Public Employees' Retirement System v. Moody's Investors Service, Inc. , 226 Cal. App. 4th 643 ( 2014 )

Filed 5/23/14
CERTIFIED FOR PUBLICATION
IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA
FIRST APPELLATE DISTRICT
DIVISION THREE
CALIFORNIA PUBLIC EMPLOYEES’
RETIREMENT SYSTEM,
Plaintiff and Appellant,
v. A134912
MOODY’S INVESTORS SERVICE, INC.
et al., (San Francisco County
Super. Ct. No. CGC-09-490241)
Defendants and Appellants.
This is an appeal from an order denying the special motion to strike of defendants
Moody’s Investors Service, Inc., Moody’s Corporation and The McGraw-Hill
Companies, Inc. (collectively, Rating Agencies or defendants)1 against plaintiff
California Public Employees’ Retirement System (CalPERS) pursuant to the so-called
anti-SLAPP statute (Code Civ. Proc., § 425.16).2 The trial court reached this decision
after finding that, although CalPERS’ complaint was indeed based upon conduct by the
Rating Agencies falling within the scope of the anti-SLAPP statute, dismissal at this stage
would be improper because CalPERS successfully demonstrated a probability of
prevailing on the merits of its sole claim of negligent misrepresentation. According to
1
Defendant The McGraw Hill Companies, Inc. owns one of the Rating Agencies,
Standard & Poor’s, referred to herein as “S&P’s.” Defendants Moody’s Investors
Service, Inc. and Moody’s Corporation are referred to collectively herein as “Moody’s.”
Also named in the complaint are Fitch, Inc., Fitch Group, Inc., and Fitch Ratings LTD,
which are not parties to this appeal.
2
Unless otherwise stated, all statutory citations herein are to the Code of Civil
Procedure.
1
the Rating Agencies, the trial court’s finding of a probability of prevailing on the merits
is erroneous.
CalPERS, in turn, cross-appeals to challenge the trial court’s initial finding that its
complaint was based upon conduct falling within the scope of section 425.16, arguing
that it seeks to hold the Rating Agencies liable for its private, commercial activities rather
than for any constitutionally-protected activities. In addition, CalPERS challenges as
arbitrary the trial court’s ruling to exclude from the record certain of its documentary
evidence (to wit, six exhibits) relating to the Agencies’ rating activities.
For reasons set forth below, we affirm the trial court’s order in its entirety, having
concluded that, at this early stage of the proceedings, dismissal pursuant to the anti-
SLAPP statute is not warranted.
FACTUAL AND PROCEDURAL BACKGROUND
On July 9, 2009, CalPERS, the largest state public pension fund in the United
States, filed a complaint against the Rating Agencies asserting causes of action for
negligent misrepresentation and negligent interference with prospective economic
advantage. The complaint challenged the veracity of the Rating Agencies’ assignment of
highly favorable credit ratings to three structured investment vehicles (SIVs) that
ultimately collapsed, causing billions of dollars in losses to CalPERS and other investors.
According to the complaint, in 2006 and early 2007, CalPERS, through its agents,
invested approximately $1.3 billion of its assets in medium-term notes and commercial
paper issued by these SIVs after the Rating Agencies assigned the debt their highest
“AAA” or equivalent ratings. When the SIVs subsequently entered bankruptcy or
receivership in 2007 or 2008, CalPERS lost “hundreds of millions, and perhaps more
than $1 billion.”
As this summary of the complaint reflects, proper understanding of CalPERS’
allegations requires proper understanding of two things: the SIV entity and its
relationship to the Rating Agencies. A SIV is a type of special-purpose investment entity
usually formed by a major commercial bank or investment management company that
has but one business activity – to wit, issuing debt. The SIV, through its asset manager,
2
purchases mainly medium- and long-term assets for its portfolio with money raised by
issuing highly-rated short-term commercial paper and medium-term notes, as well as less
highly-rated junior notes. The SIV then generates profits based on the “leveraged
spread” between the lower yields the SIV pays to the noteholders for its funding and the
higher yield the SIV earns from holding the longer-term assets. SIVs generally have a
structural hierarchy of liabilities, the most senior component of which is the commercial
paper and medium-term notes and the most junior component of which is the “capital
notes” or junior medium-term debt. Losses incurred by a SIV are first absorbed by this
junior debt.
