.)These residential mortgage CDOs were alsoknown as residential mortgage-backed secu-rities, or subprime RMBS.

In forming a CDO, a sponsor—usually aninvestment bank—would create a trust tohold the CDO’s assets, and the investmentbank would issue securities representinginterests in the CDO asset pool. In a sub-prime RMBS CDO pool, residential mort-gages would make up the bulk of the under-lying assets, but the trust might also holdother assets either to create a credit enhance-ment (for example, a holding of bonds couldprovide some income stability to a CDO, theassets of which were made of variable rateloans) or to “park” cash received from earlypayoffs or other unexpected events. TheCDO trust would then obtain interest andprincipal payments from the underlyingmortgagee obligors, which it would use tomake interest and principal payments to theCDO investors. The trust would be struc-tured to provide differing levels of creditenhancement to the securities issued in var-ious CDO tranches. Credit enhancementwould be provided through different mech-anisms, such as subordination of lowertranches to higher tranches, overcollateral-ization, excess spread, bond insurance, andcredit default swaps (CDS).

The underlying assets of a subprimeRMBS CDO often were changed during thelife of the CDO. For this task, the invest-ment bank sponsor engaged a collateral orasset management firm that was charged withpurchasing the securities that formed the sub-stance of the CDO. The collateral managercould sell bonds or other portfolio enhance-ments and purchase other ones, all in thename of complying with the CDO trust agree-ment restrictions on holdings and the ratingagencies’ requirements necessary to main-

tain the specific ratings given to the variousCDO tranches. Through this process, therating agencies maintained an ongoinginvolvement in the CDO, creating an interfacewith the collateral manager to ensure regularasset composition compliance.

In fact, the collateral manager also typi-cally was required to purchase a significantproportion of synthetic CDS contracts—ahedge against defaults in the underlying mort-gage pools—from the investment bank spon-sor, in which the investment bank would bethe swap counterparty. In other words, theCDO was required to “sell protection” to theinvestment bank, which provided a “pre-mium” in return to the CDO, with respect toa reference basket of securities. The invest-ment bank was entitled to choose the secu-rities that were in the synthetic reference bas-ket and could change the composition,without notice to or control by the collateralmanager or others.

The rating agencies played an integraland ongoing role in this process, because thecollateral eligibility criteria and the purchaseor sale of CDS protection were designed toensure that the rating agencies would be ableto assign specific ratings to the various CDOtranches offered for sale—from AAA super-senior notes in the top tranche, to BB notesin the mezzanine tranches, all the way downto the unrated equity tranche at the bottom.The credit rating for each rated tranche wassupposed to reflect the rating agency’sinformed assessment of the creditworthinessof the securities issued from the tranche,based in part on the likelihood that the CDOissuer would default on its obligations tomake interest and principal payments in fulland on time. In fact, rather than indepen-dently evaluate a CDO investment after thefact, the rating agencies worked directly withthe investment bank sponsor to produce therating the sponsor wanted in order to bettersell the CDOs to investors.

In particular, the collateral manager wassupposed to apply what are commonly calledcollateral quality tests to assess whether thedebt securities forming the vast bulk of theassets for the CDOs met the collateral eligi-bility criteria. All these tests and criteria werelinked to rating agency tests, such as Moody’sAsset Correlation Test, Moody’s WeightedAverage Rating Factor Test, Moody’sMinimum Weighted Average Recovery Test,the Weighted Average Spread Test, theWeighted Average Coupon Test, the WeightedAverage Life Test, the Standard & Poor’sMinimum Recovery Rate Test, and the FitchWeighted Average Factor Test. SubprimeRMBS CDOs offering circulars and prospec-tuses typically included default probabilityassessments that, based upon their tests andlinked to their corresponding ratings, were

intended to meet investment guidelines andrisk tolerances for institutional purchasersof the securities. These ratings were not vague,unspecific opinions but instead were toutedas scientifically and empirically based andobjective—with AAA ratings for the toptranche of super-senior notes supposedly cor-responding to a very low risk of default.

