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Credit-rating firms' shares plunge on subprime-related court ruling

September 3, 2009 |  6:11 pm

Investors who believe that major credit-rating firms should be held responsible for their disastrously optimistic ratings of subprime-mortgage bonds have won at least an interim victory.

U.S. District Judge Shira Scheindlin in New York ruled late Wednesday that Moody’s Investors Service and Standard & Poor’s can’t invoke the 1st Amendment to hide from subprime-related legal challenges.

The decision triggered heavy selling of shares of Moody’s parent Moody’s Corp. and S&P parent McGraw-Hill Cos. on Thursday. Moody’s slid $1.84, or 7%, to $24.26. McGraw-Hill’s shares tumbled $3.30, or 10.2%, to $29.01.

From Bloomberg News:

Scheindlin rejected the firms’ arguments that investors can’t sue over deceptive ratings of private-placement notes because those opinions are protected by free-speech rights.

The decision forces S&P, Moody’s and Morgan Stanley, which was also sued, to respond to fraud charges in a class-action by investors claiming the raters hid the risks of securities linked to subprime mortgages.

Defaults on the debt ignited a credit crisis that has led to more than $1.6 trillion in writedowns and losses since the start of 2007.

"The fate of the major rating companies may be determined by the courts rather than Congress or regulators," said Jerome Fons, a New York-based consultant and former Moody’s managing director for credit policy who left the firm in August 2007. "There are so many suits outstanding, if they lost a major case all bets are off. The floodgates will be open."

Some investors on Thursday were fearing the worst: Trading volume in Moody's and McGraw-Hill soared as the shares plunged.

"It’s the first major ruling upholding fraud allegations against an arranger and the rating agencies on the instruments that are at the heart of the financial crisis," Patrick Daniels, a lawyer at Coughlin Stoia Geller Rudman Robbins LLP, the San Diego-based securities litigation firm that represented investors in the case, told Bloomberg.

The suit was filed by Abu Dhabi Commercial Bank and King County in Washington state.

Still, the judge apparently dismissed most of the plaintiffs’ claims while upholding their right to bring a fraud case. She didn't rule on the merits of the case itself.

From Bloomberg:

Edward Sweeney, a spokesman for S&P in New York, said the company is pleased that Scheindlin dismissed all but one of 11 claims in the suit. "We are confident that we will prevail on the remaining claim," Sweeney said.

"We are pleased that the court dismissed all but one of the claims against Moody’s," said Michael Adler, a spokesman for Moody’s in New York. "We are confident that the remaining claim will be dismissed once the court has been presented with facts, not just plaintiff allegations."

-- Tom Petruno

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