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).

LIMITED DISTRIBUTION

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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SEC could file civil charges against some raters: report (Reuters)

(Reuters) – U.S. regulators could file civil fraud charges against some credit rating agencies, and settle with more Wall Street banks, for their role in developing mortgage-bond deals that helped trigger the financial crisis, the Wall Street Journal reported, citing people familiar with the matter.

The inquiry into the rating agencies broadens the U.S. Securities and Exchange Commission's (SEC) probe into the sales and marketing of mortgage-bond deals by several financial firms, the paper said.

It said other firms being probed by the SEC include JP Morgan, Citigroup, Morgan Stanley, Bank of America's Merrill unit and UBS AG.

The SEC was also reviewing the conduct of McGraw Hill's Standard & Poor's, and Moody's Investors Service, owned by Moody's Corp, on at least two mortgage-bond deals, the paper said.

JP Morgan is expected to settle within weeks allegations related to its sale of a $1.1 billion mortgage-bond investment as the market collapsed in early 2007, the paper said.

JP Morgan declined to comment to Reuters on any settlement of the collateralized debt obligations (CDOs).

Mortgage-backed securities and CDOs were at the heart of the financial crisis. Wall Street banks vacuumed up home loans, often subprime mortgages, and repackaged them into bonds and other securities that were sold with top-notch credit ratings.

When the U.S. housing market crashed, the securities plummeted in value, generating enormous losses for investors around the world.

Last year, Goldman Sachs settled civil fraud charges with the SEC for about $550 million regarding its role in marketing a subprime mortgage product.

The Journal said JP Morgan and most other banks facing fraud allegations are expected to agree to pay about half or less than the $550 million paid by Goldman.

The paper said a Standard & Poor's spokeswoman declined to comment, and it quoted Michael Adler, a spokesman for Moody's, as saying: "Although Moody's is uncertain as to what The Wall Street Journal is referring, we would certainly cooperate with any requests we receive from the SEC."

Reuters could not immediately reach Standard & Poor's or Moody's for comment. The SEC declined to comment.

The SEC is considering whether the credit ratings firms failed to do enough research to be able to rate adequately the pools of subprime mortgages and other loans that underpinned the mortgage-bond deals, the paper said.

The SEC last month sought public comment on proposals that the credit rating agencies needed to reveal more about how they judge financial products and how those ratings perform over time.

(Reporting by Vaishnavi Bala and A. Ananthalakshmi in Bangalore; Editing by Hans-Juergen Peters and Ian Geoghegan)

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Credit raters triggered financial crisis: panel (Reuters)

By Rachelle Younglai and Sarah N. Lynch Rachelle Younglai And Sarah N. Lynch – Thu Apr 14, 8:00 am ET

WASHINGTON (Reuters) – Moody's Corp and Standard and Poor's triggered the worst financial crisis in decades when they were forced to downgrade the inflated ratings they slapped on complex mortgage-backed securities, a U.S. congressional report concluded on Wednesday.

In one of the most stark condemnations of the credit rating agencies, a Senate investigations panel said the agencies continued to give top ratings to mortgage-backed securities months after the housing market started to collapse.

The agencies then unleashed on the financial system a flood of downgrades in July 2007, the panel said.

"Perhaps more than any other single event, the sudden mass downgrades of (residential mortgage-backed securities) and (collateralized debt obligation) ratings were the immediate trigger for the financial crisis," the staff for Senators Carl Levin and Tom Coburn wrote in their report.

The findings come after the Senate's Permanent Subcommittee on Investigations spent two years poring over countless documents and holding hearings on the causes of the crisis. The probe only focused on the two largest rating agencies; it did not study Fitch Ratings.

The report calls for radical reforms to the industry that are authorized in last year's Dodd-Frank financial reform law, but may not be realized.

Dodd-Frank did little to change what some say is an inherent conflict of interest in credit raters' business model, in which the raters are paid by the companies whose products they rate.

The panel's suggested reforms include having the U.S. Securities and Exchange Commission rank the credit raters, based on the accuracy of their ratings.

"WATCHING A HURRICANE"

The Senate panel released internal documents showing how Moody's and S&P failed to heed their own internal warnings about the deteriorating mortgage market.

Emails in 2006 and early 2007 show employees were aware of housing market troubles, well before the massive downgrades in July 2007.

"This is like watching a hurricane from FL (Florida) moving up the coast slowly toward us. Not sure if we will get hit in full or get trounced a bit or escape without severe damage ..." one S&P employee wrote in response to an article on the mortgage mess.

Senate investigators concluded that had Moody's and S&P heeded their own warnings, they might have issued more conservative ratings for the securities linked to shoddy mortgages.

"The problem, however, was that neither company had a financial incentive to assign tougher credit ratings to the very securities that for a short while increased their revenues, boosted their stock prices, and expanded their executive compensation," the report said.

Edward Sweeney, a spokesman for S&P, said in a statement on Wednesday that the Dodd-Frank Act, coupled with the company's own internal reforms, have significantly strengthened the oversight of the industry. He added that the 2007 and 2008 downgrades "reflected the unprecedented deterioration in credit quality, but were not a cause of it."

Michael Adler, a spokesman for Moody's, declined to comment ahead of the report's release.

NO REAL CHANGES YET SEEN

The SEC has been grappling with how to clamp down on the conflicts of interest embedded in the so-called "issuer-paid" model. Congress contemplated radical reforms for the agencies during the drafting of the Dodd-Frank law but in the end passed a sweeping financial regulation bill without them.

Wednesday's report includes emails from employees at both companies that illustrate the pressure that raters came under from investment banks.

An August 2006 email reveals the frustration that at least one S&P employee felt about the dependence of his employer on the issuers of structured finance products, going so far as to describe the rating agencies as having "a kind of Stockholm syndrome" -- the phenomenon in which a captive begins to identify with the captor.

The SEC did take some steps to address conflicts of interest at rating agencies in the past few years.

Although the Dodd-Frank law directs the SEC to write numerous additional regulations for raters, most have yet to be proposed.

And one key rule that did go into effect last July, subjecting credit raters to increased liability, was suspended after credit raters' refusal to include their ratings for asset-backed securities led to a freeze in the secondary market.

The reform has not been reinstated.

(With additional reporting by Kim Dixon; Editing by Steve Orlofsky)

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