Not only were the rating agencies com-plicit in structuring CDOs to achieve desiredratings, but the structure of the transactionassured that the rating agencies were paid fortheir services from the transaction itself, notfrom an independent fee or subscription. TheCDO’s trust indenture agreement almostinvariably contained so-called waterfall pro-visions that determined the priority of inter-est and principal payments. Simply put, thewaterfall provisions described how the cashflow from a CDO was distributed to thetranches. A typical priority of payments sched-ule, or waterfall, worked together with ongo-ing rating agency coverage tests to ensurethat senior tranche debt holders would be paideven if equity and lower tranches receivednothing. For example, in a typical waterfallarrangement, the CDO trust used interest(and principal) payments from the underly-ing assets to pay first the fees and expenses ofthe CDO, including trustee, custodian, andpaying agent fees, and the fees of the ratingagencies; second, the net periodic couponpayment owed to any swap counterparty;third, the periodic asset manager fees; andfinally, interest on senior tranches. Lowertranches were only paid if the foregoing pay-ments were already satisfied. Equity receivedno payments until all tranches above it andrelated administrative costs (and rating agencyfees) had been paid.

In creating this multitiered payment struc-ture, the investment banks made sure that therating agencies also would be paid beforenearly everyone else. The rating agencies alsoenjoyed a top-priority position to recovertheir fees for rating the various tranches andthe RMBS supporting those tranches in theinterest proceeds waterfall provisions of thetrust indentures for the trusts that held theunderlying assets. Moreover, the rating agen-cies had a critical, ongoing role in the pricingof the various tranches and in determining rat-ing-related events of default that triggeredthe waterfall priorities, at the top of which satthe collateral managers and rating agencies.

Accordingly, in a typical subprime RMBSCDO, the interest and principal payment pri-orities for purpose of the waterfall provi-sions of the debt instruments were specificallytied to credit default tests that were linked tothe ratings provided by the rating agencies.They used quantitative cash flow models thatanalyzed, under various stress scenarios, theamount of principal and interest payments



expected to be generated from the loan pooleach month over the life of the RMBS tranchesecurities. The output of this model was thencompared against the priority of payments(the waterfall) to the RMBS tranches specifiedin the CDO’s trust documents.

Thus, far from providing a generic opin-ion of creditworthiness to a broad-basedaudience, the rating agencies were intricatelylinked to the structuring and payment pro-visions of the assets they rated, did so specif-ically for the benefit of targeted investors(CDOs were generally marketed in privateplacements to qualified institutional buyersunder Rule 144A—Private Resales ofSecurities to Institutions—promulgated underthe 1933 Securities Act10), and were directlycompensated for this effort.

That these credit ratings were critical tothe spread of CDOs in the financial marketsis undeniable. Investors use credit ratings asa proxy for their own credit review and thusto support the level of credit risk they are will-ing to undertake with respect to particulardebt securities. Fiduciary investors (such aspension funds, trustees, and insurance com-panies) typically may only acquire “invest-ment grade” assets, primarily as determinedby credit ratings. Assets that are below invest-ment grade—speculative or junk bonds—aresupposed to be excluded from the fiduciaryinvestor’s pool of appropriate potential invest-ments. Higher-quality ratings directly affectedthe pricing and marketability of the subprimeRMBS CDOs offered for sale. Through thefinancial alchemy of CDS contracts (whichhedged the risk of underlying defaults) andassociated higher-quality ratings, pools oflow-quality residential mortgages could bemarketed as high-grade investments.

As a result, investors that would not buyindividual subprime mortgages bought sub-prime RMBS aggregated into CDOs thatsported high-quality ratings from the ratingagencies. Subprime RMBS CDOs came tobe held by pension funds, school districts,charitable organizations, municipal treasuries,and a vast number of other public and privatetrust fund investors that could ill afford thelosses that were to come.

However, even though both purchasersand issuers of RMBS CDOs have suffered bil-lions of dollars of losses resulting from theacquisition of interests in securities that nowappear to have been wrongly labeled as invest-ment grade by rating agencies, these pur-chasers and issuers typically have not sued therating agencies. These investors are likelydaunted by the legal precedents that protectrating agencies.

