Litigating the Credit Rating Agencies

AmLawDaily is among the media outlets that reported CalPERS filed a suit alleging negligent misrepresentation against Moody’s, Standard & Poors (via The McGraw Hill Companies), and Fitch. The suit – the first by a pension fund against a credit rating agency - also alleges that each rating agency played a role in the structuring of the investment vehicles. The litigation was filed in California state court, alleging violations of both the California Civil Code and California common law. The short of it: CalPERS (which manages $ 173 billion in assets) invested in structured finance vehicles that defendant rating agencies denoted as AAA; the subprime crisis revealed the vehicles were in fact not AAA, and CalPERS is seeking recompense of its lost investment.

There appears to be a consensus that the rating agencies will successfully plead their ratings are an expression of their First Amendment rights, and the CalPERS suit will be dismissed. Really? I am both a young attorney and new to the matter, so was surprised when I discovered that the rating agencies are not only subsidized by the federal government, but also receive compensation from the firms whose instruments they rate. Frank Pasquale at Co-Op has a great post on the topic. I am really intrigued by the issue, and so investigated what litigation in New York is among that pending against these actors.

In In re Moody’s Corp. Sec. Litig., 599 F. Supp. 2d 493, reconsideration denied, 612 F. Supp. 2d 397 (S.D.N.Y. 2009), plaintiff investors filed a class action against the rating agency and several of its officers and directors, alleging a variety of misrepresentations in violation of the Exchange Act § 10(b) and Rule 10b-5. Among the misrepresentations Moody’s is alleged to have made: as regards the independence of both itself as a rating agency and the ratings it released, in light of interested issuers of securities; as regards the meaning of Moody’s ratings themselves; as regards Moody’s structured finance revenue; and as regards its rating methodologies. Although I will not address such in this post, plaintiffs also alleged control person liability against individual defendants, under Exchange Act § 20(A). On defendant motion, the Court dismissed all allegations against defendant COO and Managing Director of Moody’s U.S. Asset Finance Group, and allegations regarding the meaning of Moody’s ratings and Moody’s structured finance revenue (meaning and derivation). The remaining claims proceeded to trial, and plaintiffs were otherwise left with leave to amend.

Although only an opinion on a motion to dismiss, it’s interesting to review what happened. The Court found plaintiffs provided sufficient evidence that Moody’s statements about its independence were indeed false. The Court relied on a number of WSJ articles that described events such as: Moody’s changing a rating so as to save a client issuer; and promotion of analysts who favored higher ratings and asked fewer questions. In finding so, the Court rejected defendant’s puffery argument; that language was “vague” and “non-specific.” The Court considered precedent which had ruled puffery as inactionable; language there took the form of declarations of intent and discussion of hope. Moody’s, on the other hand, was found to have treated its independence as a “cornerstone” of its very livelihood, and the Court found several public statements made by Moody’s to be neither “vague” or “non-specific.” The case is yet pending in the Southern District Court of New York, 07 CV. 8375 (SWK).

The topic is hot, not to mention interesting. As a new attorney to the issue, there are loads of topics to research and discuss, so I will certainly revisit the topic as the blawg moves forward (no pun on that last bit … ). Thanks – Sls.

(Image courtesy of Bank of the Ryukyus, Limited).

I'm reading: Litigating the Credit Rating AgenciesTweet this!