Shareholders Can Inspect Credit-Rating Records

(CN) - Already mired in multiple lawsuits accusing its credit-rating subsidiary, Standard & Poor's, of issuing fraudulently rosy ratings of mortgage-backed securities, McGraw-Hill has a newly emboldened shareholder action to worry about.

The action brought by the Retirement Plan for General Employees of the City of North Miami Beach alleges that S&P gave favorable ratings to residential mortgage-backed securities, collateralized debt obligations and other complex mortgage-related financial products despite the company's senior managers knowing the integrity of the investments was undermined by lax lending standards, failing loans and mortgage fraud.

The shareholder action, in line with the other lawsuits pending against S&P and its parent company, alleges that the credit rating agency issued inflated ratings, despite growing concerns about the mortgage-backed securities, because the issuers of the securities were clients for other services offered by S&P.

According to the retirement fund's suit, as summarized by the appellate panel in Manhattan, "McGraw-Hill's management directed S&P to further provide optimistic credit ratings in an effort to attract more business from the issuers and gain more revenue from those issuers' complex securities."

The suit further alleges that "the mortgage-related securities at the heart of the meltdown would not have been marketed and sold without S&P's high ratings, none of which accurately reflected the securities' actual risk. Petitioners assert that the rosy credit ratings, which S&P knew to be false, encouraged investment in toxic securities, thus helping to trigger the financial crisis of 2008."

In support of its petition to inspect documents of the McGraw-Hill board concerning mortgage-backed securities, the pension fund cited New York common law and a Business Corporation Law section that gives shareholders a right to inspect corporate records. The company responded that the statute allows shareholders to obtain only a list of shareholders, shareholder meeting minutes, and profit and loss statements.

New York County Supreme Court Justice Jeffrey Oing agreed with McGraw-Hill last year that the document request was overbroad and denied the shareholder's petition. Oing ruled that if the retirement fund wanted access to the board's records, it should have first made a demand on the board, and if that demand had been rejected, the fund should have commenced a shareholders' derivative action.

A five-justice appellate panel for the Appellate Division's First Department disagreed Thursday. "Under New York law, shareholders have both statutory and common-law rights to inspect a corporation's books and records so long as the shareholders seek the inspection in good faith and for a valid purpose," the unsigned ruling states.

"Here, petitioners sufficiently showed that they were acting in good faith and for a proper purpose... Specifically, the petition alleges that petitioners seek to investigate alleged mismanagement and breaches of fiduciary duty by respondent's board of directors in failing to oversee purported wrongdoing by S&P; this alleged wrongdoing, petitioners assert, exposed respondent to substantial potential liability in multiple civil actions and investigations," the justices added. "These allegations form a proper basis for petitioners' request."

A hearing was needed to determine exactly which records are "relevant and necessary for petitioners' purposes," and to determine the proper scope of discovery before McGraw-Hill will be required to turn over the board's records, the panel added.

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