Rating Agency Defenses

Several recent cases, however, have beendecided against credit rating agencies under

circumstances that appear to coincide in crit-ical respects with the involvement of theagencies in the structuring of subprime RMBSCDOs. One of these cases—In re Fitch,Inc.11—is particularly instructive. A bankpurchased various CDOs structured by oneof its brokers. The banking regulators con-cluded that the CDOs were not investmentgrade and compelled the bank to sell them.The broker refused to accept the return of the

CDOs. The bank sued the broker and sub-poenaed Fitch, having learned during dis-covery that Fitch and the broker “had exten-sive communications about the structure ofthe transactions.”12

In response to an order to show causeregarding contempt due to the failure of Fitchto comply with the subpoena, the districtcourt rejected Fitch’s First Amendment defenseunder New York’s shield law. The SecondCircuit affirmed. “Unlike a business news-paper or magazine, which would cover anytransactions deemed newsworthy, Fitch only‘covers’ its own clients. We believe this prac-tice weighs against treating Fitch like a jour-nalist.”13 In addition, the Second Circuitnoted that an employee of Fitch took “afairly active role…in commenting on pro-posed transactions and offering suggestionsabout how to model the transactions to reachthe desired ratings.”14 Fitch’s active role inhelping to structure the CDOs demonstrated

“a level of involvement with the client’s trans-actions that is not typical of the relationshipbetween a journalist and the activities uponwhich the journalist reports.”15

In LaSalle National Bank v. Duff &Phelps Credit Rating Company,16 anotherNew York case rejecting the rating agen-cy’s First Amendment defense, the courtdenied the rating agency’s motion to dis-miss claims based on its allegedly too-favor-

able rating. The dispositive factor in thecourt’s decision to reject the rating agen-cy’s First Amendment defense was the rat-ing agency’s “substantial influence in thedrafting” of the debt securities and therequirement for high ratings as a conditionof the initial issuance of the bonds.17 Due tothe rating agency’s active involvement instructuring the transactions, the agency wasin “near privity” to the purchasers of the pri-vately offered securities.18

The Duff & Phelps court also found priv-ity under another theory. In the context ofaccountant liability to third parties, the NewYork Court of Appeals previously had estab-lished in Credit Alliance Corporation v.Arthur Andersen & Company that liabilitymay be imposed when a professional or firmis aware that its work product is to be usedfor a particular purpose in furtherance ofwhich a known party was intended to rely,and the professional’s conduct connects to

Los Angeles Lawyer October 2009 41


that third party, thereby showing an under-standing of that party’s reliance on the pro-fessional’s work.19 The Duff & Phelps courtnoted that although the Credit Alliance testinitially applied only to accountants, it hassubsequently been applied to other profes-sionals—including attorneys, real estateappraisers, architects, and realtors. The courtsaw no reason why it should not also applythe privity requirement to a securities ratingcompany.20

Finally, in Commercial Financial Services,Inc. v. Arthur Andersen LLP, the court heldthat the First Amendment does not protectrating agencies from liability if they wereasked to rate investment certificates by a debtcollecting company, rated the bonds based oninformation furnished by that company, werepaid a fee by that company, were therefore inprivity with that company, and thus owed aduty of care to that company to provideaccurate ratings.21

The Commercial Financial court noted a“crucial distinction” between the suit beforeit and Jefferson County School District No.R-1 v. Moody’s Investor’s Services,22 whichdismissed claims for tortious interference,injurious falsehood, and antitrust violationsbecause Moody’s credit ratings are “pro-tected expressions of opinion.” In JeffersonCounty, Moody’s published its opinion for the

benefit of subscribers and new services. “Ithad not been asked to rate the bonds [by theschool district issuing them].”23 By contrast,in Commercial Financial the professionalrole of the rating agencies went “beyond arelationship between a journalist and sub-ject, and [was] more analogous to that of aclient and the client’s certified public accoun-tant.”24 In such a case, the First Amendmentdoes not shield the rating agencies frompotential liability.

