U.S. credit raters set back on First Amendment: judge (Reuters)

(Reuters) – A federal judge has said credit ratings are not always protected opinion under the First Amendment, a defeat for credit rating agencies in a lawsuit brought by investors who lost money on mortgage-backed securities.

The November 12 decision was a little-noticed setback for McGraw-Hill Cos' (MHP.N) Standard & Poor's, Moody's Corp's (MCO.N) Moody's Investors Service and Fimalac SA's (LBCP.PA) Fitch Ratings, which have long invoked First Amendment free speech protection to defend against lawsuits over their ratings.

These agencies had argued that the Constitution protected them from claims they issued inflated ratings on more than $5 billion of securities issued in 2006 and 2007, and backed by loans from former Thornburg Mortgage Inc and other lenders.

But the judge said the ratings were shared with too small a group of investors to deserve the broad protection sought.

"The court rejects the rating agency defendants' arguments that the First Amendment provides any protection to them under the facts of this case," U.S. District Judge James Browning in Albuquerque, New Mexico, wrote in a 273-page opinion.

Browning nonetheless dismissed claims accusing Moody's and Fitch, but not S&P, of misrepresentations, saying the investors did not adequately allege that the two agencies did not believe their ratings, or knowingly concealed their inaccuracy.

He also said federal law preempts some arguments that the investors used to recover under New Mexico securities law.

The judge said the investors may file an amended complaint, which had sought class-action status. If the state law claims went forward, it could provide an avenue for investors to go after the agencies in other states.

Browning had denied the agencies' motion to dismiss the complaint on September 30, without giving reasons.

S&P, in a statement, called the First Amendment ruling "inconsistent" with other court rulings. Fitch spokesman Daniel Noonan said that agency is pleased that claims against it were dismissed. Moody's and lawyers for the investors declined to comment or had no immediate comment.

Credit Suisse Group AG (CSGN.VX) and Royal Bank of Scotland Group Plc (RBS.L) are among the other defendants in the case.

Rating agencies have been widely faulted by investors, regulators and Congress for contributing to the global credit and financial crises that began in 2007 by issuing high ratings on debt that did not deserve it.

Thornburg made "jumbo" home loans, larger than $417,000, to borrowers considered good credit risks, but collapsed after margin calls and a plunge in the value of mortgages it held.

The Santa Fe, New Mexico-based lender filed for bankruptcy on May 1, 2009, and is now called TMST Inc (THMRQ.PK).

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Investors led by two pension funds, the Maryland-National Capital Park & Planning Commission Employees' Retirement System, and the Midwest Operating Engineers Pension Trust Fund in Illinois, claimed the agencies issued false and misleading investment-grade ratings for Thornburg securities, and were paid "substantial" sums that compromised their independence.

But Browning said the ratings were distributed only to a "limited group" of investors, not the public at large.

He also said that unlike publicly traded companies, the trusts from which the securities were issued were not "public figures" entitled to more protections.

"The court rejects the rating agency defendants' argument that the First Amendment protections regarding provably false opinions apply to their credit ratings," Browning wrote.

Rating agencies have largely been successful in raising the First Amendment defense.

For example, in September, a federal judge threw out a lawsuit by then-Ohio Attorney General Richard Cordray on behalf of pension funds, and said ratings were "predictive opinions."

In contrast, a Manhattan federal judge, in a 2009 ruling involving Morgan Stanley (MS.N), said the defense does not apply when ratings were provided to a "select group of investors" in a private placement.

S&P has asked the U.S. Securities and Exchange Commission not to file threatened civil charges over its ratings for a 2007 offering, Delphinus CDO 2007-1.

The case is Genesee County Employees' Retirement System et al v. Thornburg Mortgage Securities Trust 2006-3 et al, U.S. District Court, District of New Mexico, No. 09-00300.

(Reporting by Jonathan Stempel in New York; Editing by Tim Dobbyn)

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Facts, Figures About Federal Income Tax and the 16th Amendment (ContributorNetwork)

On Feb. 3, 1913, Congress ratified the 16th Amendment to the Constitution, allowing the government to tax individual incomes. Delaware, Wyoming and New Mexico were the last three states to approve the amendment.

To commemorate the 98th anniversary of that day, here's a taxing look back at the history of the federal income tax:

* Civil War expenses prompted the first real federal income tax. In 1861, President Abraham Lincoln signed the Revenue Act of 1862 into law, which also created the Bureau of Internal Revenue.

* Income taxes were unpopular from the very beginning, prompting a repeal in 1872.

* In 1894, the Wilson-Gorman Tariff Act revived the federal income tax and created an income tax division within the Bureau of Internal Revenue. The Supreme Court declared this new income tax unconstitutional in 1895.

* President William Howard Taft first recommended a constitutional amendment for a federal income tax in 1909.

* After the 16th Amendment was ratified in 1913, the first 1040 form appeared. Individual taxpayers with incomes above $3,000 paid a one percent flat tax.

* April 15 was not always the day when taxes were due. After ratifying the 16th Amendment to the Constitution, Congress originally chose March 1 as the deadline for filing returns. The date was moved to March 15 five years later and, in 1955, April 15 became the tax filing deadline.

* During World War I, the top taxpayers paid a whopping 77 percent to help fund the war effort.

* Legendary gangster Al Capone was a slippery character to catch, but the U.S. Treasury Department finally brought him down. In 1931, Capone pled guilty to tax evasion charges, which was the beginning of the end of his reign of terror.

* Electronic tax return filing has made life easier, especially on the trees. In 2006, the Internal Revenue Service issued a press release about the nation's largest tax return. On paper, General Electric's return would have filled an estimated 24,000 pages, but the 237 megabyte electronic return was uploaded within an hour.

* Richard Hatch may have been the last one standing on the original edition of "Survivor," but the I.R.S. was the true winner. In 2006, Hatch was convicted of failure to pay taxes on his winnings.

* Speaking of tax evasion, each year, protest groups argue that the 16th Amendment is unconstitutional because it was not ratified by all states. In truth, an amendment does not have to be ratified by all 50 states, so a tax protest is still tax evasion.

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