Sam Brotman, JD, LLM, MBA January 15, 2014 6 min read

Consequences for Non-Compliance of Dodd-Frank

Consequences for Non-Compliance of the Law

Along with the increased responsibility placed on the credit rating agencies, there are also harsher consequences if they are not compliant with the Dodd-Frank Act. Part of the legislation includes standards and new liabilities for the credit rating agencies. First, there are harsher penalties under the 1934 Securities and Exchange Act including new responsibility for information filed with the SEC.

Credit rating agencies can be severely punished by the SEC for statements that contain false information or misrepresentations with respect to facts that are material. Materiality has defined by the courts as any fact that has a tendency to influence the decision making of a shareholder or investor.[1] These penalties include broader power by the SEC to suspend or revoke registrations of ratings agencies who fail “over a sustained period of time…to produce ratings that are accurate for that class or subclass of securities.[2]

Perhaps one of the most important clauses of the Dodd-Frank Act that has the greatest impact on credit rating agencies is Sec. 939G, which nullifies Rule 436G of the Securities Act of 1933. "Rule 436(g) exempts credit ratings provided by NRSROs from being considered a part of the registration statement prepared or certified by a person under such Act".[3] The nullification of this rule now holds NRSROs accountable for their ratings because they become subject to "expert liability" once credit ratings become part of the registration statement.

This requires that the agency produce evidence that there were reasonable ground to believe that the rating that was issued was accurate. In addition, the Dodd-Frank establishes a new private right of action against the agencies. Previously private action was not allowed against the agencies, but they can be now be held liable. State of mind is important because it allows legal actions to go forward when a complaint alleges that the credit rating agency either knowingly or recklessly failed to reasonably verify factual elements received from a third party source that the rating agency has relied upon and about that source’s independence from the issuer or the underwriter of the securities.

This also extends to factual elements that the rating agency puts out on its’ own. If a complaint is allowed to go forward, it can lead to additional discovery that the plaintiff can then use to substantiate their claims.

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[1] Blacks Law Dictionary. http://blackslawdictionary.org/materiality/. Last accessed November 16, 2011.

[3] The Library of Congress. http://www.loc.gov/index.html. Last accessed November 16, 2011.

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Sam Brotman, JD, LLM, MBA

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