Judge Limits Credit Firms' 1st-Amendment Defense
Ruling in Cheyne Finance Case Lifts Protection for Ratings Not Made Public; Moody's, McGraw-Hill Stocks Fall
SEPTEMBER 4, 2009
By NATHAN KOPPEL, ANDREW EDWARDS and CHAD BRAY
online.wsj.com
(See Corrections & Amplifications below)
Shares in two companies that own credit-rating firms, Moody's Corp. and McGraw-Hill Cos., declined on Thursday in reaction to a court decision that rejected the companies' longtime claim that the First Amendment protected them from lawsuits.
The ruling is expected to spur more lawsuits and could apply to structured investment vehicles once valued at as much as $400 billion.
McGraw-Hill, which owns Standard & Poor's, fell 10%, and Moody's Corp., parent of Moody's Investors Service, fell 7.1% in New York Stock Exchange composite trading.
The firms had long argued that their ratings of securities were constitutionally protected opinion. But U.S. District Judge Shira Scheindlin ruled on Wednesday in a 68-page opinion that the ratings of certain securities -- those that were distributed to a limited number of investors -- don't deserve the same free-speech protection as more general ratings of corporate bonds that were widely disseminated.
The judge's decision is one of the first to interpret the extent to which the firms can expect First Amendment protection for their ratings of certain securities, which have been the focus of much litigation since the credit crisis. "Her decision breaks new ground," says New York attorney David Grais, who represents investors in suits alleging losses from asset-backed securities.
Judge Scheindlin's ruling is not binding on other judges in the district but could influence them, attorneys say, because the judge presides over many securities suits and is highly regarded.
The case involved a suit filed by institutional investors against the two firms in 2008, claiming the two ratings services issued misleading "investment grade" ratings to a $5.86 billion structured investment vehicle, once known as Cheyne Finance, that collapsed in 2007. The suit is seeking class-action status on behalf of investors who had losses from the liquidation of notes issued by Cheyne SIV between October 2004 and October 2007.
SIVs typically used short-term debt to buy long-term assets, largely residential mortgage-backed securities. The model broke down when these complex securities started to fall apart during the financial crisis, prompting lenders to shut off their supply of cheap short-term funding.
Pieces of the SIVs sold to investors were rated AAA by leading ratings firms, meaning they were considered as safe as U.S. Treasury bonds, only offering significantly better returns. Now that many SIVs have fallen apart, investors have filed suit against the ratings firms, alleging that they were intentionally misled.
Lawyers for the plaintiffs, Abu Dhabi Commercial Bank and King County, Seattle, said the ruling could be applied to any deal in the SIV world, meaning it is potentially applicable to investments that they estimate at $350 billion to $400 billion before the crisis. "There certainly will be other cases filed; that's the future impact of this decision," said Patrick Daniels, a founding partner at San Diego law-firm Coughlin, Stoia, Geller Rudman & Robbins LLP.
Moody's and S&P moved to dismiss the suit on free-speech grounds. The judge said ratings are typically protected from liability and subject to an actual malice exception because their ratings are considered matters of public concern. "However, where a rating agency has disseminated their ratings to a select group of investors rather than to the public at large, the rating agency is not afforded the same protection," the judge said.
Judge Scheindlin partially dismissed the plaintiffs' case, which was filed against the ratings firms and some banks, but allowed the fraud claim to go forward.
"We are pleased that the court has dismissed all but one of the 11 claims, and we are confident that we will prevail on the remaining claim," said Chris Atkins, a spokesman for S&P.
"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 spokesman.
Martin Redish, a constitutional-law professor at Northwestern University School of Law, questioned whether the judge is correct in seeing free-speech protection for publicly disseminated communication but not for private communication. "The fact that [a rating] was just to a select audience should not disqualify it from First Amendment protection."
Cheyne Finance was set up and operated by London hedge-fund group Cheyne Capital Management (UK) LLP until its collapse in September 2007. It changed its name to SIV Portfolio in November 2007 to reflect that Cheyne Capital was no longer involved.
Write to Nathan Koppel at nathan.koppel@wsj.com, Andrew Edwards at andrew.edwards@dowjones.com and Chad Bray at chad.bray@dowjones.com
Corrections & Amplifications
A ruling by U.S. District Judge Shira Scheindlin of the Southern District of New York is not binding on other judges in the district but could influence them. A previous version of this article incorrectly said that the judge's ruling is binding.
online.wsj.com |