The Commercial Financial court also heldthat the facts of that case satisfied Section 552of the Restatement (Second) of Torts, titledInformation Negligently Supplied for theGuidance of Others,25 which supported itsanalysis that liability may be imposed on aprofessional information provider that neg-ligently furnishes information for a fee thatit knows will be provided to and relied uponby a limited group of persons. Because the rat-ings at issue in Commercial Financial weredone at the request of the plaintiff, for a fee,and were intended to be provided to theplaintiff, who could be expected to rely uponthem, the Commercial Financial court heldthat Section 552 applied to the credit ratingagency.26

Based upon the reasoning and analysesunderlying the holdings in In re Fitch, Inc.,Duff & Phelps Credit Rating Company, and

Commercial Financial, the role of rating agen-cies in the structuring, marketing, and sale ofsubprime RMBS CDOs went far beyond theparameters of protected speech and analyti-cal opinion established under FirstAmendment-based journalist’s privilege orrelated statutory shield laws. In view of theircentral role in the structuring of subprimeRMBS CDOs, and their dynamic and ongo-ing role in re-rating CDO tranches over timeafter their initial issuance, a strong argumentcan be made that the rating agencies were pro-viding professional services to issuers andinvestment banks, with a clear set of poten-tial investors in mind—typically qualifiedinstitutional buyers in private (nonpublic)securities Rule 144A offerings—and werenot engaged in any meaningful sense or degreein news gathering, news analysis, or otherjournalistic activities.

In summary, the structure of typical sub-prime RMBS CDOs, and related CDS pro-tection, provides a strong basis for liabilityagainst the rating agencies involved in thosetransactions, for negligent misrepresentation,because 1) they were paid fees to structure thetransactions and had a direct financial incen-tive to be actively involved, in an ongoing,dynamic manner, in the management of theratings process (i.e., the collateral managercould replace securities with higher-ratedsecurities as necessary to maintain the over-all rating of particular tranches, 2) the ratingsof the subprime RMBS CDOs were providedto a limited group of recipients to whom thesecurities were marketed and sold, ratherthan to the larger public, at least with respectto the original purchases in the private place-ments (versus purchases made in the sec-ondary market), and with respect to the orig-inal sellers of CDS protection in the initialprivate placements, 3) the rating agencieshad an active, central, interactive, and ongo-ing role in the structuring and rating of thesubprime RMBS CDOs and their respectivetranches, and 4) taken together, these cir-cumstances ought to be sufficient to show thateither privity or near privity existed betweenthe rating agencies, on the one hand, andthe limited group of plaintiffs to whom thesecurities were marketed and sold, on theother.27

Negligence or Wrongful Acts

Once the four elements are shown to be sat-isfied, it is still necessary to show that the rat-ing agencies acted negligently or wrongfully.In this regard, the question is whether the rat-ing agencies knew or should have knownthat their assigned ratings were less reliablethan the rating agencies made them appear,knowing the reliance placed on the ratings.When rating subprime RMBS CDOs, the rat-ing agencies typically used indenture guide-



lines as a template to run worst-case scenar-ios based on the underlying assets. The rat-ing agencies would apply their proprietarycomputer models to the types of collateralpools permissible under the indenture guide-lines, placing the most emphasis on the weak-est pools. Next they would compare the com-puter model results against the capitalstructure of the CDOs to assess whether thelevel of subordination, overcollateralization,and excess spread available to each ratedtranche provides the necessary amount of“credit enhancement” to support a particu-lar rating.

This sounds impressive, but the sad truthis that the rating agencies used computermodels that were inadequate, were basedupon inadequate information and faultydefault assumptions, and were operated andanalyzed by rating analysts who did not under-stand what they were doing and what thedata revealed. In particular, the rating agen-cies and the issuers and underwriters thatpaid their fees relied almost universally onMonte Carlo simulation-based approachesto assessing default probabilities, predicatedon a correlation model called the Gaussiancopula formula, which was developed by for-mer J.P. Morgan quantitative analyst David X.Li. Monte Carlo simulation-based approachesto assessing default probabilities rely on sev-eral key assumptions regarding default fre-quencies, recovery rates, and correlations.The primary rating agencies used proprietarysoftware tools to conduct these complexMonte Carlo simulations. During the timeleading up to the beginning of the financial cri-sis in 2007 and 2008, Standard & Poor’sused CDO Evaluator 3.3, Moody’s usedCDOROM, and Fitch used VECTOR 3.0.

These computer models are only as reliableas the assumptions on which they are predi-cated and the people who operate and inter-pret the models. The assumptions were out-dated. Assessing future default risk insubprime mortgage loans based upon pastperformance was not and could not be a reli-able predictor when the fundamental under-writing criteria used in the past was not beingused in connection with subprime RMBSthat formed the core of the CDO tranchesactually being rated. But the rating agenciesevidently turned a blind eye to this problem,relying on the Gaussian copula formula toprovide supposed added security to theirprobabilistic default assessments.

