Angry about possible U.S. downgrade? Don’t bother suing raters

By Alison Frankel
August 2, 2011

With U.S. markets fretting Tuesday at the prospect of a downgrade in the government’s triple-A credit rating, you may be wondering: Who can we sue? Litigation, after all, is practically an unalienable American right. The problem, however, is that any attempt to sue the credit rating agencies for downgrading U.S. securities will run smack into the Bill of Rights. The rating agencies, as many a disgruntled mortgage-backed securities investor has discovered in the last few years, are shielded from liability because their ratings are considered to be public opinion protected by the First Amendment of the U.S. Constitution.

The agencies’ First Amendment protection dates back at least to 1999, when the U.S. Court of Appeals for the Tenth Circuit upheld a Colorado judge’s dismissal of a case against Moody’s Investor’s Services. The Jefferson County School District had sued Moody’s, claiming that the credit rating agency published an unfair assessment of the district’s 1993 bond offering. (The suit alleged that Moody’s was retaliating because the district hired other agencies to rate the bonds, but that wasn’t important in the case’s outcome.) Jefferson County, which had to re-price the bonds after the unfavorable Moody’s report, claimed the rating agency had illegally interfered with its bond offering and also committed antitrust violations.

The trial court treated Moody’s as a member of the media and found that the First Amendment protected its report on the school district bond offering from both state and federal claims. On appeal, the school board argued that the report was not protected free speech, but the Tenth Circuit disagreed. The appellate panel didn’t even waste much time discussing the trial court’s assumption that Moody’s is entitled to the same First Amendment protection as, say, Reuters. Instead, the Tenth Circuit opinion analyzed the allegedly false statements in the Moody’s report and concluded they’re too vague to be “provably false,” so Moody’s was constitutionally protected.

In a similar 1999 case, a Santa Ana, California, federal district judge granted summary judgment to Standard & Poor’s parent McGraw-Hill Companies, finding that a credit rating agency’s opinion must be issued with actual malice to lose its First Amendment protection. (That’s the same standard that applies for journalists.) In the Santa Ana case, Orange County claimed that S&P had granted too rosy a rating to county bond offerings. It sued for negligence and breach of contract, but the court held that Orange County would have to show actual malice by S&P to proceed with either claim. The County couldn’t make the requisite showing, so its case was tossed.

The software outfit Compuware Corp had a stronger case for actual malice, considering that it accused Moody’s of unreasonably downgrading its credit rating (instead of issuing an overly-optimistic assessment, as Orange County claimed S&P had). But in a 2005 suit against the rating agency, Compuware argued that it shouldn’t have to show actual malice to proceed with a breach of contract case. The U.S. Court of Appeals for the Sixth Circuit nevertheless upheld the actual malice standard in a 2007 opinion that seems to take for granted the notion that credit rating agency products are protected by the First Amendment.

“The contract between Compuware and Moody’s involves matters central to the First Amendment,” the Compuware court found. “The relevant agreement, as best we can determine from the evidence presented by the parties, consists of Moody’s promise to provide its opinion of Compuware’s creditworthiness and to publish a report of that opinion. Moody’s agreed to do no more. Moody’s provided that opinion, and Compuware does not claim to the contrary. Both Moody’s opinion and its publication are matters protected by the First Amendment; thus the whole of this agreement — the very subject matter and corresponding duties — is intimately tied to speech, expression, and publication.”

The First Amendment shield has proved to be incredibly valuable to the credit rating agencies in the wake of the 2008 economic meltdown, when court after court has dismissed MBS investors’ claims that the rating agencies worked hand-in-glove with issuers to confer AAA ratings on mortgage-backed dreck. The Teflon properties of the First Amendment even attracted the attention of Congress, which attempted to impose broader liability on the credit rating agencies in the 2010 Dodd-Frank financial reform litigation. As you might expect, the rating agencies and their lawyers have lobbied hard to blunt the force of the Dodd-Frank rules as the Securities and Exchange Commission contemplates implementation.

In a brilliant 2010 column, Susan Beck of the American Lawyer’s Litigation Daily argued that the premise of broad First Amendment protection for the agencies’ actual ratings is “shaky” because “courts gave the rating agencies First Amendment protection for statements or information contained in publications they had issued.” No court, Beck wrote, has actually found that an agency’s stand-alone rating is protected by the First Amendment, although she noted that the Sixth Circuit’s Compuware ruling contains a very strong endorsement of the concept of credit rating agencies as financial publishers.

So maybe some investor — or the United States itself — will assert liability against an agency that dares to downgrade U.S. securities. But I would rate the chance of such a suit succeeding as no better than junk.

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