They published books. They issued updates. They had excellent lawyers. And for years, the rating agencies presented themselves as neutral providers of opinions as to the credit worthiness of corporate and government debt. Those opinions were available to be purchased by those interested or could be found in a public library, just like any other organ of opinion such as a newspaper or magazine. Despite that much of their income came from those very institutions that wished their debt to be rated prior to its issuance or sold to investors, the rating agencies insisted that they were not part of the process by which the debt was issued. If what their opinions did was facilitate the sale, so well and good. They argued that they were not at all intimately involved in the sale of the securities that they rated.
Thus, when challenged, their lawyers argued and persuaded the Courts that the agencies too should be treated just like newspapers and magazines, and afforded the same broad First Amendment rights from second-guessing lawsuits when their opinions turned inaccurate. Indeed, even when there was proof that the rating companies had information that should have caused them not to issue such rosy opinions, the Courts provided them with a blanket protection under the First Amendment to issue those opinions. After all, reasoned the Courts, everyone knew these were opinions and opinions were just that: to be taken for whatever the reader thought them to be useful given the providers of the opinion.
Now, a Federal Judge has ruled otherwise. The case bears close scrutiny although it is certain to be argued by the rating agencies that it should be limited to its facts.
On September 7, 2009, Judge Shira Scheindlin of the United States District Court for the Southern District of New York rejected the First Amendment argument and denied a motion to dismiss by Moody’s Investor Service and Standard & Poors in Abu Dhabi Commercial Bank vs. Morgan Stanley (08 Civ. 7597).
The case involved an investment by two institutions in a structured investment vehicle in a largely private transaction. The institutional investors alleged that Standard & Poors and Moody’s made false and misleading assessments about the notes issued by the special investment vehicle which were then provided to potential investors such as themselves. Moody’s and S&P, it was alleged, received three times their fees for the high ratings and “unbeknownst to investors at the time the rating agencies’ compensation was contingent upon the receipt of desired ratings . . . and only in the event that the transaction closed with those ratings.”
Judge Scheindlin’s opinion narrowly construes these facts to distinguish the case from those which hold that “under typical circumstances, the First Amendment protects rating agencies, subject to an ‘actual malice’ exception, from liability arising out of the issuance of ratings and reports because the ratings are considered matters public concern.” The case in front of the Court, however, involved a private offering. Thus, the Court concluded “[w]here a rating agency has disseminated its ratings to a select group of investors rather than the public at large, the rating agency is not afforded the same protection.” The Court did not accept the argument that mere opinion was not actionable under all circumstances. The plaintiffs have pleaded, the Court wrote, that “[t]he rating agencies did not genuinely or reasonably believe that the ratings they assigned to their rating notes were accurate and had a basis in fact.”
Indeed, the commentary so far on this opinion has largely noted the care and preciseness of Judge Scheindlin’s opinion. This is one of the few opinions where the plaintiffs were able to allege in their complaint the integral involvement of the rating agencies in the process of offerings of debt securities. The rating agencies, plaintiffs alleged, were not neutral commentators at all. Not only did they get paid by the issuer for undertaking the rating, they received a fee for providing a particular rating and assisted in the transaction in order to achieve the rating that resulted in the fee. In short, they played a crucial role in guiding the offering itself and then made statements knowing that the investors would be relying upon those opinions in determining investment decisions.
It would seem hardly to be a distinction Ratings are always opinions but opinions can be knowingly false and actionable. It should hardly matter whether the target of the opinion is an identifiable group of potential private investors or more anonymous public investors both institutional and retail as to which the rating will be knowingly utilized to sell the instruments. As with sell-side analysts whose scandalous issuance of buy ratings for investment banking companies was disclosed during the dot.com era to have been corrupted, so too with the rating agencies, as plaintiffs have alleged.
Serious reform of those agencies has been proposed legislatively. Getting their own house in order should not take government action.