Opinion

Alison Frankel

S&P: State AGs trying to usurp federal regulation of rating agencies

By Alison Frankel
April 8, 2013
S&P

Over the next few weeks, federal courts in more than a dozen states are going to begin to consider a very interesting question: Does coordination between and among state attorneys general and the U.S. Department of Justice constitute an improper attempt to override federal regulation?

The credit rating agency Standard & Poor’s is asserting that it does, in an argument that could affect how state AGs enforce consumer laws against defendants in regulated industries. You’ll recall that when the Justice Department announced its $5 billion suit against S&P in February, seven state AGs were in attendance to announce their own parallel state-court claims that the rating agency lied about its independence and objectivity, in violation of state consumer protection and trade practice laws. Three such suits, by Connecticut, Illinois and Mississippi, were already under way at the time of the Justice Department filing, and several more states have since brought claims in their home courts. S&P has now removed all of the state-court AG cases to federal court and has asked the Judicial Panel on Multidistrict Litigation to consolidate the proceedings before one of two judges in federal court in Manhattan.

The rating agency’s lawyers at Cahill Gordon & Reindel argue that the coordinated attack by the Justice Department and the state AGs is a de facto pre-emption of the Credit Rating Agency Reform Act of 2006, which gave oversight of S&P and its competitors to the Securities and Exchange Commission. “Taken as a whole, the actions represent a concerted effort to undermine, if not supplant, a detailed, comprehensive and carefully balanced federal scheme through patchwork and inevitably conflicting rulings across the country,” Cahill wrote in S&P’s brief to the JPMDL. “These nominally separate actions – the vast majority of which were filed on the same day and touted as the result of a ‘coordinated’ effort at a joint press conference held by several of the Attorneys General to announce their filing – are, in effect, a single hindsight-infused attempt by the states to lay blame with S&P for failing to predict the financial crisis and they should be treated collectively.”

When S&P made a pre-emptive strike against suits by the AGs of South Carolina and Tennessee by filingdeclaratory judgment actions in federal court, I said that I didn’t think much of the rating agency’s straw-man argument that credit ratings are protected by the First Amendment, since that wasn’t at issue in the state cases. But S&P’s pre-emption argument isn’t so easily dismissed. At the very least, the credit rating agency has bought itself time. (More on that below.) And if it convinces the JPMDL that the state actions interfere with federal regulation, it could seriously impair state enforcement actions.

One immediate benefit of S&P’s maneuver has been to slow down litigation against it. After removing the AG cases to federal court and filing a transfer order before the JPMDL, S&P moved to stay proceedings until the panel decides whether to consolidate the suits. States have generally opposed the stay – they’re eager to litigate remand motions – but on Friday, a federal judge in Pennsylvania agreed to put AG Kathleen Kane’s case on hold until the JPMDL makes a decision. Meanwhile, as S&P forces states to move for remand, oppose its stay motion and oppose consolidation by the JPMDL, it forestalls its day of reckoning on the merits of the state claims against it.

That’s exactly what Connecticut and Illinois don’t want. Connecticut first brought a deceptive trade practices suit against S&P in state court in 2010. Mississippi followed in 2011 and Illinois in 2012. S&P removed the Mississippi case to federal court, where a remand motion by AG Jim Hood is pending. But the Connecticut and Illinois cases have been under way in state court: Connecticut AG George Jepsen succeeded in getting his case remanded after S&P removed it, and the rating agency moved to dismiss claims by Illinois AG Lisa Madigan suit without removing the case to federal court. State judges in both cases subsequently denied the agency’s motions to dismiss and ordered discovery to proceed.

Nevertheless, after the Justice Department filed its case, S&P removed the Connecticut and Illinois suits to federal court, then asked the JPMDL to consolidate them with the other AG suits. Connecticut and Illinois, as you can imagine, wholeheartedly oppose S&P’s removal gambit. In its brief to the panel, Illinois called the maneuver “untimely” and prejudicial to its case. Connecticut also used the word “untimely” in its brief to the JPMDL, which argues (among other things) that Connecticut courts have already determined once that the AG’s case belongs in state court, and that each of the state actions against the rating agency is brought under that state’s consumer laws, so federal consolidation isn’t appropriate.

The federal judges in Connecticut and Illinois who are now presiding over the cases removed by S&P have both refused to stay remand proceedings, so we’re looking at an unusual scenario in which federal judges could very well snatch cases out of the JPMDL’s jurisdiction by sending them back to state court.

In an amicus brief in the Connecticut remand proceeding, the Justice Department says that’s just what should happen. There’s no proper basis to litigate state-law claims by state AGs in federal court, the brief said. State consumer laws don’t supplant federal regulation of credit rating agencies but operate alongside them, according to the Justice Department. “The state-law causes of action are straightforward claims under consumer protection and deceptive business practice statutes,” the brief said. “The crux of these claims is that S&P made false representations regarding its own practices. At issue are representations made by S&P itself and whether the facts show those representations to be false. Resolving these issues requires no interpretation of (the Credit Rating Agency Reform Act).”

S&P countered in a filing last week that the Justice Department’s brief ignores the essence of its argument: The department is collaborating with the AGs in what amounts to a subversion of federal regulation of the credit rating agencies. That’s a matter for the federal courts to decide, according to S&P.

U.S. District Judge Stefan Underhill of Connecticut will probably be the first federal court to decide where the AG cases against S&P should be litigated. That ruling is going to be widely read.

For more of my posts, please go to Thomson Reuters News & Insight

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