A federal court in the Ninth Circuit has ruled in an important recent case, that debt ratings issued by rating agencies are not financial advice, and reaffirmed that such ratings are speech that is constitutionally protected under the First Amendment. The court confirmed that rating agencies act as independent evaluators of the creditworthiness of specific debt issues, not as advisors to the issuer of such debt. County of Orange v. The McGraw-Hill Companies, d/b/a Standard & Poor's Ratings Services, United States District Court, Central District of California, Case No. SACV 96-0765. This principle allows rating agencies to continue to perform their vital role in the securities markets vis-a-vis investors, issuers, securities professionals and financial advisors, in analyzing and reporting on the ability and willingness of issuers to repay their debt obligations.
In June 1996, one-and-a-half years after Orange County declared bankruptcy, the County sued Standard & Poor's, a publisher and leading rating agency, claiming its 1993 and 1994 ratings of the County's notes and bonds were too high. The suit was one of many filed by Orange County seeking recovery of its investment losses; in addition to Standard & Poor's, Orange County sued broker-dealers, financial advisors, accountants, bond counsel and others. Orange County's theory against Standard & Poor's was that the ratings given to 11 of the County's debt issues in 1993 and 1994 were allegedly "too high," and allowed County Treasurer Robert Citron to pursue his risky investment strategy with the proceeds of those debt issues. Orange County's investment strategy, in turn, ultimately led to its financial meltdown in December 1994.
Orange County attempted to characterize Standard & Poor's as its advisor who could be held liable on the same basis as any other "financial professional." The County contended Standard & Poor's was liable for the consequences of allegedly erroneous "advice" in the form of ratings -- including its bankruptcy and more than $1.8 billion in investment losses and damages.
Standard & Poor's vigorously challenged Orange County's charges on the grounds that Standard & Poor's -- a publisher of ratings, commentary and other financial information -- is not an advisor. While Standard & Poor's issues public finance ratings on request and for a fee, those same ratings are published in Standard & Poor's publications such as CreditWeek and CreditWire, its online service, and widely disseminated in the media. The securities markets look to Standard & Poor's published ratings as unbiased and independent opinions as to the likelihood that a particular debt will be repaid to investors.
In essence, Orange County's suit challenged the independent role of rating agencies -- and that challenge was soundly defeated. In an April 21, 1999 ruling, the District Court Judge rejected Orange County's claims that the ratings were "financial advice" to the County and subject to ordinary negligence and breach of contract liability. Instead, the Court found that Standard & Poor's ratings were published speech on a matter of public concern and therefore protected by the First Amendment. The ratings could be the basis of liability only if Orange County proved by clear and convincing evidence that Standard & Poor's acted with "actual malice" -- that is, knowledge that the ratings were false - or reckless disregard of their truth or falsity. This ruling established an extremely onerous burden for Orange County to meet in its attempt to recover damages from Standard & Poor's.
Following the District Court's ruling, the Ninth Circuit Court of Appeals refused to permit an expedited appeal and, in June 1999, Orange County agreed to dismiss its $2 billion-plus lawsuit against Standard & Poor's in exchange for the nominal sum of $140,000, namely, a partial refund of rating fees paid by Orange County during 1994.
The Orange County suit against Standard & Poor's is emblematic of the continuing efforts of plaintiffs in commercial litigation -- and particularly securities litigation -- to find new ways to expand the liability of professionals for losses due to allegedly defective disclosures and professional opinions. Orange County's attempt to add rating agencies to the list of defendants typically sued in such cases ultimately fell short because, as the District Court found, rating agencies do not -- through their published ratings of debt -- provide financial advice or services to the issuers of such debt. The result in the Orange County litigation against Standard & Poor's has clarified both the independence of rating agencies in the securities markets, and the role of ratings as protected speech under the First Amendment.