Tag Archives: Abu Dhabi

Rating Agency 1st Amendment Defense Weakened, Again

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Federal District Judge O’Toole (D. Mass.) issued an Opinion and Order in Federal Home Loan Bank of Boston v. Ally Financial Inc. et al., No. 11-10952 (Sept. 30, 2013)  relating to the potential liability of S&P and Moody’s (the Rating Agency Defendants) for their ratings. The case “arises from the purchase of private label mortgage-backed securities” (PLMBS) by the plaintiff, FHLB Boston. (1)  FHLB Boston alleges that the rating agency defendants knew that their ratings “were inaccurate and based on flawed models, and that their conduct gives rise to” a claim for fraud as well as other causes of action. (1) The Rating Agency Defendants sought to have the claims dismissed for failure to state a claim. The Court rejected this as to the fraud claim:

The Rating Agency Defendants’ argument that their ratings are non-actionable opinions is unconvincing. As discussed in Abu Dhabi I, “[a]n opinion may still be actionable if the speaker does not genuinely and reasonably believe it or if it is without basis in fact.” 651 F. Supp. 2d at 176 (internal citations omitted). Here the Bank has pled with sufficient particularity that the Rating Agency Defendants issued ratings that they did not genuinely or reasonably believe. For example, the Amended Complaint alleges that the Rating Agency Defendants diluted their own standards and carried out their ratings procedures in an intentionally lax manner as to PLMBS while maintaining higher standards in other contexts. The Bank has also sufficiently pled scienter, alleging that the Rating Agency Defendants competed for business by artificially inflating ratings, as they were only paid if they provided high ratings. (4)

Rating agencies were able to avoid liability for decades, claiming that their ratings were like min-editorials that were protected by the First Amendment. A number of recent cases reject that defense in a variety of contexts (See here, here and here for instance). It is unclear what will happen when these cases are appealed, but for now it appears that a number of courts have identified situations where an opinion can be more than an opinion — it can amount to actionable fraud.

Scheindlin Allows More Fraud Claims Against Rating Agencies To Go To Trial

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Judge Scheindlin (SDNY) has ruled that investors can proceed with their fraud claims against the big three rating agencies for giving a top rating to a SIV.  There are no surprises in this opinion as it tracks the reasoning of Judge Scheindlin’s earlier opinion in a related action (Abu Dhabi Commercial Bank v. Morgan Stanley & Co. Inc. (Abu Dhabi I), No. 08 Civ. 7508, WL 3584278 (S.D.N.Y. Aug. 17, 2012).)

loan application fees

I think this quotation from the King County opinion puts the issue nicely:

While ratings are not objectively measurable statements of fact, neither are they mere puffery or unsupportable statements of belief akin to the opinion that one type of cuisine is preferable to another. Ratings should best be understood as fact-based opinions. When a rating agency issues a rating, it is not merely a statement of that agency’s unsupported belief, but rather a statement that the rating agency has analyzed data, conducted an assessment, and reached a fact-based conclusion as to creditworthiness. If a rating agency knowingly issues a rating that is either unsupported by reasoned analysis or without a factual foundation, it is stating a fact-based opinion that it does not believe to be true.41

I subsequently held that the rating agency defendants could “only be liable for fraud if the ratings both misstated the opinions or beliefs held by the Rating Agencies and were false or misleading with respect to the underlying subject matter they address.” To sustain a fraud claim against each rating agency, then, plaintiffs must provide evidence that the rating agency issued a rating that it knew was unsupported by facts or analysis — that the rating agency did the equivalent of issuing a restaurant review despite never having dined at the restaurant. (12-13, footnote omitted)

Judge Scheindlin has now made it clear that rating agencies may face liability for their opinions under certain circumstances.  Time will tell whether the 2nd Circuit (which has favored the rating agencies in other cases) will agree.

I can only find the King County opinion and the Abu Dhabi opinion behind the NYLJ paywall for now.