Sheen of Invincibility Dims for Rating Agencies with New DOJ Suit
The credit rating agencies may have helped to invite worldwide financial calamity by propping up subprime securities with too-good-to-be-true ratings, but for a long while it seemed that they would remain all-but impervious to liability for the crisis. In case after case, Standard & Poor's Financial Services, Moody's Corp., and Fitch Ratings Inc. managed to beat back investor claims by arguing that their wildly optimistic ratings amounted to constitutionally protected opinions.
But cracks in the rating agencies' First Amendment armor have begun to spread in a series of decisions in private investor litigation and cases brought by state AGs. And now that the Justice Department has brought its own 119-page civil complaint against S&P, the agencies must be feeling more exposed than ever.
As our colleagues at The National Law Journal report, the DOJ alleged Monday that S&P misled investors and manipulated ratings to drum up more business and boost its profits. The suit was filed under the Financial Institutions Reform, Recovery and Enforcement Act of 1989, a creation of the Savings and Loan crisis that allows prosecutors to go after penalties equal to the losses of federally insured financial institutions. Bringing the suit under FIRREA will presumably allow the government to allege violations like mail, wire and bank fraud without meeting the high burden of proof required in criminal cases.
Among the internal communications cited in the complaint are some oldies but goodies that have popped up in past investor litigation (one S&P analyst wrote to another that a security "could be structured by cows and we would rate it"), and some entertaining new material, like an S&P analyst's spoof of the Talking Heads' "Burning Down the House" lamenting the imploding housing market.
If the DOJ can get any of its claims to stick (and that may be a big if), it will have succeeded where many private litigants have failed. As recently as December, S&P and its competitors at Moody's, and Fitch were able to squash securities fraud and negligent misrepresentation claims brought by five Ohio pension funds at the U.S. Court of Appeals for the Sixth Circuit. S&P's lawyer, First Amendment legend Floyd Abrams of Cahill, Gordon & Reindel, handled oral arguments at the Sixth Circuit for the ratings agencies in that case; Abrams will be defending S&P once again in the DOJ's case.
The First Amendment defense has not been fail-safe though. As we reported, way back in September 2009 U.S. District Judge Shira Scheindlin in Manhattan ruled that the free speech defense doesn't apply to ratings that were only disseminated to a specific group of investors, rather than to the public at large. That case, which was brought by lawyers at Robbins Geller Rudman & Dowd on behalf of investors who lost money in a highly-rated structured investment vehicle, cleared another hurdle in August when Scheindlin refused to dismiss common law fraud claims against Moody's and S&P. (Trial is set for May in the case.) Meanwhile, Scheindlin ruled in January that the same Robbins Geller lawyers could proceed with claims that the ratings agencies misled investors in a different $1.1 billion SIV.
Prior to Monday's DOJ suit, the attorneys general of Connecticut, Mississippi, and Illinois had all brought state law claims against ratings agencies. The Mississippi case was removed to federal court in June 2011, where it remains pending. In May 2012, the Connecticut AG's suit against Moody's survived a motion to strike when a judge ruled that Moody's "opinions may enjoy First Amendment protection, [but] that protection does not give the defendants license to misrepresent to consumers the way in which they operate their business or arrive at their opinions." And in November a state court judge refused to toss the Illinois AG's complaint against S&P, citing rulings that held that the rating agencies' statements about their methodologies--if not the ratings themselves--are fair game.
Thirteen additional states and the District of Columbia filed new actions against S&P for alleged violations of state and local laws this week. It would be reasonable to assume that the Justice Department and various states are also eyeing new claims against Moody's and Fitch. Either way, Floyd Abrams is going to be a very busy man.