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Unpublished Paper
A JUSTIFIED ASSAULT UPON THE CITADEL OF PRIVITY AND THE FIRST AMENDMENT
ExpressO (2010)
  • Joseph G Bunn, Esq.
Abstract

The active involvement of credit rating agencies (“CRAs”) in the structured finance market and the recent financial crisis is an adequate basis for investors to pursue claims against CRAs for negligent misrepresentation. 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 CRAs are not typically in a contractual relationship with investors who utilize their ratings. CRAs qualified for protection under the First Amendment because courts viewed their ratings as “speech” regarding public matters. However, this dual protection is limited in certain 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 (“SFPs”) serve a particular purpose because those ratings provide issuers the ability to offer SFPs to qualified institutional investors under Rule 144A. 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 are in a relationship that is “approaching privity” with investors 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 “speech” that 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.

Keywords
  • credit rating agencies,
  • misrepresentation,
  • privity,
  • First Amendment,
  • structured financial products
Disciplines
Publication Date
August 19, 2010
Citation Information
Joseph G Bunn. "A JUSTIFIED ASSAULT UPON THE CITADEL OF PRIVITY AND THE FIRST AMENDMENT" ExpressO (2010)
Available at: http://works.bepress.com/joseph_bunn/1/