According to the complaint, “[t]he assets which make up SIVs are typically
represented in offering materials to be mostly highly-rated asset-backed securities from
many sectors: financial, auto loans, student loans, credit card loans, home equity loans,
residential mortgage-backed securities (‘RMBS’), commercial mortgage-backed
securities, and other structured finance products like collateralized debt obligations
(‘CDOs’) and collateralized loan obligations (‘CLOs’).” And the Rating Agencies, of
course, are the institutions that provide credit ratings for the notes issued by the SIVs.
As a general matter, these ratings represent an Agency’s assessment of the
likelihood that a SIV noteholder will be paid the expected amount of principal and
interest through the note’s maturity date. Before assigning a particular rating, the Rating
Agency conducts detailed research and risk analysis with respect to the SIV notes. The
Rating Agency, among other things, reviews the results of “various structural tests” run
by the SIV’s manager to determine whether the SIV would, if the need arose, possess
adequate capital, collateral and liquidity to cover a particular period of maturities without
having to sell its underlying assets.3
Once a rating is given, it is published in the SIV’s offering materials made
available to potential investors. Pursuant to federal law, SIV debt securities cannot be
3
As CalPERS explains: “In the event that one or more of these tests were breached,
and not remedied within the relevant cure period, this would constitute an ‘enforcement
event’ that would trigger the wind-down of the vehicle.”
3
sold to the general public, but only through private placements to two categories of
investors: Qualified Institutional Investors (QIBs) and Qualified Purchasers (QPs). (See
S.E.C. Rule 144A, 17 C.F.R. § 230.144A(a); 15 U.S.C. § 80a-2(a)(51)(A).) CalPERS is
one of the limited number of investors qualifying as both a QIB and QP.
Aside from their inclusion in the SIV offering materials, the ratings were also
disseminated more broadly by the Rating Agencies. Generally, when a rating is given,
the Agencies post information about the rating in the form of an article on their websites
and distribute it to financial reporting services such as Bloomberg and Reuters.4 These
articles not only identify the Agency’s rating for a particular note, but also provide
detailed commentary regarding the rating methodology and factual basis. The Rating
Agencies’ websites and articles, as well as the offering materials relevant to this case,
also carry cautionary language informing readers that, among other things, ratings are the
subjective views of the assigning agency rather than statements of fact; are not a
recommendation to buy, sell or hold a particular security; and may be subject to revision,
suspension or withdrawal at any time. Readers are further cautioned to undertake
independent study and evaluation of the rated security before deciding whether to invest.
In many ways, the Rating Agencies’ involvement in the issuance of SIV debt
mirrored their involvement in the issuance of more traditional corporate and municipal
bonds. For example, the Agencies charged the SIVs a fee for rating their debt, just as
they do other corporate or municipal entities. In addition, the Agencies disseminate the
SIVs’ ratings and accompanying commentary on its websites and to other reporting
services, just as they do other bond ratings. However, in certain key regards, the
Agencies’ relationship with the SIVs was unique.5 According to the complaint, in the
4
A Rating Agency generally publishes its rating and accompanying commentary on
its free public website for a period of several days, after which the information remains
accessible on the agency’s subscription-based website. Relevant here, CalPERS
maintained subscriptions with each of the Rating Agencies, and thus had a right to access
the subscription-based websites.
5
Only 28 SIVs were ever created, a few as far back as the late 1980s but most after
2000. In the period from 2005 to 2007 alone, the quantity of assets held by SIVs
4
case of SIVs, and in particular the SIVs at issue in this lawsuit, the Ratings Agencies
played a much more active role by actually assisting the issuer in structuring the SIV
product in advance of rating it with the mutual goal that the product would have credit
characteristics worthy of a high rating. In addition, the Rating Agencies were actively
involved in the creation of the structured finance assets, like RMBS and CDOs, held by
the SIVs. Often, the SIV’s payment of Agency fees was contingent on its notes being
offered to potential investors, which, according to CalPERS, would not occur unless the
notes earned an “investment grade” rating, generally considered any rating of AAA, A or
BBB.6 As such, “the Rating Agencies had . . . every incentive to give high ‘investment
grade’ ratings, or else they wouldn’t receive their full fee” – which, CalPERS says, was
an inherent conflict of interest.7
It is the nature of the Rating Agencies’ role in the SIV market that lies at the heart
of CalPERS’ lawsuit. Specifically, CalPERS alleges that, with respect to the three
collapsed SIVs that caused its enormous investment losses – identified as Sigma, Inc.
