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A Strict Liability Regime for Rating Agencies

2015; Wiley; Volume: 52; Issue: 4 Linguagem: Inglês

10.1111/ablj.12054

1744-1714

Alessio M. Pacces, Alessandro Romano,

Regulation and Compliance Studies

American Business Law JournalVolume 52, Issue 4 p. 673-720 Original Article A Strict Liability Regime for Rating Agencies Alessio M. Pacces, Alessio M. PaccesSearch for more papers by this authorAlessandro Romano, Alessandro RomanoSearch for more papers by this author Alessio M. Pacces, Alessio M. PaccesSearch for more papers by this authorAlessandro Romano, Alessandro RomanoSearch for more papers by this author First published: 21 October 2015 https://doi.org/10.1111/ablj.12054Citations: 6 A previous version of this article was published as ECGI research paper in law and a short summary of it was posted on the Harvard Law School Forum on Corporate Governance and Financial Regulation. Part of the research included in this article was carried out at the Study Center Gerzensee of the Swiss National Bank, whose hospitality is gratefully acknowledged. This article benefited from the feedback of participants in the 2014 European Summer Symposium on Economic Theory (ESSET) in Gerzensee, the 2014 MaCCI Law and Economics Conference on Financial Regulation and Competition in Mannheim, the 2013 Meeting of the Canadian Association in Law and Economics in Toronto, the 15th Joint Seminar of the European Association of Law and Economics and the Geneva Association in Girona, the 4th Annual Conference of the Spanish Association of Law and Economics in Granada, and the 11th Annual Meeting of the German Association of Law and Economics in Bolzano. We thank Gaia Barone, Patrick Bolton, Jeff Gordon, Alice Guerra, Martin Hellwig, Todd Henderson, Claire Hill, Giovanni Immordino, Yair Listokin, Vyacheslav Mikhed, Marcello Puca, Pietro Reichlin, Roberta Romano, Ulrich Schroeter, Alan Schwartz, Bob Scott, Angela Troisi, and Roland Vaubel for valuable comments on previous versions of this work. The usual disclaimers apply. Read the full textAboutPDF ToolsExport citationAdd to favoritesTrack citation ShareShare Give accessShare full text accessShare full-text accessPlease review our Terms and Conditions of Use and check box below to share full-text version of article.I have read and accept the Wiley Online Library Terms and Conditions of UseShareable LinkUse the link below to share a full-text version of this article with your friends and colleagues. Learn more.Copy URL Footnotes 1See, e.g., Lawrence J. White, Markets: The Credit Rating Agencies, 24 J. Econ. Perspectives 211, 212–13 (2010) ("The purpose of credit rating agencies is to help pierce the fog of asymmetric information by offering judgments—they prefer the word 'opinions'—about the credit quality of bonds that are issued by corporations, U.S. state and local governments, 'sovereign' government issuers of bonds abroad, and (most recently) mortgage securitizers."). 2See Reinier H. Kraakman, Gatekeepers: the Anatomy of a Third-Party Enforcement Strategy, 2 J. L. Econ. & Org. 53, 54 (1986); Gregory Husisian, What Standard of Care Should Apply to the World's Shortest Editorials? An Analysis of Bond Rating Agency Liability, 75 Cornell L. Rev. 411, 421 (1990) (arguing that rating agencies add value because they analyze issues less expensively than the average investor); Susan M. Phillips & Alan N. Rechtschaffen, International Banking Activities: The Role of the Federal Reserve Bank in Domestic Capital Markets, 21 Fordham Int'l L.J. 1754, 1762–63 (1998) ("Finally, credit rating agencies enhance the capital markets infrastructure by distilling a great deal of information into a single credit rating for a security. That rating reflects the informed judgment of the agency regarding the issuer's ability to meet the terms of the obligation. Such information is frequently critical to potential investors and could not be acquired otherwise, except at substantial cost."). 