Judge Rejects Credit Rating Firms? Free-Speech Claims

[WSJ_law_blog]

As we have studiously noted, ratings firms have gotten sued left and right by investors who claim the firms issued misleading opinions about mortgage-backed securities and were partly to blame for the financial crisis. (Here’s one post on the rash of litigation against ratings firms and another noting that the SEC chief favors lowering the barriers to suing ratings firms.)

Ratings firms often have cloaked themselves in the Constitution, claiming that their ratings are mere opinions protected by the First Amendment. And courts in the past have held that investors can not sue on the alleged grounds that ratings are too high or too low, unless, that is, plaintiffs can also show that particular ratings were issued with “actual malice.”

But on Wednesday, Manhattan federal Judge Shira Scheindlin dealt a blow to ratings firms, rejecting a free-speech defense asserted by Moody’s Investors Services and Standard & Poor’s. See the opinion here.

The suit alleges the two ratings services issued misleading ratings to a $5.86 billion investment vehicle that collapsed in 2007. Scheindlin acknowledged that ratings typically are “matters of public concern,” protected by the First Amendment from liability. However, the protection doesn’t apply, she wrote, “where a rating agency has disseminated their ratings to a select group of investors rather than to the public at large,” as the plaintiffs in the case alleged.

The ruling is one of the first to interpret whether the First Amendment applies to ratings of certain securities, such as mortgage-backed securities, which tend to be rated as discrete issuances for investors as opposed to more general ratings of corporate bonds.

“Her decision breaks new ground on the issue of whether the First Amendment applies to ratings of privately offered securities,” says New York attorney David Grais.

“The court’s ruling on the First Amendment was based purely on plaintiffs’ allegations, and we are hopeful the court will review the issue once the true facts are before it,” said Michael Adler, a Moody’s spokesperson.

And S& P spokesman noted the court dismissed all but one of the plaintiffs’ 11 claims. “We are confident that we will prevail on the remaining claim,” he said.