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The Scope of Imposing Criminal Liability on Credit Rating Agencies

Updated: May 31


Imagine the big rating agencies as three competitive saloons standing side by side, with each free to set its own drinking age. Before long, nine-year-olds would be downing bourbon”

― Roger Lowenstein

Ever since the 2008 global financial crisis, the regulations on Credit Rating Agencies (hereinafter, “CRAs”) have been under much contention around the world. The free fall of Wall Street raised several doubts on the functioning of CRAs and their relationship with issuers of stock such as Lehman Brothers. The discrepancies in the working of CRAs has resulted in heavy losses to Indian stakeholders too. One of the most significant incidents is the crashing of the mutual fund market as a result of huge loan defaults of Infrastructure Leasing & Finance Services (IL&FS) in 2018.

Such incidents have led economists and policy-makers to ponder over different methods to deter CRAs from giving incorrect or inefficient ratings to companies, banks and finance houses that pile up their Non-Performing Assets (hereinafter, “NPAs”) and eventually default. Many suggestions have been made to change the structure of CRAs or fill legislative loopholes such as abandoning the ‘issuer pay’ business model or increasing penalties on inefficient ratings or adopting a disclosure-based approach. One such proposition is the imposition of criminal liability on CRAs. This article will first examine the concept of CRAs and laws governing CRAs. It will then analyse the hurdles in imposing criminal liability and whether criminal liability should be imposed.

What are Credit Rating Agencies?

CRAs give investors or potential investors (the general public) of a particular company a detailed breakdown of the levels of risk associated with investing in that company. The investment or the ‘debt securities’ could be in the form of government or cooperate bond, stocks, municipal bonds and so on. To simplify the understanding of the risk associated with investing in a particular debt security, rating agencies also grade different institutions. These grades are ‘AAA’, ‘AA’, ‘A’, ‘B’, ‘C’ and so on, with ‘AAA’ being the best grade, where the debt issuer has the highest possibility of making timely payments.

Moody’s, Standard & Poor (S&P) and Fitch Ratings are the ‘Big Three’ of CRAs which together dominate around 95 percent of the credit rating market. All three are US-based and virtually control the market of credit rating. Credit Rating Information Services of India (CRISIL), Investment Information and Credit Rating Agency (ICRA) of which Moody’s is the largest shareholder, Credit Analysis and Research Limited (CARE) and India Rating and13 Research Pvt. Ltd. owned by the Fitch group are some of the leading CRAs in India along with the Big Three.

Current Regulations

In the USA, the Dodd-Frank Wall Street Reform and Consumer Protection Act was passed by the Obama administration in 2010. This act was on the lines of the Glass-Steagall Act which was repealed in 1999 (the 2008 financial crisis is also said to have been instigated by the Gramm-Leach-Bliley Act which deregulated use of deposited funds by banks by repealing the Glass-Steagall Act). Along with regulations on insurance giants, use of deposited money, risk derivatives and federal bailouts, the Dodd-Frank Act set up the Office of Credit Ratings at the US Securities and Exchange Commission to supervise the working of CRAs. The office can order CRAs to disclose the protocols and methodologies behind their ratings.

Similarly, as a result of the Eurozone sovereign debt crisis, the European Securities and Markets Authority (ESMA) was set up in 2011. Among other things, ESMA supervises the working and the ratings produced by CRAs. Concurrently, seven CRAs are registered with the Security and Exchange Board of India (SEBI). CRAs in India are regulated under the Securities and Exchange Board of India (Credit Rating Agencies) Regulations, 1999.

Although regulating the working of CRAs can help improve the efficacy of their ratings to some extent, the structure of the global credit rating industry demands better reforms. The two main hurdles in the working are the issuer payer business model and the minimal competition. Credit rating agencies are private organisations that are hired by debt issuers to rate their debt instruments. This is known as the issuer payer business model which replaced the subscription-based business model in the 1970s. Thus, the integrity of the credit rating market and the well-being of the stock market solely depend on the good faith of CRAs and to some extent the regulating powers of government institutions in laissez-faire economies. This inherit flaw in the scope of misuse of the issuer payer model is only aggravated by the dominance of the Big Three that have, in many cases, issued false ratings for profits giving free reign to banking and non-banking financial institutions to rack up on NPAs at the cost of investors’ money.

Can criminal liability be imposed?

During the financial crisis in 2008, some investors opted to file criminal cases against debt issuers and CRAs over civil suits. However, most of them did not materialize. The existence of mens rea as well as actus reus are essential for imposing criminal liability.

In white-collared criminal cases, due to the high standards of proving the guilt of the accused beyond reasonable doubt, CRAs mainly get away with defences of failure in producing correct ratings due to the complexity of the debt products and the high-risk metric in the market. Thus, the ‘wilful intent’ to impose criminal liability becomes difficult to prove. At the same time, in civil suits, a plaintiff can succeed against a CRA without having to prove misconduct at the part of a specific individual or group of individuals. However, in a criminal prosecution, a generalized causation would not be sufficient to convict the CRAs. The prosecution has to prove the intent to default as well as the act of knowingly spreading misinformation causing investors to believe the security of investing in a debt instrument leading to a loss. The defendants, on the other hand, can also avail the defences of wilful blindness, mistake of facts and failure in the functioning of their models or protocols that produce the ratings.

Should criminal liability be imposed?

One of the most prevalent arguments for opting for remedies against CRAs under criminal law is that civil remedies are expensive and ineffective. Concurrently, imposing civil liability does not provide the much-needed deterrence required to stabilize the issuer payer business model. This is mainly because the Big Three can simply pay a miniscule amount from their over-the-top income as damages to investors and move onto give more falsified ratings for profit in the future. Criminal liability as a deterrence is further justified by the high stakes involved in the ratings provided by CRAs. The whole stock market and the investors depend on these ratings. The failure to deliver doesn’t just disrupt the stock market, but the economy of the country, as a whole, suffers tremendous loss and the job market destabilizes. Thus, raising the stakes for CRAs by imposing criminal liability may deter these profit-based institutions from misusing the limited competition and issuer payer model.

Imposing criminal liability is further backed by the theory of retributive justice which promotes the idea of punishment focused on imposing merited harm upon the criminal for his wrong. It also follows the utilitarian theory of specific deterrence that aims to prevent repeat offences by a single individual or institution.

However, criminal cases are usually not opted for in cases of false ratings by CRAs because of the high standards of proof required and the fact that the investors cannot recover as much damages in criminal cases. This can be amended by bringing in statutory provisions that cater to specific cases of false ratings by CRAs. A shift in burden of proving good faith in certain cases where circumstances point towards the incapability of hypothesis other than malice on the part of CRAs may also help in smoothening the justice delivery in criminal cases.


Credit Rating Agencies have the power to make or break the credibility of a debt issuer in the stock market. They also influence the decisions of investors. Their failure to deliver comes at a high cost for the economic health of the country. Thus, all possible solutions to fill the loopholes must receive due consideration. Criminal liability, although harsh, may contribute in bringing severe repercussions to CRAs that profit from the free fall of the stock market and the collateral damage to investors. At the same time, criminal liability on CRAs might adversely change the market dynamics if not imposed fairly and effectively. Affirmative action is needed to compel CRAs to perform their obligations without compromising the integrity of the market and the livelihood of the public.

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