(Sigma), Stanfield Victoria, Ltd. (Stanfield) and Cheyne Finance, LLC (Cheyne) – the
Rating Agencies helped structure not just the SIVs themselves, but also the structured-
finance securities that made up their portfolios. 8 Moreover, at least two of these three
SIVs had portfolios of over 50 percent RMBSs and CDOs that, according to CalPERS,
were “stuffed full of toxic, subprime mortgages, home equity loans, and other types of
increased from $173 billion to nearly half a trillion dollars. None, however, survive
today.
6
Notes rated below BBB are considered sub-investment grade or “junk.”
7
According to the complaint, “[s]tructured finance increasingly became Moody’s
dominate source of income.” Rating a typical SIV generated fees of about $300,000 to as
much as $1 million, on top of the fees already generated by rating the SIV’s underlying
assets. “By contrast, rating a traditional municipal bond of an equivalent size would have
generated only [about] $50,000 in fees.”
8
Sigma was formed in 1995 by Gordian Knot, a London-based investment
management company. Stanfield was formed in 2002 by New York-based Ceres Capital,
a majority stake of which was bought the same year by New York-based Stanfield
Capital Partners LLC. Cheyne, in turn, was formed in 2005 by Cheyne Capital
Management (UK) LLP, a London-based hedge fund management company.
5
structured-finance securities linked to subprime mortgages.” Nonetheless, the $1.3
billion in commercial paper and medium-term notes that CalPERS’ agents purchased
from the SIVs were all rated AAA or the equivalent by one or more of the Rating
Agencies.9 According to CalPERS, those ratings, on which it relied, were negligent
misrepresentations.10
At the time, the Agencies justified their ratings based on the purportedly high
quality of the assets purchased by the SIVs (the exact make-up of which was kept
confidential), and on the internal structural mechanisms designed to ensure minimum
capital levels were maintained to protect SIV investors. CalPERS, however, alleges the
Rating Agencies lacked reasonable grounds for such high ratings. Specifically, CalPERS
contends the Rating Agencies used flawed and incomplete methodologies that failed to
adequately capture market risk, with the result that the SIV ratings were inflated.11 In
9
Specifically, until at least August 2007, defendant S&P issued a AAA/A-1+ rating
to all three SIVs and defendant Moody’s issued them each a Aaa/P-1 rating. According
to the complaint, these credit ratings are the highest assigned by each agency for long-
term debt.
10
As discussed in more detail below, CalPERS acknowledges that, when these
purchases were made on its behalf by authorized agents eSecLending, LLC (eSec) and
Credit Suisse First Boston (CSFB), it was unaware of the transactions or of the ratings
that had been ascribed to the SIVs by the Rating Agencies.
11
The complaint explains that the Rating Agencies created or approved structural
tests to measure the SIVs’ default risk that were “critically flawed” because they did not
take into account the “foreseeable scenario” that, if the market soured, the SIVs would be
unable to fund itself by either “rolling” more commercial paper or by liquidating the
assets in their portfolios, causing their collapse. It further explains that the Agencies
created or approved investment parameters that permitted the SIVs’ portfolios to become
overly concentrated in assets of the same class, industry and geographic region
(particularly the RMBSs), making them more susceptible to loss. At the same time, it is
alleged the Agencies, when rating the RMBSs and CDOs that made up the SIVs’
portfolios, used similarly faulty models and inadequate asset correlation values, and
failed to account for key risk factors such as the deterioration of loan origination
standards for subprime and other mortgage loans and increased default rate for subprime
and exotic mortgages as compared to traditional mortgages. The Agencies then relied on
the artificially high ratings of the SIVs’ underlying assets to assess the overall
6
addition, CalPERS contends market pressures from two sources – to wit, the contingent
nature of the Rating Agencies’ fee arrangement with the SIVs and the “market share war”
among themselves – led the Agencies to employ increasing lax rating standards to ensure
SIV products could be issued, thereby prompting a “race to the bottom.” In fact,
CalPERS contends: “High credit ratings were critical to the SIVs’ existence.” Without
the high ratings indicating stable financial returns, the SIVs would not have attracted
buyers, like CalPERS, with institutional policies restricting note purchases to investment
grade products. In other words, CalPERS alleges, had the Rating Agencies not given
their highest ratings to Cheyne, Stanfield and Sigma, it would not have purchased their
debt issues and suffered the significant investment losses when, in 2007 and 2008, the
SIVs suffered a series of downgrades and were eventually forced to wind down.
