The rating agencies have been widely criticised for their role in the sub-prime crisis and the wider credit crunch. In the past, the agencies have managed to avoid liability for investment disasters. This time things may be different. There have already been claims against them in the US, and it has been suggested that the scale of the losses means that claims in England are inevitable - but what are the prospects of success?
To whom was a duty owed?
Any claim against the rating agencies is most likely to be for negligent misstatement. To be successful, an investor must establish that the agency owed it a duty of care. There is no existing authority establishing a duty in these circumstances, so claimants will be moving into virgin territory on this issue. There are various legal analyses which may lead to a duty but, in general terms, the claimant must establish that the agency assumed responsibility to the investor, that the loss to the investor was reasonably foreseeable, that there was 'proximity' between the investor and the agency and that it is just and reasonable to impose the duty.
One hurdle in the way of a duty being found is the English courts' unwillingness to impose a duty that could leave the agency facing claims from an indeterminate and potentially very large class of investors, for potentially very large sums. Thus, to be successful, an investor may need to argue that it was a member of a particular group, which the agency must have known would rely on a particular rating.
It may be said by disgruntled investors that since the agencies were often involved in structuring the failed CDOs so that the securities achieved a favourable rating, the imposition of a duty is not unreasonable. On the other side of the coin, the rating agent may point to disclaimers covering the rating. In addition, an agent's fees for rating securities are likely to be dwarfed by the amounts that investors have lost investing in them.
Breach of duty
Having established the existence of a duty, a claimant must prove breach. This is most compelling where there is some identifiable standard against which the performance of an individual defendant may be measured. In this case, while the standard of a 'reasonably prudent rating agency' may readily be identified as applicable, quite what that means in practice in the sub-prime context is more difficult to identify. The investor may find some assistance, however, in Standard and Poor's recent admission that it made mistaken assumptions in rating some CDOs and in Moody's reported admission that IT problems led to the incorrect rating of various securities.
Against this, however, all three major agencies failed to identify the risks now apparent in these securities. Similarly, many sophisticated investors in, and issuers of, the sub-prime CDOs failed to understand the inherent risks. These factors will be prayed in aid by defendants against allegations of negligence in failing to identify particular risks in a specified security.
Reliance/causation
If the investor can establish a relevant breach of duty, the next step will be to show that it relied on the rating in deciding to invest - that the rating played a 'real and substantial part, though not by itself a decisive part' in the investment decision. For an institutional investor, this may be difficult, particularly in the light of its own knowledge of or investigation into the securities in question.
Finally, there will be arguments about what loss falls within the scope of the agent's duty. The rating agency will argue that it should not be held responsible for all the investor's loss, which is a consequence of the collapse of the market for these securities. Agents will also argue that the investors were the authors of their own misfortune, investing in securities which they, and perhaps even the securities' issuer, did not understand, in what has been described as "collective madness" in the "search for yield".
Nevertheless, while the hurdles in the way of recovering sums from a rating agency are high, serious consideration of the prospects in particular cases may well be merited given the scale of investors' losses.
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