3See John C. Coffee, Jr., Ratings Reforms: The Good, The Bad and the Ugly, 1 Harv. Bus. L. Rev. 231, 261 (2011) ("Some believe that the basic error made by regulators was to grant ratings agencies a de facto regulatory role. In truth, this decision, which dates back to the 1930s in the United States, was the product of the inability of financial regulators to define excessive risk themselves."). 4For an overall comparative analysis of the regulatory approaches towards CRAs in the European Union and in the United States, see generally Aline Darbellay, Regulating Credit Rating Agencies (2013). 5Before the Dodd- Frank Wall Street Reform and Consumer Protection Act of 2010, Pub. L. No. 111-203, 124 Stat. 1376 (2010) [hereinafter Dodd-Frank Act], CRAs were largely immune to liability in the United States. See Frank Partnoy, How and Why Credit Rating Agencies Are Not Like Other Gatekeepers, in Financial Gatekeepers: Can They Protect Investors? 61 (Yasuyuki Fuchita & Robert E. Litan eds., 2006). See also John C. Coffee, Jr., Gatekeepers: The Professions and Corporate Governance 302 (2006) (emphasizing that CRAs had enjoyed de facto immunity to liability). CRAs were immune to legal liability for various reasons. For one, some U.S. courts placed ratings under the umbrella of the first amendment. See Jefferson Cty. Sch. Dist. No. R-1 v. Moody's Investor's Serv., Inc., 175 F.3d 848, 852–56 (10th Cir. 1999); In re Enron Corp. Sec. Derivative & "ERISA" Litig. 511 F. Supp. 2d 742, 819–27 (S.D. Tex. 2005) (analyzing case law addressing first amendment protection). For arguments against these decisions, see Caleb Deats, Note, Talk That Isn't Cheap: Does The First Amendment Protect Credit Rating Agencies' Faulty Methodologies From Regulation?, 110 Colum. L. Rev. 1818, 1818 (2010). Along similar lines, it was practically impossible to sue CRAs for fraud under Securities and Exchange Commission (SEC) Rule 10b-5 until the pleading standard—particularly regarding the showing of scienter—was lowered by section 933 of the Dodd-Frank Act. See Coffee, supra note 3, at 267–68. Finally, SEC Rule 436(g) exempted CRAs from liability as experts under section 11 of the Securities Act of 1933. Adoption of Integrated Disclosure System, 47 Fed. Reg. 11,380, 11,391 (Mar. 18, 1982). Rule 436(g) was abolished by section 939G of the Dodd-Frank Act, supra. 6ABN AMRO Bank NV v Bathurst Regional Council [2014] FCAFC 65 (Austl.) (confirming the decision by the court of first instance to hold Standard & Poor's liable for negligently deceiving investors through inflated ratings). 7See Aruna Viswanatha & Karen Freifeld, S&P reaches $1.5 Billion Deal With U.S., States over Crisis-era Ratings, Reuters (Feb. 3, 2015, 1:46 PM), http://www.reuters.com/article/2015/02/03/us-s-p-settlement-idUSKBN0L71C120150203. Interestingly, the Department of Justice decided to bring suit against S&P's based on the private cause of action of a long-standing statute, the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA), Pub. L. No. 101-73, 103 Stat. 183 (1989). Under FIRREA, the plaintiff needs to establish its claim under a preponderance of evidence standard avoiding the more demanding requirements of criminal law enforcement. 8For example, among other things, the Dodd-Frank Act creates the "Office of Credit Rating" to monitor and control CRAs behavior. Dodd-Frank Act, supra note 5, § 939C. Also, the consistency of the methodologies adopted by CRAs is checked annually. With regards to the enhanced liability threat, see Valentin Dimitrov et al., Impact of the Dodd-Frank Act on Credit Ratings, 115 J. Fin. Econ. 505, 506 (2015) ("Dodd-Frank significantly increases CRAs' liability for issuing inaccurate ratings by lessening the pleading standards for private actions against CRAs under Rule 10b-5 of the Securities and Exchange Act of 1934."). 9For a legal analysis, see Nan S. Ellis et al., Is Imposing Liability on Credit Rating Agencies a Good Idea? Credit Rating Agency Reform in the Aftermath of the Global Financial Crisis, 17 Stan. J.L. Bus. & Fin. 175, 221–22 (2012) (arguing that CRAs should be subject to a credible threat of liability). For a treatment of this problem from an economic perspective see Dimitrov et al., supra note 8, at 513–14 (showing that liability might be counterproductive). 