American Signature, Inc. v. Moody's Investors Services, Inc.

Background

American Signature, Inc. and SEI, Inc. alleged that Moody’s Investors Services, Inc. and Standard & Poor’s Financial Services, LLC, along with The McGraw-Hill Companies, Inc., assigned falsely high ratings to certain auction rate securities. The plaintiffs alleged that they followed a conservative investment policy, relied on the agencies’ high ratings, and instructed their former investment adviser to purchase highly rated securities. They claimed that the securities later became essentially worthless, causing tens of millions of dollars in losses.

The plaintiffs asserted claims under Section 10(b) of the Securities Exchange Act and Rule 10b-5, common-law fraud, negligent misrepresentation, Ohio securities laws, and a claim seeking declaratory relief concerning the First Amendment. The defendants moved to dismiss under Federal Rules of Civil Procedure 12(b)(1), which addresses jurisdiction and standing, and 12(b)(6), which addresses whether a complaint adequately states a legal claim.

Standing

The defendants argued that the plaintiffs lacked standing because their losses were not fairly traceable to the rating agencies’ conduct and because the plaintiffs had not alleged a sufficient injury. The court rejected that argument. It held that the plaintiffs had adequately pleaded standing because they alleged that they bought the allegedly improperly rated securities, that the securities lost value, and that the loss was connected to the alleged misrepresentations. The court emphasized that the standard for pleading standing is less demanding than the standard for proving that the defendants caused the investment losses.

Fraud-based claims

The court dismissed the federal and common-law fraud claims. It explained that credit ratings are opinions about a security’s creditworthiness. To plead fraud based on such an opinion, a plaintiff must allege that the rating agency did not actually believe the opinion when it issued the rating and that the rating was false or misleading about the subject it addressed.

The court concluded that the complaint did not meet that requirement. The plaintiffs alleged that the agencies used outdated or flawed models, faced financial pressure to issue favorable ratings, had conflicts of interest, helped structure securities, and knew about problems in the mortgage market. The court characterized these allegations as general or conclusory. In its view, they might suggest poor methods, negligence, conflicts, profit motives, or hindsight criticism, but they did not specifically show that either agency disbelieved a particular rating at the time it was issued.

The court also considered statements by agency personnel, government reports, internal emails, and other materials cited by the plaintiffs. It concluded that these materials showed general awareness of mortgage-market problems or pressure to prioritize business interests, but did not establish contemporaneous disbelief in the assigned auction rate security ratings. Because the complaint did not plausibly allege an actionable false statement, the court dismissed the fraud-based claims without reaching the defendants’ other arguments concerning reliance, loss causation, the statute of limitations, scienter, or First Amendment protections for opinions.

Negligent misrepresentation

The court dismissed the negligent misrepresentation claim under both New York and Ohio law. Under New York law, the claim required a special relationship involving direct contact or a relationship close to a contract. The plaintiffs conceded that their complaint did not allege the necessary contact with the rating agencies.

Under Ohio law, the plaintiffs needed to allege a special relationship in which the agencies supplied information for the guidance of a specific person or limited group. The court found that the securities had been marketed widely and broadly, including to retail businesses such as the plaintiffs. It therefore concluded that the plaintiffs were not members of a limited class and could not establish the required duty of care.

Ohio securities-law claims

The court also dismissed the Ohio Blue Sky Law claim. It held that the defendants were not sellers of the securities and that the complaint did not allege that their fees were contingent on an actual sale. Alleging that investment banks and issuers paid the defendants for rating services did not establish that the defendants received profits from the sale of the securities to the plaintiffs’ former investment adviser.

The court further held that the complaint did not allege the required underlying violation by a seller for the plaintiffs’ claim under another Ohio provision. As to the Ohio provisions concerning knowingly false statements, the court found that the complaint did not adequately allege that the defendants knowingly made false representations to sell securities in Ohio or that they disbelieved their ratings when issued.

Disposition

The court granted the defendants’ motion to dismiss the First Amended and Supplemented Complaint. Judge Gardephe did not reach the defendants’ remaining alternative arguments concerning preemption, the statute of limitations, or the First Amendment.