Thus, the underlying complaint, to which the Rating Agencies demurred, was
filed.12 The trial court overruled the demurrer as to negligent misrepresentation and
sustained with leave to amend the demurrer as to negligent interference with prospective
economic advantage. However, CalPERS elected not to amend its claim for negligent
interference with prospective economic advantage, leaving only negligent
misrepresentation. The Ratings Agencies, in turn, petitioned for writ of mandate seeking
review of the trial court’s ruling on demurrer with respect to negligent misrepresentation;
however, this Court denied their petition. (Moody’s Investor Services, Inc. v. Superior
Court, No. A128793 (June 29, 2010).)
Subsequently, on October 4, 2010, the Rating Agencies filed the special motion to
strike under the anti-SLAPP statute at the heart of this appeal. Through their motion, the
Rating Agencies asked the trial court to dismiss CalPERS’ lone claim for negligent
misrepresentation on the grounds that it is based on activities in furtherance of their right
of free speech, and that there was no probability CalPERS could prevail on the merits.
creditworthiness of the SIVs, compounding their error. These circumstances allegedly
had severe, yet unaccounted for, effects on the SIVs’ creditworthiness.
12
On August 10, 2009, the Rating Agencies timely removed to federal court, but the
case was subsequently remanded to state court for lack of diversity jurisdiction.
7
Following several hearings, the trial court found that the negligent misrepresentation
claim fell within the scope of the anti-SLAPP statute, but nonetheless denied the special
motion to strike after finding CalPERS had succeeded in proving a probability of success
on the merits. Both parties have timely appealed aspects of this decision.
DISCUSSION
The Rating Agencies contend CalPERS failed to make a prima facie case of
negligent misrepresentation for four reasons, each of which independently requires
reversal of the trial court’s denial of its anti-Slapp motion. Specifically, the Rating
Agencies contend CalPERS failed to produce substantial evidence with respect to each of
the following essential elements of its claim: (1) a misrepresented past or existing
material fact with respect to the SIV ratings; (2) the absence of a reasonable basis for
believing the SIV ratings were true when published; (3) a legal duty owed by the
Agencies to CalPERS with respect to the SIV ratings; and (4) actual and justifiable
reliance by CalPERS on the SIV ratings. Additionally, the Rating Agencies contend the
complaint should have been dismissed on the basis of two of its affirmative defenses – to
wit, the First Amendment and preemption – both of which they contend constitute
complete legal bars to this lawsuit.
CalPERS, in turn, raises two issues on cross-appeal – to wit, that the trial court
erred by (1) finding as an initial matter that its lawsuit comes within the ambit of the anti-
SLAPP statute because it is based on activity “arising out of” the Rating Agencies’
constitutional right of free speech (§ 425.16, subd. (b)(1)); and (2) excluding from the
record six exhibits proffered by CalPERS relating to certain of the Rating Agencies’
rating activities.
We address each of these contentions below in proper analytical order after first
setting forth the legal principles governing our review.
I. The Anti-SLAPP statute.
Section 425.16, the “anti-SLAPP” statute, provides in relevant part: “A cause of
action against a person arising from any act of that person in furtherance of the person’s
right of petition or free speech under the United States or California Constitution in
8
connection with a public issue shall be subject to a special motion to strike, unless the
court determines that the plaintiff has established that there is a probability that the
plaintiff will prevail on the claim.”13 (§ 425.16, subd. (b)(1).)
The express purpose of the statute is to “encourage continued participation in
matters of public significance” and to prevent the “chill[ing]” of such participation
“through abuse of the judicial process.” (§ 425.16, subd. (a).) To ensure that purpose is
met, the California Legislature amended the statute in 1997 to mandate that it “be
construed broadly.” (Ibid., as amended by Stats. 1997, ch. 271, § 1; see also Ketchum v.
Moses (2001) 24 Cal. 4th 1122, 1130.)
