"It could be structured by cows and we would rate it."
--Standard & Poor's analyst (1)
When two Bear Steams hedge funds collapsed in July 2007, it quickly became clear that investment products tied to subprime mortgage loans were overvalued. (2) What little was left of the once-booming business of structuring complex securities and collateralized debt obligations came to a screeching halt. The market for these investment products dried up and investors watched as the ratings agencies finally slashed credit ratings. (3) Unfortunately, for most it was already too late to withdraw. Investors suffered crippling losses on supposedly safe investment products that bore the stamps of ratings-agency approval. How could this have happened? Weren't the ratings agencies supposed to prevent just this kind of marketwide valuation crisis? What were these gatekeepers doing with nonpublic information if not protecting the investing public? The ratings agencies became the target of scholarly, political, and mass-media censure. (4) Critics began to reevaluate the role of the ratings agencies and how the regulatory framework in which they operate did not adequately control misconduct.
Despite this widespread and often scathing criticism of the credit ratings agencies (CRAs) (5) for their role in the subprime and credit crises, there have been no criminal prosecutions for CRA misconduct. (6) The ratings agencies have taken a major blow in the court of public opinion, (7) and investor confidence in their ratings has plummeted. (8) Civil litigation against the CRAs has marched forward: individual investors have sued the CRAs in lawsuits for negligence, fraud, and deceit; (9) class actions have named the CRAs as co-defendants; (10) and the federal government has sued the CRAs for civil violations. (11) The failures of the ratings agencies precipitated a push for regulatory reform, (12) but the possibility of reshaping or strengthening the criminal disincentives that control the ratings agencies has not been under serious consideration. (13) The integrity of our markets is so dependent on the good faith of the CRAs that their wrongdoing, which we might elsewhere address with civil liability, should face stricter criminal disincentives. The absence of any criminal prosecutions, let alone convictions, under the existing law should signal to Congress that the existing criminal law is not providing a sufficient check on the ratings agencies.
Not only the CRAs but the entire financial sector faced public and academic scrutiny for the credit crisis. The investing public was furious at Wall Street when the economy began to cave in; many wanted heads on the chopping block. (14) Many top executives seemed to be in a vulnerable position, widely despised for their complicity. From an outsider's perspective, it looked like criminal prosecutions might bring some catharsis to the investors who suffered catastrophic losses. But as the crisis wore on and court dockets filled up with complex civil cases seeking damages, the high-stakes white-collar criminal cases that many anticipated did not materialize. (15) At first glance, potential white-collar criminal cases looked promising. There were substantial harms caused by decisions and actions of high-level market players: the only hurdle for prosecutors was proving the requisite mens rea of knowledge or intent. (16) And yet only a handful of cases went forward. (17)
This Comment argues that misconduct at the ratings agencies should be subject to criminal punishment even absent a mens rea of knowledge or intent. (18) When the entire investing public bears a risk of catastrophic losses for misconduct at the ratings agencies, there should be a strict criminal code controlling that conduct. The integrity of the markets depends on accurate credit ratings provided in good faith. With the stakes so high, criminal sanctions are justified both …