In Australia, Lazy Negligence Isn’t Protected by Free Speech
- Posted by DynamicHedge
- on November 9th, 2012
The ratings agencies and their insane conflict-ridden ratings process have been hiding behind the “free speech” defense. These are the same agencies who are partially responsible for plunging the world into a deep financial crisis. Their arguement is that ratings are akin to opinion and thus a protected form of speech. While I agree that it’s not the government’s role to persecute analysts for errors in judgement or for being bad at their job (that’s the market’s job). There is a logical end to that reasoning. One Australian court has ruled that Standard and Poor’s and ABN AMRO, the bank that spoon fed them the product, the model, and the fees, are responsible for client losses.
There is nothing in the ruling to suggest the shoddy behaviour that took place in this instance was widespread across the firm. It would be a mistake to attribute all ratings that subsequently turn out to be wrong to negligence. Making predictions is hard, as Yogi Berra, a famously quotable baseball player, noted, especially when they are about the future. From The Economist:
But the Australian case does challenge a central part of the defence proffered by S&P and other ratings agencies (Moody’s and Fitch are the other two big ones) in some 40 ongoing cases worldwide alleging negligence. They argue that ratings are merely opinions and protected by constitutional safeguards on free speech, and that only imprudent investors would take decisions solely based on them.
This defence has already worked in a number of high-profile cases in America. Investment analysts and lawyers reckon that there is no sign that courts elsewhere are likely to follow the Australian ruling; it may not even survive the appeal. But the reasoning in the Australian case is persuasive. The judge argued that agencies could not wash their hands of all responsibility if investors took their ratings at face value and then lost money. “The issuer of the product is willing to pay for the rating not because it may be used by participants and others interested in financial markets for a whole range of purposes but because the rating will be highly material to the decision of potential investors to invest or not,” the judge wrote.
I’m not suggesting that the clients and investors are off the hook in this case either. They had a responsibility to know that there is absolutely no free lunch. In this case, the derivatives sold were CDPOs designed to add leverage when they incurred losses. Yet were sold as if they were as safe as unlevered US Treasuries. C’mon.
The issue at hand is that the clients have already been punished for their errors in judgement through deep capital losses while banks have been bailed out and ratings agencies largely held harmless. Ratings agencies should not be able to hide behind free speech like some sort of invisible force-field protecting them from accountability. There are damages to be recovered. It’s critical for public confidence in financial markets that those who engage in gross-negligence, misconduct, or collusion be held responsible for their actions.
Standard and Poor’s, even now, publicly denies that their ratings were inappropriate and have vowed to appeal the ruling.
Source: Crisis in ratings land? The greater-fool defence takes a blow (The Economist)
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DynamicHedge is an equities, futures and derivatives trader based on the West Coast. He runs a long/short opportunistic relative-value strategy within a proprietary trading group. More