In a letter to the SEC, Massachusetts Attorney General Martha Coakley urged the Commission to enforce legal requirements against credit rating agencies established under the Dodd-Frank Act in order to protect investors and avert another lending crisis. The letter says that the SEC has defeated the intent of Congress to impose Section 11 expert liability on rating agencies by issuing staff no-action letter allowing the sale of asset-backed securities without the required ratings disclosure or rating agency consents. As a result, said the Mass. AG, investors may be unprotected from potential failures on the part of rating agencies.
The SEC exempted ratings by nationally recognized statistical rating organizations from Securities Act Section 11 liability for a period of 28 years. From 1982 until July 22, 2010, Rule 436(g) under the Securities Act provided that NRSRO ratings disclosed in a registration statement must not be considered a part of the registration statement prepared or certified by a person within the meaning of Sections 7 and 11 of the Act.
Section 939G of Dodd-Frank nullified Rule 436(g), noted the AG, thereby imposing Section 11 liability on rating agencies. The AG observed that Senator Richard Shelby (R-AL), who has experience in the ratings agency space from his role as sponsor of the Credit Rating Agency Reform Act of 2006, referred to Dodd-Frank's provisions as resulting in heightened liability standards for rating agencies. 156 Cong. REC. S4076 (May 20, 2010)
In the week preceding the effective date of Section 939G, the major rating agencies issued public statements refusing to allow their ratings to be included in registration statements. SEC Regulation AB, however, requires that a prospectus for an asset-backed offering disclose ratings whenever an issuance or sale is conditioned on the assignment of a rating. Thus, the public asset-backed securitization markets froze on July 22, 2010.
While the SEC had multiple options to thaw the market, including recognizing new NRSROs willing to consent to Section 11 liability, noted the AG, the Division of Corporation Finance released a no-action letter to Ford Motor Credit (the July 22 Letter) stating that the Division would not recommend enforcement action regarding the ratings disclosure requirements. While the enforcement position expressed in the July 22 Letter was time-limited, the staff issued a replacement letter on November 23 containing substantially similar language and extending the no-action position indefinitely.
Section 939G was self-executing, with immediate legal effect, said the AG, and SEC no-action guidance is a statement of staff enforcement intent and does not change the law. Nonetheless, continued the AG, no-action letters often set the tone for market practice and a no-action letter's endorsement of a practice is often viewed as suggesting the practice's legality. Thus, in the view of the Mass. AG, the SEC has opened a divide between the plain language of the federal securities laws and its own regulations, on the one hand, and market practice guided by informal SEC staff compliance statements, on the other.
The Ford Letters neither offer a legal interpretation nor alternatively clarify that the ratings disclosure requirements of Regulation AB remain intact. To the extent that the prospectus disclosure of ratings remains required by Regulation AB, reasoned the AG, the possibility of issuer liability for material omissions is evident. The AG urged the SEC to address this situation to end confusion in the marketplace.
While recognizing the SEC's desire to maintain functioning public securitization markets, the AG is concerned about the road the Commission has taken. It is a road, continued the AG, on which multi-billon dollar registrants have represented to their shareholders that the SEC has permitted them or their affiliates to cease complying, or relieved them from compliance, with elements of Regulation AB.
The law requires asset-backed issuers to disclose ratings, obtain rating agency consents,and thus secure Section 11 protections for investors, said the AG, and the Ford Letters are delivering a different message to many issuers. Indeed, the AG fears that the Division of Corporation Finance may have exacerbated confusion in this area with five new Compliance and Disclosure Interpretations ("C&DIs"), issued on July 27, 2010.
Taken together with the Ford Letters, the only authority they cite, the C&DIs create a compliance scheme not contained in the applicable regulations, suggesting alternatives to be observed in issuer-by-issuer consultation with the Division. Like the no-action letters, this compliance scheme encourages the misapprehension that it is lawful to issue asset-backed securities without complying with the ratings disclosure requirements of Regulation AB. In fact, emphasized the AG, the situation is one where such issuances will not lead to a staff recommendation of SEC enforcement, but the issuances may remain in violation of the Securities Act, which can be enforced by both the government and private actors.