10Anand M. Goel, & Anjan V. Thakor, Credit Ratings and Litigation Risk, 1 (Mar. 15, 2011), available at http://ssrn.com/abstract=1787206 ("If the legal liability increases asymmetrically—higher legal liability only for ratings deemed ex post to be too high—the rating agency responds by increasing its downward bias in ratings."). 11See supra note 5 and accompanying text. Other jurisdictions have likewise introduced negligence liability for CRAs. See infra note 62 and accompanying text. 12Dimitrov et al., supra note 8 and Goel & Thakor, supra note 10, are notable exceptions. Both works investigate the defensive conduct of CRAs in the face of liability. 13Dimitrov et al., supra note 8, at 507 (showing empirical evidence supporting the view that the Dodd-Frank Act has reduced the informative content of ratings of corporate bonds). Structured finance products were excluded from that study and in any event, the case of structured finance bonds is radically different. See infra notes 137–39 and accompanying text. 14Amit R. Paley, Credit-Rating Firms Grilled Over Conflicts: Risks Were Known, Documents Show, Wash. Post, Oct. 23, 2008, at Al (quoting Representative Henry A. Waxman, The Chairman of the House Committee on Oversight and Government Reform). 15Dimitrov et al., supra note 8, at 507. 16The example is taken from Fitch's historical (annualized) default experience. Joshua Coval et al., The Economics of Structured Finance, 23 J. Econ. Perspectives 3, 9 (2009). 17For a formal definition of rating inflation, see Part III. 18In the economic literature, rating inflation generally refers only to intentional misreporting. See, e.g., Patrick Bolton, Xavier Freixas & Joel Shapiro, The Credit Ratings Game, 67 J. Fin. 85, 95 (2012). We adopt a broader definition of rating inflation because, from a practical perspective, we argue that it is generally very hard to distinguish cases of intentional misreporting. 19For example, Bolton et al., supra note 18, at 106, recognize that increasing CRAs liability exposure might reduce rating inflation, yet they do not investigate how the liability mechanism should work. 20See, e.g., Coffee, supra note 3, at 252–53; Yair Listokin & Benjamin Taibleson, If You Misrate, Then You Lose: Improving Credit Rating Accuracy Through Incentive Compensation, 27 Yale J. on Reg. 91, 101–02 (2010). But see Partnoy, supra note 5, at 96 (suggesting that a modified form of strict liability could be introduced for CRAs, like for other gatekeepers). 21Coffee defines the process of defining and controlling CRAs care level a "Serbonian bog." John C. Coffee, Jr., Gatekeeper Failure and Reform: The Challenge of Fashioning Relevant Reforms, 84 B.U. L. Rev. 301, 347 (2004). 22See Dimitrov et al., supra note 8, at 507. 23As mentioned supra note 5, Dodd-Frank Act § 939G eliminated CRAs' exemption from liability under under section 11 of the Securities Act of 1933. As a result, CRAs went on "strike" and refused to be named as experts in the prospectus of any securitization. Because the SEC Regulation AB does not allow asset-backed securities to be offered without disclosure of their ratings, initially the U.S. securitization market froze. The SEC subsequently issued two no-action letters—the first establishing a six-month moratorium and the second extending it indefinitely—with which they allowed securitizations to go through without the inclusion of ratings in the prospectus. See Ford Motor Credit Co. LLC, SEC No-Action Letter (Nov. 23, 2010), available at http://www.sec.gov/divisions/corpfin/cf-noaction/2010/ford072210-1120.htm. In this way, CRAs may effectively participate in securitizations without being exposed to Section 11 liability. 24The need for a cap in CRAS' liability regime has long been recognized. See, e.g., Coffee, supra note 3, at 253 ("[A]ny cause of action against the CRAs should logically be coupled with a ceiling on liability to ensure that the deterrent threat does not lead to the financial destruction of an arguably necessary financial intermediary."). 