Consistent with the statutory language, courts apply a two-prong test when ruling
on a special motion to strike. First, the moving defendant must make a prima facie
showing that the acts that are the subject of the plaintiff’s claims were performed in
furtherance of the defendant’s constitutional right of petition or free speech in connection
with a public issue. (Equilon Enterprises v. Consumer Cause, Inc. (2002) 29 Cal. 4th 53,
67 (Equilon); § 425.16, subd. (b).) If the moving defendant makes this requisite showing,
the burden then shifts to the plaintiff to establish, based on competent and admissible
evidence, a probability of prevailing on the merits of the plaintiff’s claims. (Ibid.;
College Hospital Inc. v. Superior Court (1994) 8 Cal. 4th 704, 719.) “Only a cause of
action that satisfies both prongs of the anti-SLAPP statute—i.e., that arises from
protected speech or petitioning and lacks even minimal merit—is a SLAPP, subject to
being stricken under the statute.” (Navallier v. Sletten (2002) 29 Cal. 4th 82, 89.)
13
“SLAPP” is an acronym for a strategic lawsuit against public participation.
(Navellier v. Sletten (2002) 29 Cal. 4th 82, 85, fn. 1, citing Canan & Pring, Strategic
Lawsuits Against Public Participation (1988) 35 Soc. Probs. 506.) SLAPPs are meritless
lawsuits brought primarily to harass persons who have exercised their constitutionally
protected rights of free speech and petition. (Dowling v. Zimmerman (2001) 85
Cal. App. 4th 1400, 1424.) The SLAPP statute sets forth a procedure designed to
expeditiously resolve SLAPPs at an early stage of the litigation before litigation costs
escalate. (Ibid.; Kibler v. Northern Inyo County Local Hospital Dist. (2006) 39 Cal. 4th
192.)
9
On appeal, we review a trial court’s ruling on a special motion to strike de novo.
(City of Cotati v. Cashman (2002) 29 Cal. 4th 69, 79.) In doing so, we consider the
pleadings and the evidence offered in support of and in opposition to the motion, but we
do not consider the credibility of witnesses or the weight of the evidence. (Ibid.) We
also keep in mind that the legislative purpose underlying the anti-SLAPP statute is to
promptly dismiss meritless lawsuits designed to chill a defendant’s exercise of the
constitutionally-protected rights to free speech and petition. (Briggs v. Eden Council for
Hope & Opportunity (1999) 19 Cal. 4th 1106, 1109; § 425.16, subd. (a).)
A. Does CalPERS’ action arise from the Rating Agencies’ exercise of
constitutionally-protected speech activities?
For purposes of the anti-SLAPP statute, “[an] ‘act in furtherance of a person’s
right of petition or free speech under the United States or California Constitution in
connection with a public issue’ includes: (1) any written or oral statement or writing
made before a legislative, executive, or judicial proceeding, or any other official
proceeding authorized by law; (2) any written or oral statement or writing made in
connection with an issue under consideration or review by a legislative, executive, or
judicial body, or any other official proceeding authorized by law; (3) any written or oral
statement or writing made in a place open to the public or a public forum in connection
with an issue of public interest; or (4) any other conduct in furtherance of the exercise of
the constitutional right of petition or the constitutional right of free speech in connection
with a public issue or an issue of public interest.” (§ 425.16, subd. (e).) Failure to meet
this initial prong renders the anti-SLAPP statute inapplicable, thereby making
unnecessary any determination under the second prong whether CalPERS made a prima
facie showing of negligent misrepresentation. (Navallier v. Sletten, supra, 29 Cal.4th at
p. 89.)
Here, CalPERS challenges the trial court’s finding under the first prong of the
anti-SLAPP statute that its negligent misrepresentation claim “arises from” the Rating
Agencies’ activity in furtherance of their constitutional right of free speech in connection
with a public issue (to wit, the public interest in investment community activities).
10
According to CalPERS, the trial court erred in finding the “gravamen” of its claim arose
from the Agencies’ “after-the-fact press releases and internet posts [to reporting services
like Reuters and Bloomberg].” CalPERS insists its claim arose from the agencies “acts
of engineering the SIVs while working hand-in-glove with the issuers, and then providing
‘AAA’ ratings to those issuers for use in the private placement sale of the SIV securities.”
Thus, CalPERS contends its claim “would have arisen even if the Rating Agencies had
never publicly disseminated the SIV ratings at all.” Accordingly, the trial court should
have denied the Rating Agencies’ anti-SLAPP motion without considering whether
CalPERS could demonstrate a probability of success on the merits. We disagree.
