A Conceptual Framework for Imposing Statutory Underwriter Duties on Rating Agencies Involved in the Structuring of Private Label Mortgage-Backed Securities
Uzzi, Gerard, St. John's Law Review
The mortgage-backed security has evolved, in only thirty years, from a virtually non-existent investment vehicle into such a common investment alternative that today the market for these securities is characterized as a "mature market."1 This market has been traditionally dominated by government sponsored enterprises such as The Federal National Mortgage Association ("Fannie Mae") and The Federal Home Loan Mortgage Corporation ("Freddie Mac").2 Since 1982, however, the issuance of private label mortgage-backed securities has grown dramatically.3
A catalyst for the rapid growth of the private label mortgage-backed securities market has been the involvement of rating agencies.4 In fact, due to investor reliance on ratings and a host of ratings-dependent rules used by financial regulators,5 rating agencies have become essential market participants for mortgage-backed securities.
As will be shown, the mortgage-backed securities rating process has lead rating agencies to assume an active role in the mortgage-backed securities arena, with rating agencies essentially dictating the structure of these securities. Yet, despite this active role, and the reliance placed upon the rating agencies by financial regulators utilizing ratings-dependent rules, the ratings industry has remained largely unregulated.6 Principally, this has occurred because the traditional activity of the rating agencies has generally fallen outside the scope of federal securities laws and because the current application of common law principles has acted as a virtual shield against liability to investors relying on negligently assigned ratings.7
This Note, however, suggests that under current interpretation of federal securities laws, rating agencies involved in the structuring of mortgage-backed securities may be deemed "statutory underwriters" and therefore subject to regulation. First, this Note will examine the role of the rating agencies in the structuring of mortgage-backed securities, and the criticism that market pressures may be impacting rating objectivity. This Note will then discuss the traditional impediments to liability imposed by the common law. Finally, this Note will provide a conceptual framework for imposing statutory underwriter duties on rating agencies involved in the structuring of mortgagebacked securities.
BRIEF DEVELOPMENT OF THE RATING INDUSTRY
John Moody first started the securities rating industry in 1909 when he began rating United States railroad bonds.8 Over the remainder of the twentieth century, various independent ratings companies entered the market, and through subsequent mergers and acquisitions, the United States ratings industry expanded and consolidated into four major players; Moody's Investors Service ("Moody's"), Standard & Poor's Corporation, Fitch Investors Service, Inc. ("Fitch"), and Duff & Phelps, Inc..9 Today, the rating agencies rate a variety of instruments in addition to long term corporate bonds, including municipal bonds, commercial paper, and asset backed securities.10
Initially, the ratings industry was financed through the sale of the agencies' various publications and investor materials, with the ratings assigned independent of fees to the issuers.ll However, as the demand for rating services increased, the imposition of charges to issuers became commonplace, with Standard & Poor's first charging municipal bond issuers in 1968.12 Both Fitch and Moody's began charging corporate issuers in 1970.13 Currently, approximately eighty percent of Standard & Poor's revenue is generated from issuer fees.14
While the fees vary, the agencies typically charge the issuers a spread on the principal rated and sometimes, other additional fees.15 Although charging issuers could seemingly influence an agency's objectivity when assigning ratings to client products, the agencies insist that the overriding need to maintain investor confidence through high quality, accurate ratings, provides a sufficient deterrent against adjustments to ratings based upon undue issuer influence. …