Corporate Governance

Subprime Litigation, the Role of the Rating Agencies, and the ?Journalist?s Privilege?

By Jim Hodgson

George Covington and Wen Hutchinson, both of King & Spalding LLP, recently addressed the role played by rating agencies in the subprime mortgage crisis.  (Their article appears in the March 2008 issue of The Metropolitan Corporate Counsel, which is accessible here.)  The authors predict that ?the rating agencies are destined to be in the middle of much of the litigation arising out of the meltdown of subprime mortgage securitizations.?  This is because the rating agencies, themselves, worked closely with issuers and underwriters in structuring many subprime transactions; and, as a result, the senior tranche of the majority of these securitizations carried the rating agencies? highest ratings.

Thus, subprime-related litigation is expected to focus sharply on what information issuers and underwriters provided to the rating agencies in order to determine the extent of the agencies? due diligence efforts in determining ratings.  And it seems abundantly clear that the agencies were deeply conflicted as issuers shopped their mortgage products around the various agencies in an effort to secure AAA ratings.  In fact, issuers would routinely compensate an agency for its favorable rating.  According to Covington and Hutchinson, ?the ratings that are candidates for involvement in the subprime litigation were solicited ratings for which the agencies were paid a fee by the issuers.?

In their defense, it is predicted that the agencies will assert the ?journalist?s privilege? in the face of subprime-related lawsuits, claiming that ?the information gathered during the rating process and their analysis is protected.?  But, case law in the Second Circuit (where many subprime-related lawsuits are likely to be brought) suggests that at least two factors weigh against the rating agencies? ability to invoke the journalist?s privilege.  First, the privilege is unlikely to apply in situations where an agency rates only transactions for which it has been hired.  Second, the privilege is unlikely to apply to an agency that has played a critical role in structuring the very products that it has gone on to rate.

Both disqualifications make abundant sense:  journalists are not routinely paid by the subjects of their reporting; nor do they participate in the very news that they subsequently report.  According to Covington and Hutchinson, ?look for the agencies to try to settle the disputes by producing the materials provided to them during the rating process while retaining the privilege claim on their internal analyses.?

Full post as published by PomTalk on March 06, 2008 (boomark / email).