Legal News

A First Amendment Defense for the Rating Agencies?

By Ashby Jones

Does the First Amendment’s free-speech guarantee attach to opinions doled out by credit-rating agencies?

Historically, the answer has been yes. But that protection is being questioned amid allegations that the firms had conflicts that encouraged them to give unduly rosy opinions about the creditworthiness of securities backed by subprime mortgages. Click here for the story, from the WSJ’s Nathan Koppel.

The three main credit-rating shops, Moody’s Corp., McGraw-Hill Cos.’ Standard & Poor’s and Fimalac SA’s Fitch Ratings, have all been hit with litigation over their ratings after homeowner defaults triggered investor losses in the securities.

On the one hand, rating firms generally enjoy a free-speech right to “make informed, thoughtful predictions about the future,” says UCLA School of Law professor Eugene Volokh. “That is no different from what newspapers or scholars do.”

To get around the Constitution, judges have ruled, a plaintiff suing a rating agency would have to show that a firm not only made false statements, but also did so with “actual malice” — a high legal hurdle.

Richard Blumenthal, the Connecticut attorney general, sees things slightly differently. “The very nature of [rating firms'] so-called speech is very different from the classic First Amendment-protected expression,” Blumenthal says. “It’s much more akin to an advertisement that misstates the price of an item on sale than a political candidate on a soapbox.” Blumenthal has filed a lawsuit about ratings issued by S&P, though not in connection with mortgage-backed securities.

McGraw-Hill denies wrongdoing in the Connecticut case. “The claims asserted by the Attorney General violate First Amendment rights and would result in an erosion of analytical independence,” the company said. S&P, Moody’s and Fitch have denied wrongdoing in all suits brought along these lines.

Still, the extent to which a rating firm deserves free-speech protection depends heavily on the facts of a particular rating transaction. And no court, lawyers say, has addressed whether the First Amendment applies specifically to the ratings of mortgage-backed securities, which tend to be rated as discrete issuances for investors as opposed to more general ratings of corporate bonds.

Rating firms, they say, could have a hard time claiming free-speech rights if courts construe their ratings of mortgage-backed securities to be akin to private commercial transactions. “The more it looks like [ratings] firms were hired specifically to do this one rating for this one company…the less likely it is that the First Amendment will be applied,” says Larry Ellsworth, a partner with Jenner & Block LLP and a former litigator at the SEC.

Full post as published by Law Blog - WSJ.com on April 21, 2009 (boomark / email).