25From this perspective, our proposal somehow echoes the self-tailored liability regime for gatekeepers advocated by Professor Stephen Choi. Stephen Choi, Market Lessons for Gatekeepers, 92 Nw. U. L. Rev. 916, 919 (1998) (arguing that "[t]hrough self-tailored liability, regulators may allow intermediaries to choose from a range of different criminal penalties as well as invoke public enforcement and monitoring"). 26See infra notes 38–40 and accompanying text. 27Paul Krugman, Berating the Raters, N.Y Times (April 25, 2010), http://www.nytimes.com/2010/04/26/opinion/26krugman.html?_r=0. 28Frank Partnoy, The Siskel and Ebert of Financial Markets?: Two Thumbs Down for the Credit Rating Agencies, 77 WASH. U. L.Q. 619, 652 (1999) ("Perhaps the most important change in the credit rating agencies' approach since the mid-1970s has been their means of generating revenue. Today, issuers, not investors, pay fees to the rating agencies. Ninety-five percent of the agencies' annual revenue is from issuer fees."). 29See, e.g., Deryn Darcy, Credit Rating Agencies and the Credit Crisis: How the Issuer Pays Conflict Contributed and What Regulators Might Do About It, 2009 Colum. Bus. L. Rev. 605, 622–31. 30See Kia Dennis, The Rating Game: Explaining Rating Agency Failures in the Buildup to the Financial Crisis, 63 U. Miami L. Rev. 1111, 1137 (2009). 31See Marco Pagano & Paolo F. Volpin, Credit Ratings Failures and Policy Options, 25 Econ. Pol'y 401, 420–22 (2010) (acknowledging that imposing an investor-pays model by regulation would require coping with some practical problems); Jerome Mathis et al., Rating the Raters: Are Reputation Concerns Powerful Enough to Discipline Rating Agencies?, 56 J. Monetary Econ. 657, 669 (2009). 32Partnoy, supra note 28, at 662 ("[T]he credit information that credit agencies discover and disseminate has the characteristics of a public good, and therefore is immediately available to all market participants at zero cost."); see also Coffee, supra note 3, at 255 ("A 'subscriber pays' model may be doomed to failure by the 'public goods' nature of ratings. Because the rating agency cannot effectively prevent the communication of its ratings to non-paying investors once it discloses its ratings to its clients, it cannot capture the full value of the financial information that it creates."). But see Pagano & Volpin, supra note 31, at 420–23 (arguing that the investor-pays model could be adapted to cope with the public good problem). 33Dodd-Frank Act, supra note 5, section 939F(b) mandates a SEC study of the funding system of CRAs to determine whether the Franken proposal or a variation thereof would be appropriate. The SEC published this study in December 2012, with almost half a year delay. SEC, Report to Congress on Assigned Credit Ratings (Dec. 24, 2012), available at http://www.sec.gov/news/studies/2012/assigned-credit-ratings-study.pdf. The study recommended a roundtable with the relevant stakeholders, which took place on May 14, 2013. After completing these investigations, the SEC could have used its statutory authority to regulate the funding of CRAs. So far, however, the SEC has refrained from doing so. 34This is in line with the so-called reputational capital view of rating agencies. See Choi, supra note 25, at 961 ("The value of both debt rating agencies lies in their ability to convince financial purchasers of the validity and accuracy of their ratings."). See also Jonathan R. Macey, Wall Street Versus Main Street: How Ignorance, Hyperbole, and Fear Lead to Regulation, 65 U. Chi. L. Rev. 1487, 1500 (1998) ("Indeed, the only reason that rating agencies are able to charge fees at all is because the public has enough confidence in the integrity of these ratings to find them of value in evaluating the riskiness of investments."). 35See, e.g., Steven L. Schwarcz, Private Ordering of Public Markets: The Rating Agency Paradox, 2002 U. Ill. Rev. 1, 26 ("Rating agencies are already motivated to provide accurate and efficient ratings because their profitability is directly tied to reputation."). 