The rating agencies have been among the targets in many of
the lawsuits filed as part of the subprime-related litigation wave. By and
large, the rating agencies have been successful in knocking out these cases in
the early stages, particularly the
lawsuits seeking to hold them liable as "underwriters" under the
federal securities laws.
At the same time, there is a small but growing number
of cases in which the rating agencies' preliminary motions have been
unsuccessful, and there is a definite sense in which these decisions are
building on each other, particularly with respect to the issues surrounding the
First Amendment defenses on which the rating agencies are seeking to rely.
The latest example of a case where the rating
agencies' preliminary motion on First Amendment grounds have been unsuccessful
is the negligence suit that Calpers filed in California state court against the
three principal rating agencies.
In July 2009, Calpers sued
the three main rating agencies in California state court. Calpers alleged
that it had invested about $1.3 billion in instruments issued by three structured
investment vehicles (SIV). The investments carried the rating agencies
highest ratings, which ratings Calpers alleged were "wildly
inaccurate." Calpers claims to have lost over $1 billion on the
Calpers alleged that it would not have invested in the
securities if the securities had not carried the highest investment ratings.
Calpers alleged that the rating agencies "did not have a reasonable
basis" for giving the SIVs the highest investment ratings.
The ratings were flawed, Calpers alleged, because they
failed to account for "foreseeable scenarios" and failed to account
for the SIVs' critical risk - that is, that they were highly concentrated in
certain types of residential mortgages and residential mortgage backed
securities. Calpers also alleged that the rating agencies used "inadequate
mathematical and statistical models" and "employed increasingly lax
standards" while giving the SIVs the highest ratings, in order to be able
to continue to secure business providing ratings for structured financial
The rating agencies demurred to Calpers'
complaint, asserting that the allegations were legally insufficient. In early
May 2010, California (San Francisco County) Superior Court Judge Richard Kramer announced from the bench that
he would be overruling the rating agency defendants' demurrer to Calpers'
negligence claims, but that he was sustaining the demurrers with leave to amend
as to Calpers' allegations of negligent interference with prospective economic
advantage. Judge Kramer indicated at the hearing that the reasons for his
reasons would appear in a forthcoming opinion.
The May 24 Opinion
In an opinion dated May 24, 2010 and filed on June 1, 2010
(and which can be found here), Judge
Kramer set out the reasons for his rulings on the rating agency defendants'
The most noteworthy aspect of Judge Kramer's opinion
is his statement of the bases on which he rejected the defendants' argument
that they could not be held liable for their ratings opinions because the
opinions are protected under the First Amendment. Judge Kaplan said (citing and
relying on Judge Shira Sheindlin's opinion in the Cheyne Financial case, about
which refer here):
The court rejects Defendants' arguments that the First
Amendment to the United States Constitution preempts Plaintiff's claims. The
right to free speech allows us to give our opinions to things of public
concern. The issuance of these SIV ratings is not, however, an issue of public concern.
Rather, it is an economic activity designed for a limited target for the
purpose of making money. That is not something that should be afforded First
Amenment protection and the Defendants are not akin to members of the financial
Judge Kaplan also rejected the rating agency defendants'
arguments that the plaintiff's claims are precluded by New York's Martin Act or
by the Credit Rating Agency Defense Act. However, he did find that plaintiff's
claim of negligent interference with prospective economic advantage was legally
insufficient, although he allowed plaintiff leave to attempt to replead the
There have only been a handful of preliminary motion rulings
so far that have been unfavorable to the rating agencies. But Judge Kaplan's
opinion in the Calpers case demonstrates that each of these rulings, even
though seemingly limited, creates an opportunity for later plaintiffs to try to
exploit the rulings in other cases.
For example, Judge Kaplan expressly relied on Judge Sheindlin's
September 2009 opinion in the Cheyne Financial case. Judge Sheindlin's
rejection of the rating agencies' First Amendment defense in that case was by
its own terms narrow; she said only that credit rating that is not directed to
the public at large, but that is "provided instead to a select group of
investors," is not entitled to First Amendment protection.
Though Judge Kaplan expressly quoted this narrowing
language, his opinion arguable is not as narrow. To be sure, he emphasized that
the SIV itself was designed for a "limited target. But he also said that
the rating agencies are not the equivalent of the "financial press,"
and he indicated that the opinions were not entitled to protection where the
opinions are not of "public concern." This analysis may or may not be
sufficient to bar the First Amendment defense in a public-at-large kind of
claim, but it nonetheless does seen to constrain the availability of the
defense in a wide variety of circumstances - and a wider variety of
circumstances than would the standard in Judge Sheindlin's case.
Whether plaintiffs in other cases will be able to build
further on Judge Kaplan's opinion remains to be seen. It particularly remains
to be seen whether Judge Kaplan's analysis will prove useful in a public-at-large
case, as opposed to a "select group of investors" kind of case.
Nevertheless the plaintiffs in these cases have shown
themselves capable of building on openings in the defense. However, even the
plaintiffs that have already survived preliminary motions are all still a very
long way from any actual recovery. But surviving the motions to live for
another day is the name of the game for plaintiffs in these kinds of cases. The
small but growing number of rulings favorable to the plaintiffs seem to offer
some reason to suspect that a number of these cases against the rating agencies
may yet go forward.
Special thank to Henry Turner
of the Turner Law Offices for providing me with a copy of Judge Kaplan's
opinion in the Calpers case.
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