Ruling: Credit-rating agencies can't use free-speech defense

NEW YORK -- Moody's and McGraw-Hill's shares fell Thursday following a court ruling that may make it harder for credit-rating agencies to argue that their opinions deserve free speech protection.

In an order issued late Wednesday, U.S. District Judge Shira Scheindlin in Manhattan said ratings on notes sold privately to a "select" group of investors were not "matters of public concern" deserving of traditionally broad protection under the First Amendment of the U.S. Constitution.

The judge said the plaintiffs may pursue fraud claims accusing Moody's Investors Service, McGraw-Hill's Standard & Poor's unit and Morgan Stanley, which marketed the notes, of making false and misleading statements about the notes, which were backed by subprime mortgages and other debt. Scheindlin said credit ratings could be subject to challenge "if the speaker does not genuinely and reasonably believe it or if it is without basis in fact."

The ruling may aid lawsuits by pension funds and other investors seeking to hold banks and rating agencies responsible for inflating the value and safety of debt to win fees.

"This is potentially a very significant opinion," says Joseph Mason, finance professor at Louisiana State University. "It seems they have found a hole in the First Amendment defense, the agencies' primary line of defense."

The case involved losses that Abu Dhabi Commercial Bank and King County in Washington state, which includes Seattle, said they suffered from the Cheyne Structured Investment Vehicle.

Scheindlin said Cheyne issued notes with ratings as high as "triple-A," and the rating agencies were paid above-normal fees that were in part "contingent upon the receipt of desired ratings." The Cheyne vehicle went bankrupt in August 2007.

The judge did not decide the merits of the case. McGraw-Hill spokesman Frank Briamonte and Moody's spokesman Michael Adler expressed confidence their companies would prevail. Morgan Stanley declined to comment. The plaintiffs did not return requests for comment. The nation's largest public pension fund, the California Public Employees' Retirement System, in July sued Moody's, S&P and Fimalac's Fitch Ratings for $1 billion about their ratings, including for the Cheyne vehicle. Calpers spokesman Clark McKinley declined to comment.