Court Finds Rating Agencies Not Liable on Toxic Mortgages

Major credit rating agencies won a fresh legal victory on Monday when a federal appeals court rejected a lawsuit by Ohio pension funds that sought to recoup millions of dollars of losses on risky mortgage debt they said were based on flawed, inflated ratings.

The 6th U.S. Circuit Court of Appeals in Cincinnati upheld the September 2011 dismissal of the lawsuit against Moody’s Investors Service, Standard & Poor’s and Fitch Ratings.

Investors, regulators and politicians have criticized the agencies for exacerbating the housing and financial crises by awarding high ratings to risky debt that soon turned toxic. The agencies have long said their ratings were protected opinions under the First Amendment to the U.S. Constitution.

Five pension funds led by the Ohio Police & Fire Pension Fund said they lost $457 million by having made 308 investments in mortgage debt between Jan. 1, 2005, and July 8, 2008, relying on “triple-A” ratings that proved “unfounded and unjustified.”

The three-judge appeals court panel unanimously ruled that the Ohio funds failed to show that the agencies should be liable under various Ohio laws, or for acting negligently in misrepresenting their ratings.

“Based on publicly available information describing the agencies’ business practices, the funds draw the inference that the agencies did not believe in the correctness of their ratings with respect to any mortgage-backed securities the funds purchased over a three-year period,” Circuit Judge Julia Smith Gibbons wrote for the panel. “That inference is an unreasonable one.”

Eve Mueller, a spokeswoman for Ohio Attorney General Mike DeWine, who represents the pension funds, said the office is reviewing the decision.

S&P spokesman Ed Sweeney and Fitch spokesman Daniel Noonan said their agencies were pleased with the decision. Moody’s spokesman Michael Adler did not respond to requests for comment.

CONFLICTS OF INTEREST

The case was originally brought in November 2009 by then-state Attorney General Richard Cordray, who is now the director of the federal Consumer Financial Protection Bureau.

His lawsuit also said the business model by which debt issuers pay for ratings created conflicts of interest, and that agencies conspired with issuers to inflate ratings.

The appeals court upheld a ruling by U.S. District Judge James Graham in Columbus, Ohio, who agreed with the agencies that their ratings were “predictive opinions.”

It also left intact Graham’s dismissal of the case with prejudice, meaning it cannot be brought again.

Moody’s Corp. owns Moody’s Investors Service, McGraw-Hill Cos. owns Standard & Poor’s, and Fitch is part of France’s Fimalac SA.

Despite a series of court rulings in their favor, the practices of rating agencies remain under scrutiny.

In an annual examination required under the 2010 Dodd-Frank Act, the U.S. Securities and Exchange Commission last month said some agencies have not properly disclosed methodology changes or were slow to follow their own policies on downgrades.

Moody’s shares closed up 40 cents at $48.98 in Monday trading, while McGraw-Hill shares rose 33 cents to $53.44.

The case is Ohio Police & Fire Pension Fund et al v. Standard & Poor’s Financial Services LLC et al, 6th U.S. Circuit Court of Appeals, No. 11-4203.

Topics USA Agencies Ohio