The rating agencies must defend against  claims for negligent misrepresentation in connection with the ratings the firms assigned to a pair of structured investments vehicles, Southern District of New York Judge Shira Scheindlin has ruled in a pair of May 4, 2012 decisions. Judge Scheindlin did grant the defendants’ motions to dismiss claims for negligence, breach of fiduciary duty and aiding and abetting, which substantially narrowed the plaintiffs’ claims.  But she denied the rating agencies’ motions to dismiss with respect to the negligent misrepresentation claims, finding that, based on the plaintiffs’ allegations, the ratings qualified as actionable misstatements under New York law.


Judge Scheindlin issued the opinions in two cases involving structured investment vehicles, one called Rhinebridge and one called Cheyne Financial. Judge Scheindlin’s opinion in the Rhinebridge case can be found here and the opinion in the Cheyne Financial case can be found here.


The background on the Cheyne financial case can be found here. The Rhinebridge case arose out of the Rhinebridge structured investment vehicle’s (SIV) June 27, 2007 offering of certain investment securities to certain Qualified Institutional Buyer and Qualified Purchasers. In connection with the offering, the rating agencies gave the Rhinebridge securities the highest ratings. The plaintiffs also allege that the rating agencies helped structure the investment vehicle. The offering proceeds were invested in a variety of residential mortgage related investments. The SIV was forced into receivership on October 22, 2007, becoming, the plaintiffs alleged, “perhaps the shortest-lived ‘Triple A’ investment fund in the history of corporate finance.”  In addition to the rating agencies, the plaintiff investors had also sued IKB Deutsche Industriebank AG , the bank that sponsored the SIV, and Morgan Stanley, which had acted as offering underwriter.


Judge Scheindlin had originally dismissed the plaintiffs’ common law claims, holding under New York law that the common law claims were preempted by the Martin Act. However, in December 2011, as discussed here, the New York Court of Appeals rejected Martin Act preemption for common law claims, and Judge Scheindlin allowed the plaintiffs leave to amend their pleadings to assert common law claims. After the plaintiffs amended their pleadings the defendants renewed their motions to dismiss.   


In her May 4 ruling in the Rhinebridge case, Judge Scheindlin granted the defendants’ motions to dismiss the plaintiffs’ claims for negligence, breach of fiduciary duty and aiding and abetting. However, she denied the motion to dismiss the plaintiffs’ claims against the rating agencies for negligent misrepresentation.


In denying the motions to dismiss the negligent misrepresentation claims, Judge Scheindlin said that:


the Rating Agencies (1 intended that their ratings would be used to evaluate the SIV; (2) intended that the plaintiffs –members of a select group of qualified investors – would rely in the ratings to evaluate the SIV; and (3) prepared their ratings with the end and aim of inducing investors such as the plaintiffs to invest in the SIV.


Judge Scheindlin’s ruling was specifically dependent on her determination, based on the plaintiff’s allegations, that “there was a privity-like ‘special relationship’ between the plaintiffs and the Rating Agencies.”  Judge Scheindlin also allowed the negligent misrepresentation claims to go forward as to IKB Deutsche Industriebank and Morgan Stanley.


Judge Scheindlin’s ruling in the Cheyne Financial case paralleled her rulings in the Rhinebridge case, and her order in the Cheyne Financial case expressly referenced her rulings in the Rhinebridge case.



Among the causes many cite for the subprime meltdown is the willingness of the rating agencies to assign investment grade rating to securities backed by subprime mortgages. For that reason, in many of the lawsuits filed as part of the subprime litigation wave, plaintiffs have named rating agencies as defendants, seeking to hold them responsible for their investment losses. However, as discussed here, whether the rating agencies could actually be held liable is unclear, because in the past courts have found the rating agencies’ rating opinions to be protected by the First Amendment. The rating agencies have also raised a number of other defenses regarding their rating opinions.


A series of rulings in several cases have questioned the rating agencies’ defenses. As discussed here, in a September 2009 ruling in the Cheyne Financial case, Judge Scheindlin held that, at least where the rating agencies’ ratings were released only to a select group of investors, the rating agencies could not rely on their First Amendment defense. In May 2010, a California state court judge followed Judge Scheindlin in rejecting the rating agencies first amendment defense, as discussed here. In November 2011, in a case involving Thornburgh Mortgage mortgage pass through certificates, District of New Mexico Judge James Browning also rejected the rating agencies first amendment defenses, also relying on Judge Scheindlin’s opinion in the Cheyne Financial case, as discussed here.


Judge Scheindlin’s May 4 rulings arguably represent the latest decisions holding that the rating agencies could at least potentially be held liable for their ratings opinions. However, Judge Scheindlin’s latest rulings, like the prior rulings holding that the rating agencies could not rely on First Amendment defenses, were largely reliant on the fact at that the securities in question had only been distributed to a select group of investors. Indeed, in the Rhinebridge case, Judge Scheindlin found that the plaintiffs had adequately alleged that there was a privity-like relationship between the plaintiff investors and the rating agencies.


The various rulings In these cases, including also Judge Scheindlin’s most recent rulings in the Rhinebridge and Cheyne Financial cases, represent significant developments in connection with investors’ efforts to try to hold the rating agencies liable. However because these rulings are all dependent on the fact that the securities at issue were distributed only to a select group of investors, these rulings may not be helpful in cases involving securities that were more broadly distributed. But though these rulings have limitations, they also represent a growing body of case law on which investors can try to rely in asserting their claims against the rating agencies.


David Bario’s May 7, 2012 Am Law Litigation Daily article discussing Judge Scheindlin’s rulings can be found here.  Special thanks to Dan Newman of SCN Strategies for sending along copies of the opinions.


FCPA-Related Securities Class Action Suit Filed Against Wal-Mart: In yesterday’s post, I noted that CalSTRS had filed a shareholder derivative action against Wal-Mart, as nominal defendant, and certain of its directors and officers, in connection with the revelations concerning the company’s Mexican bribery allegations. Now, in addition to the shareholder derivative lawsuits, investors have also launched a securities class action lawsuit in connection with the bribery allegations.


According to their May 7, 2012 press release (here), the plaintiffs’ lawyers have filed a securities class action lawsuit against the company and certain of its directors and officers in the Middle District of Tennessee. The complaint, which can be found here, features a quote from and even a picture of company founder Sam Walton (allegedly taken from the company’s annual report). According to the press release, the complaint alleges that the defendants “ concealed from the investing public during the Class Period” that “the Company had violated the Foreign Corrupt Practices Act in connection with the bribery payments” and  that  "Walmart management did not address ethical concerns in a ‘timely and effective manner’ as represented by defendants.”


As I said previously about the CalSTRS derivative suit, these lawsuit filings reinforce the view that follow-on civil litigation is an almost invariable accompaniment of FCPA-related investigations, and show that FCPA-related exposures are a matter of serious shareholder concern. Taken collectively, the risk of an FCPA investigation as well of the related follow-on civil litigation risk are increasingly important liability exposures for companies and their directors and officers.