36See Bolton et al., supra note 18, at 86. Also legal scholars have often referred to a similar problem. Miller and Rosenfeld argue that investors sometimes looked at ratings without inquiring into their credibility. Geoffrey P. Miller, & Gerald Rosenfeld, Intellectual Hazard: How Conceptual Biases in Complex Organizations Contributed to the Crisis of 2008, 33 Harv. J.L. & Pub. Pol'y 807, 828–29 (2010). See also Claire A. Hill, Why Did Anyone Listen to the Rating Agencies After Enron?, 4 J. Bus. & Tech. L. 283, 283–84 (2009). 37See supra notes 34–35 and accompanying text. 38See Partnoy, supra note 28, at 681, 703. 39Christian C. Opp et al., Rating Agencies in the Face of Regulation, 108 J. Fin. Econ. 46, 47 (2013). 40Charles W. Calomiris, A Recipe for Ratings Reform, Economists' Voice 1 (Nov. 2009), available at http://www.degruyter.com/view/j/ev.2009.6.11/ev.2009.6.11.1678/ev.209.6.11.1678.xml?format=INT. 41See Mark J. Flannery et al., Credit Default Swap Spreads as Viable Substitutes for Credit Ratings, 158 U. Pa. L. Rev. 2085, 2095 (2010) (arguing that credit default swap spreads would be a valid substitute). 42Dodd-Frank Act, supra note 5, section 939A requires each federal agency to remove references to credit rating. The implementation of this provision has proven difficult, although major agencies like the Federal Reserve Board and the SEC have ultimately found ways to issue the necessary regulations. For the Federal Reserve Board, see Implementing the Dodd-Frank Act: The Federal Reserve Board's Role Fed. Res. Bd., http://www.federalreserve.gov/newsevents/reform_milestones.htm (last visited June 28, 2015); for the SEC's implementing measures concerning credit rating agencies, see Credit Rating Agencies, SEC, http://www.sec.gov/spotlight/dodd-frank/creditratingagencies.shtml (last visited June 28, 2015). 43A part of the problem stems from the circumstance that the performance of money managers is assessed in comparison to their peers. This gives money managers an incentive to rely on ratings, so long as other market players do the same, in order to shield themselves from litigation when they perform poorly. See Claire A. Hill, Justification Norms Under Uncertainty: A Preliminary Inquiry, 17 Conn. Ins. L.J. 27, 37–40 (2010). 44The regulatory approach in the European Union has been different from that in the United States. While EU legislation also aims at reducing overreliance on ratings, it explicitly acknowledges that financial regulation cannot simply do away with ratings in the absence of viable alternatives. See Recital 72 of Directive 2013/36/EU, the so-called Capital Requirements Directive IV ("Overreliance on external credit ratings should be reduced and the automatic effects deriving from them should be gradually eliminated. Institutions should therefore be required to put in place sound credit-granting criteria and credit decision-making processes. Institutions should be able to use external credit ratings as one of several factors in that process but they should not rely solely or mechanistically on them." (emphases added)); Recital 6 of Regulation 462/2013, the so-called CRA Regulation III ("The Union is working towards reviewing, at a first stage, whether any references to credit ratings in Union law trigger or have the potential to trigger sole or mechanistic reliance on such credit ratings and, at a second stage, all references to credit ratings for regulatory purposes with a view to deleting them by 2020, provided that appropriate alternatives to credit risk assessment are identified and implemented." (emphases added)). 45Coffee, supra note 3, at 261. ("Some believe that the basic error made by regulators was to grant ratings agencies a de facto regulatory role. In truth, this decision, which dates back to the 1930s in the United States, was the product of the inability of financial regulators to define excessive risk themselves."). 46Id. at 264–66. 47Claire A. Hill, Limits of Dodd-Frank's Rating Agency Reform, 15 Chap. L. Rev. 133, 146–47 (2011). 