The Wall Street Journal recently reported on a federal district court decision that could pave the way for future lawsuits by investors against credit rating firms such as Moody’s, Standard & Poors and Fitch, whose ratings of junk investments as investment grade have come under fire by Congress. The September 4th article by Nathan Koppel, Andrew Edwards and Chad Bray, entitled “Judge Limits Credit Firms’ 1st-Amendment Defense,” describes an Opinion and Order (“Order”) issued by Judge Shira A. Scheindlin in a class action brought by two institutional investors, Abu Dhabi Commercial Bank, King County, Washington, against Moody’s Investors Service, Inc. and its affiliates, and The McGraw Hill Companies, Inc. and its affiliates, including its wholly owned and controlled business division, Standard and Poors Ratings Services (collectivley, “the Rating Agency Defendants”), and others. The case is pending in the U.S. District Court for the Southern District of New York.
As noted by the article, the class action, which was filed in 2008, claimed that the Rating Agencies issued false and misleading AAA “investment grade” ratings on a $5.86 billion structured investment vehicle known as Cheyene Finance, which collapsed in 2007. The basic idea behind structured investment vehicles was to use short-term debt to buy long term assets, such as residential mortgage-backed securities. The pooled securities were sliced into tranches of varying priorities and risks. The tranches with their bogus AAA ratings were then sold to investors. These complex securities imploded during the financial crisis, when lenders stopped lending and housing prices cratered.
The Order ruled on the various motions to dismiss filed by the defendants. The Rating Agency Defendants argued that the plaintiffs had not pled an actionable misrepresentation because (1) the Rating Agencies are entitled to immunity under the First Amendment and (2) even if they could be held liable, their ratings are non-actionable opinions. The court rejected these arguments and denied the Rating Agencies motions to dismiss the common law fraud claims, thus allowing those claims to proceed to trial.
“Her decision breaks new ground,” said one legal observer. “There certainly will be other cases filed; that’s the future impact of this decision,” said one of the plaintiffs’ attorneys. The ruling is expected to spur more lawsuits against the Rating Agencies involving structure investment vehicles once valued as much as $400 billion.
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