Thus, to assess the myriad variables andthe range of different probabilistic outcomesarising from multiple ever-changing variables,the rating agencies relied on the Gaussiancopula formulation to simplify and quantifyRMBS default probabilities based upon com-plex and exceedingly variable correlations.28

(In statistics, a copula is used to couple the


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behavior of two or more variables.) TheGaussian copula soon became such a uni-versally accepted part of the world’s financialvocabulary that brokers started quoting pricesfor bond tranches based on their correla-tions. “Correlation trading has spreadthrough the psyche of the financial marketslike a highly infectious thought virus,” wrotederivatives guru Janet Tavakoli in 2006.29

But this Gaussian copula formula wassimplistic and flawed. The damage was fore-seeable and foreseen. In 1998, before Li hadeven invented his copula function, PaulWilmott wrote that “the correlations betweenfinancial quantities are notoriously unsta-ble.”30 Yet the rating agencies in rating sub-prime RMBS CDOs relied heavily on thiscopula correlation model that they did notreally understand, even though they claimedthat their ratings were based upon objective,thorough, and comprehensive analyses.

Finally, in addition to turning a blind eyeto the increasingly lax underwriting stan-dards used by loan originators and to theoverly optimistic and reductionist formulaused to quantify default risk, the rating agen-cies also mistakenly relied upon CDS to“insure” tranches that they were rating inorder to buttress the ratings assigned to thosetranches. A CDS typically acts—or rather, issupposed to act—like an insurance contractthat protects the protection purchaser fromthe decline in value or other trigger event ina referenced entity or security in relation towhich the CDS provides credit default insur-ance. In the case of subprime RMBS CDOs,“insurance” often was provided againstdefault rates exceeding the predicted range forthe asset type supporting a particular invest-ment grade by the rating agencies for partic-ular CDO tranches.

The key problem with the use of CDS tosupport the creditworthiness of particulartranches of subprime RMBS CDOs—a prob-lem that should have been obvious to issuers,investors, and rating agencies alike—is thatCDS contracts were freely tradable, usuallywithout notice to CDO investors, and it wasalmost always difficult, if not impossible onan ongoing basis, to determine who the CDScounterparty was at any particular time andwhether and to what extent that CDS coun-terparty was sufficiently solvent, creditwor-thy, and ready to fulfill its insurance obliga-tions in an event of default. In fact, the CDSbecame a financial product with a life of itsown, and CDOs were often linked with syn-thetic credit default swaps and complex hedg-ing structures that in many cases were them-selves linked to yet other CDOs imbeddedwith credit default swaps and hedging struc-tures whose values and risk levels were notand could not be assessed accurately.

This history should provide more than


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enough to overcome the traditional defensesof ratings agencies and expose them to lia-bility. However, given the continuing centralrole that ratings agencies play in our financialand credit markets, it remains to be seenwhether Congress, the Executive Branch, orthe judiciary will be willing to address themassive liability that could face the ratingagencies as a result of their complicity in thefinancial crisis. ■

1 PBS Online, Free Market Society, THE ONLINE NEWS

HOUR, Feb. 13, 1996, available at http://www.pbs.org/newshour/gergen/friedman.html.2 Credit reporting services (not credit rating agencies)lost the First Amendment issue in Dun & Bradstreet,Inc. v. Greenmoss Builders, Inc., 472 U.S. 749 (1985);Oberman v. Dun & Bradstreet, Inc., 460 F. 2d 1381(7th Cir. 1972); and Grove v. Dun & Bradstreet, Inc.,438 F. 2d 433 (3d Cir. 1971), cert. denied, 404 U.S.898 (1971).3 New York Times v. Sullivan, 376 U.S. 254 (1964). Seealso Compuware Corp. v. Moody’s Investors Servs.,Inc., 499 F. 3d 520 (6th Cir. 2007) (affirming grant ofsummary judgment in favor of rating agency sued byissuer over an allegedly erroneous downgrade and rat-ings report); Newby v. Enron Corp. (In re Enron Corp.Sec. Derivative & ERISA Litig.), No. MDL-1446, 2005U.S. Dist. LEXIS 4494 (S.D. Tex. Feb. 16, 2005) (grant-ing motions by rating agencies to dismiss tort claims byEnron creditor grounded on their allegedly too-favorableratings of Enron debt), motion for reconsiderationdenied, 2007 U.S. Dist. LEXIS 41091 (S.D. Tex. June 5,2007); Jefferson County Sch. Dist. v. Moody’s Investor’s