48Pagano & Volpin, supra note 31, at 423, 424. 49This article does not address unsolicited ratings, which typically concern sovereign issuers. 50Bo Becker & Todd Milbourn, How Did Increased Competition Affect Credit Ratings?, 101 J. Fin. Econ. 493, 493 (2011) (finding empirical evidence that increased competition lowers rating quality). 51This is the essence of the so-called Cuomo Plan, named after the former New York State Attorney General who proposed this approach. This approach does not eliminate rating shopping in the absence of an explicit obligation to disclose also unfavorable ratings. Bolton et al., supra note 18, at 89. 52Francesco Sangiorgi et al., Credit-Rating Shopping, Selection and the Equilibrium Structure of Ratings, (June 8, 2009) (unpublished manuscript), available at http://finance.sauder.ubc.ca/conferences/summer2009/files/papers/ChesterSpatt.pdf; Pagano & Volpin, supra note 31, at 406. 53Bolton et al., supra note 18, at 106. 54In the economic literature, the signal received by the CRA is always imperfect, thus acknowledging that predictions cannot be perfect. E.g., id. at 96. 55Pagano & Volpin, supra note 31, at 405. 56Bolton et al., supra note 18, at 106. 57One important exception is the work from Professors Gorton and Ordonez citing, inter alia, the study by Park. This study, however, does not deny that the triple-A subprime-related securities turned out to be riskier than implied by their initial rating. Rather, their point is that few of these securities actually defaulted and that the losses stemming from such defaults were quantitatively small (too small to justify a global financial crisis). See Gary Gorton & Guillermo Ordoñez, Collateral Crises, 104 Am. Econ. Rev. 343, 343 (2014); Sun Young Park, The Size of the Subprime Shock (2011) (unpublished manuscript). 58Coffee, supra note 3, at 253. 59See supra notes 5, 11 and accompanying text. 60Dimitrov et al., supra note 8, at 509. 61See supra notes 10–15 and accompanying text. 62In the United States, the exemption of CRAs from liability as experts pursuant to section 11 of the Securities Act of 1933 was removed in 2010. Dodd-Frank Act, supra note 5, § 939G,. As a result, CRAs are currently subject to liability under a due diligence standard provided that they are named as experts in the prospectus, which they can and do refuse to do particularly in the case of structured finance. See supra note 23; Coffee, supra note 3, at 265. On this side of the Atlantic, an EU-wide liability of CRAs was only introduced in 2013. "Where a credit rating agency has committed, intentionally or with gross negligence, any of the infringements listed in Annex III having an impact on a credit rating, an investor or issuer may claim damages from that credit rating agency for damage caused to it due to that infringement" (art. 35a, 1, Reg. (EC) no. 1060/2009, as amended by art. 1, (22), Reg. (EU) no. 462/2013). For Australia, see ABN AMRO Bank NV v Bathurst Regional Council [2014] FCAFC 65, discussed supra note 6. 63See Coffee, supra note 21, at 347. 64When courts cannot observe ex post the behavior of an injurer (in this case the CRA), the level of precautions adopted will systematically be inefficient. Steven Shavell, Strict Liability Versus Negligence, 9 J. Legal Stud. 1, 22–23 (1980). 65Coffee, supra note 21, at 347. See also Assaf Hamdani, Gatekeeper Liability, 77 S. Cal. L. Rev. 53, 59 (2003) (although acknowledging this point, the author argues that strict liability might be excessive). 66For a pioneering work on this problem, see Richard Craswell, & John E. Calfee, Deterrence and Uncertain Legal Standards, 2 J.L. Econ. & Org. 279, 299 (1986) ("Our analysis shows that if the uncertainty created by the legal system is distributed normally about the optimal level of compliance, and if the uncertainty is not too large-two seemingly plausible assumptions-then the result under normal damage rules will be too much deterrence rather than too little."). 67This potential problem has long been recognized by the legal literature. See, e.g., Coffee, supra note 21, at 306. 