Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Thursday, May 12, 2011

2d Circuit: Rating Agencies are not "Underwriters" or "Control Persons"

The Second Circuit, in In re Lehman Brothers Mortage-Backed Securities Litigation (May 11, 2011)(Download 2dCir.LehmanMortBackAssets) affirmed the district court's dismissal of three class action complaints brought by purchasers of mortgage pass-through certificates registered with the SEC that entitled them to distributions from the underlying pools of mortgages.  Most of the certificates received AAA ratings from one of the three major credit rating agencies named as defendants -- S&P, Moody's, and Fitch.  According to plaintiffs, the rating agencies exceeded their traditional roles by actively aiding in the structuring and securitization process and helped to determine the composition of the loan pools, the certificates' structures and the amount and kind of credit enhancement for particular tranches.  Plaintiffs argued that the rating agencies' activities made them "underwriters" for purposes of Securities Act section 11 liability or "control persons" under section 15.  The Second Circuit, however, was not persuaded. 

As to underwriter status, the Second Circuit held that:

To qualify as an “underwriter” under 15 U.S.C. § 77b(a)(11), a person must
have participated, directly or indirectly, in the purchase of securities with a view toward
distribution, or in the sale or offer of securities in connection with a distribution. Because
the Rating Agencies’ alleged structuring or creation of securities was insufficient to
demonstrate their involvement in the requisite distributional activities, plaintiffs’ § 11 claims
against these defendants were properly dismissed.

The court based its holding on statutory interpretation, legislative history and policy.

As to "control person" liability:

Because the Rating Agencies’ provision of advice and guidance regarding
transaction structures was insufficient to permit an inference that they had the power to direct
the management or policies of alleged primary violators of § 11, plaintiffs’ “control person”
claims against these defendants pursuant to 15 U.S.C. § 77o(a) were properly dismissed.

The court also found that the district court did not abuse its discretion in implicitly denying plaintiffs' cursory requests to amend their complaints.

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