Servs., 175 F. 3d 848, 856 (10th Cir. 1999) (dismissingclaims for tortious interference, injurious falsehood,and antitrust violations because Moody’s credit ratingsare “protected expressions of opinion”); County ofOrange v. McGraw-Hill Cos., 245 B.R. 151, 157 (C.D.Cal. 1999) (“The First Amendment protects S&P’spreparation and publication of its ratings.”).4 See, e.g., In re Scott Paper Co. Sec. Litig., 145 F.R.D.366 (E.D. Pa. 1992); In re Burnett, 269 N.J. Super. 493(Super. Ct. 1993); In re Pan Am Corp., 161 B.R. 577(S.D. N.Y. 1993); Stephens v. American Home Assur.Co., No. 91 Civ. 2898 (JSM) (KAR) (S.D. N.Y. Apr.17, 1995).5 Moody’s has been a stand-alone public companysince 2000, when it was spun off from Dun &Bradstreet.6 Fitch is owned by Fimalac, S.A., in France, which iscontrolled by Group Marc de Lachairière.7 Standard & Poor’s is a division of the McGraw-HillCompanies, Inc.8 See infra notes 15-31 and accompanying text.9 A CDO can hold different types of loans, emergingmarket debt, sovereign debt, high-yield corporatebonds, distressed securities (also junk bonds), assetbacked securities, commercial mortgage backed secu-rities, and commercial and industrial loans. By meansof credit default swaps and other vehicles, access tothese assets also can be achieved synthetically.10 17 C.F.R. §230.144A (2009).11 In re Fitch, Inc., 330 F. 3d 104 (2d Cir. 2003).12 Id. at 107.13 Id. at 109.14 Id. at 110.15 Id. at 111.16 LaSalle Nat’l Bank v. Duff & Phelps Credit RatingCo., 951 F. Supp. 1071 (S.D. N.Y. 1996). The district

court adopted the magistrate judge’s opinion, with itsrecommendation regarding the critical First Amendmentissue, in toto.17 Id. at 1076.18 Id. at 1092-93.19 Credit Alliance Corp. v. Arthur Andersen & Co., 65N.Y. 2d 536 (1985).20 Duff & Phelps, 951 F. Supp. at 1093.21 Commercial Fin. Servs., Inc. v. Arthur AndersenLLP, 2004 OK CIV APP 56, 94 P. 3d 106 (Okla. Civ.App. 2004).22 Jefferson County Sch. Dist. No. R-1 v. Moody’sInvestor’s Servs., 175 F. 3d 848, 856 (10th Cir. 1999).23 Commercial Fin., 94 P. 3d at 110 (quoting JeffersonCounty, 175 F. 3d at 850).24 Id. at 110.25 Id. at 112-14.26 Id. at 113.27 Compare, e.g., In re Fitch, Inc., 330 F. 3d 104, 110-11 (2d Cir. 2003) (communications between ratingagency and arranger “reveal a level of involvement withthe client’s transactions that is not typical of the rela-tionship between a journalist and the activities uponwhich the journalist reports”) with Compuware Corp.v. Moody’s Investors Servs., Inc., 222 F.R.D. 124,131 (E.D. Mich. June 10, 2004). Cf. CompuwareCorp. v. Moody’s Investors Servs., 324 F. Supp. 2d 860,862, and 904 n.7 (E.D. Mich. 2004). 28 On Default Correlation: A Copula Function Approach,9 J. OF FIXED INCOME 43-54 (Mar. 2000).29 Felix Salmon, Recipe for Disaster: The Formula ThatKilled Wall Street, WIRED MAGAZINE, Feb. 23, 2009(quoting Janet Tavakoli), available at http://www.wired.com/techbiz/it/magazine/1703/wp_quant?currentPage=all.30 Id. (quoting Paul Wilmott).



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Rating Agency Liability for Current Financial Crisis