68Dimitrov et al., supra note 8, at 518. See also supra notes 10–15 and accompanying text. 69Coffee, supra note 21, at 306 ("[T]he auditor would know that it sinks or swims with its client; hence, half-hearted or pro forma monitoring, which may be a rational strategy under a negligence or fault-based legal regime, no longer protects the gatekeeper."). 70Listokin & Taibleson, supra note 20, at 104–10. 71See Frank Partnoy, Barbarians at the Gatekeepers? A Proposal for a Modified Strict Liability Regime, 79 Wash. U. L.Q. 491, 540 (2001) (proposing gatekeeper strict liability as an alternative to a due-diligence regime); Coffee, supra note 21, at 309. But see Partnoy, supra note 5, at 96 (mentioning in passing that a modified strict liability regime could be applied to CRAs too). 72Coffee, supra note 3, at 253 (noting that the danger of overdeterrence in absence of a damage cap "is especially acute in the case of a CRA, because its mistakes are typically interlinked and involve multiple securities issuances"). 73Steven Shavell, Strict Liability Versus Negligence, 9 J. Leg. Stud. 1, 1 (1980); Omri Ben-Shahar, Causation and Foreseeability, in Tort Law and Economics 83–108 (Michael Faure ed., 2009). 74Coffee, supra note 3, at 253. 75Coffee, supra note 21, at 363. 76Brigitte Haar, Civil Liability of Credit Rating Agencies After CRA 3-Regulatory All-or-Nothing Approaches between Immunity and Over-Deterrence (2013) (unpublished manuscript), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2198293. 77Part III.C extends the reasoning to a slightly more detailed discussion of the activity performed by rating agencies. 78See supra note 10–15 and accompanying text. 79Goel & Thakor, supra note 10. Another way to put it is that there is a cliff, or at least a very quick decline, in CRAs expected liability when moving towards rating deflation. Therefore, at the margin rating deflation generates great benefits in terms of reduced liability. Our rule allows eliminating this cliff thus reducing the benefits of rating deflation for the CRA. 80As already mentioned, the case of structured finance bonds is different. See infra t notes 137–39 and accompanying text. 81See supra notes 59–61 and accompanying text. 82See George L. Priest, The Current Insurance Crisis and Modern Tort Law, 96 Yale L.J. 1521, 1534–35 (1987). 83Id. at 1540. 84Systemic risk is not easy to define, and it is even more difficult to measure. See NBER, Risk Topography—Systemic Risk and Macro Modelling (Markus Brunnermeier & Arvind Krishnamurthy eds., 2014) (presenting the results of a recent collective study). However, for purposes of this article, we focus on "economic catastrophes," in which defaults occur across otherwise uncorrelated financial claims, as systemic risk events. See generally Joshua Coval et al., Economic Catastrophe Bonds, 99 Am. Econ. Rev. 628, 628 (2009). Bonds that default only in the worst possible state of the economy are greatly exposed to systematic risk although they are safe in all the other (more likely) states of the world. Because ratings are silent about the state of the world on which defaults occur, they are informative about systemic risk and should not be exposed to it. Coval et al., supra note 16, at 23. 85Coval et al., supra note 16, at 23. 86See Part IV.A (presenting empirical evidence on this point). 87Coval et al., supra note 16, at 23. 88CRAs going on "strike" and refusing to rate securitizations until liability under section 11 of the Securities Act could be avoided suggests that this might be actually the case. See supra note 23 and accompanying text. 89See infra notes 137–139 and accompanying text. 90Matthew Rablen, Divergence in Credit Ratings, 10 Fin. Research Letters 12, 12 (2013). 91See Marshall E. Blume et al., The Declining Credit Quality of US Corporate Debt: Myth or Reality, 53 J. Fin. 1389, 1396 (1998) (showing that bond ratings became increasingly conservative over the period 1978–1995); Ramin P. Baghai et al., Have Rating Agencies Become More Conservative? Implications for Capital Structure and Debt Pri