MANHATTAN (CN) – The 2nd Circuit axed three class action securities fraud complaints against the rating agencies Moody’s Investors Service, Standard & Poor’s and Fitch Ratings, finding that the AAA ratings the agencies assigned to risky mortgage-backed securities just before the financial crisis were merely expert opinions, rather than acts of underwriting.
In a unanimous decision, the three-judge panel upheld the dismissal of class action complaints filed by a group of unions, the Wyoming Retirement System and a holding company, Vaszurele Limited, agreeing with District Judge Lewis Kaplan that the rating agencies were not underwriters and had no actual control over the ultimate ratings banks assigned to securities.
“Because these three appeals raise common questions of law, we dispose of them in a single opinion, Circuit Judge Reena Raggi wrote in a 42-page decision.
The plaintiffs claimed that the agencies served as underwriters, structuring securities in misleading ways and caving to market pressure by banks that awarded their business to the rating agency that issued the highest number of the AAA ratings denoting the safest investments.
But Judge Raggi wrote that the Securities Exchange Act “limits liability to persons who participate in the purchase, offer, or sale of securities for distribution. While such participation may be indirect as well as direct, the statute does not reach further to identify as underwriters persons who provide services that facilitate a securities offering, but who do not themselves participate in the statutorily specified distribution-related activities.”
The judge said that the Securities Exchange Act excluded “a number of persons necessary to the creation of securities, such as banks that originated the underlying loans, traders who structured the transactions or experts who did not consent to being named.”
Expanding liability under the law would “render these narrowly drawn categories meaningless,” Raggi wrote.
The judge also rejected the claim that the agencies acted as underwriters, writing that the agencies are “classically evaluated under the ‘expert’ provision” of the statute.
“The rating issued by a Rating Agency speaks merely to the Agency’s opinion of the creditworthiness of a particular security,” Raggi wrote. “Indeed, each offering document explained that the assigned credit rating was ‘not a recommendation to buy, sell or hold securities and may be subject to revision or withdrawal at any time.'”
And Raggi said there was no evidence that the agencies were in control of the ratings actually assigned to securities.
“Providing advice that the banks chose to follow does not suggest control,” Raggi wrote.
Nor did the agencies have a voice in the banks’ policies, according to the opinion. The classes’ claims “do not support any inference that the rating agencies had the power to direct the primary violators’ policies,” Judge Raggi wrote.
The judge maintained that the dismissal will not shield ratings agencies from all securities fraud allegations.
“Contrary to plaintiffs’ assertion, this conclusion will not absolve rating agencies of all liability for their roles in fraudulent securities offerings,” the decision states. “As plaintiffs acknowledged at oral argument, they may bring securities fraud claims against the Rating Agencies pursuant to § 10(b) of the Securities Exchange Act of 1934.”