The California Supreme Court has explained the first prong of the anti-SLAPP
statute as follows: “[T]he statutory phrase ‘cause of action . . . arising from’ means
simply that the defendant’s act underlying the plaintiff’s cause of action must itself have
been an act in furtherance of the right of petition or free speech. [Citation.] . . . [T]he
critical point is whether the plaintiff’s cause of action itself was based on an act in
furtherance of the defendant’s right of petition or free speech. [Citations.] ‘A defendant
meets this burden by demonstrating that the act underlying the plaintiff’s cause fits one of
the categories spelled out in section 425.16, subdivision (e) . . . .’ ” (City of Cotati v.
Cashman, supra, 29 Cal.4th at p. 78. See also Navallier v. Sletten, supra, 29 Cal.4th at
p. 89.) In determining whether this burden is met, we keep in mind that “ ‘the nature or
form of the action is not what is critical but rather that it is against a person who has
exercised certain rights’ [Citation.]” (Navallier v. Sletten, supra, 29 Cal.4th at p. 93.)
Moreover, “the gravamen of an action is the allegedly wrongful and injury-producing
conduct, not the damage which flows from said conduct.” (Renewable Resources
Coalition, Inc. v. Pebble Mines Corp. (2013) 218 Cal. App. 4th 384, 387.) And, finally,
where, as here, the cause of action alleges both protected and nonprotected activities, the
statute does not apply if the protected activities are “merely incidental” or “collateral” to
the nonprotected activities. (Peregrine Funding Inc. v. Sheppard Mullin Richter &
Hampton LLP (2005) 133 Cal. App. 4th 658, 672 (Peregrine Funding). See also Freeman
v. Schack (2007) 154 Cal. App. 4th 719, 727.)
11
Applying these governing principles to this record, we reject CalPERS’ claim that
its negligent misrepresentation claim is not based in significant part on the Rating
Agencies’ speech-related activity. CalPERS’ complaint itself makes clear the negligent
misrepresentation claim arises from allegations that the “Rating Agencies assigned
untrue, inaccurate and unjustifiably high credit ratings to the [SIVs],” which were then
“communicated to Plaintiff via the offering materials of the [SIVs], the Rating Agencies’
respective websites, through financial reporting services and directly to CalPERS
authorized agent . . . .”
The fact that the complaint also challenges the publication of SIV ratings in
otherwise private offering materials available to the select class of qualified investors
does not necessarily bring the activity outside the scope of the anti-SLAPP statute. As
our colleagues in the Fourth District, Division Three have explained, “in order to satisfy
the public issue/issue of public interest requirement of section 425.16, subdivision (e)(3)
and (4) of the anti-SLAPP statute, in cases where the issue is not of interest to the public
at large, but rather to a limited, but definable portion of the public (a private group,
organization, or community), the constitutionally protected activity must, at a minimum,
occur in the context of an ongoing controversy, dispute or discussion, such that it
warrants protection by a statute that embodies the public policy of encouraging
participation in matters of public significance.” (Ruiz v. Harbor View Community Assn.
(2005) 134 Cal. App. 4th 1456, 1468 [Ruiz], citing Du Charme v. International
Brotherhood Electrical Workers (2003) 110 Cal. App. 4th 107, 118-119.) In Ruiz, this
standard was met where allegedly defamatory statements were contained within two
letters from a housing association’s attorney to a homeowner regarding the parties’
dispute over, among other things, architectural plans. Although these letters were private,
they concerned an ongoing dispute that was of interest to a “definable portion of the
public” – to wit, the association members, which included residents of over 523 lots, who
would be impacted by the dispute’s outcome and had a stake in the association’s
governance. (Id. at pp. 1468-1469.) Similarly, this standard was met in Church of
Scientology v. Wollersheim (1996) 42 Cal. App. 4th 628, 650-651, where an individual
12
brought a private tort suit against a church given that, as the court observed, the “record
reflects the fact that the Church is a matter of public interest, as evidenced by media
coverage and the extent of the Church’s membership and assets.” 14 (See also Damon v.
Ocean Hills Journalism Club (2000) 85 Cal. App. 4th 468, 479 [written statements
regarding a homeowners’ association’s internal management touched on issues of public
interest because they related to “the very manner in which this group of more than 3,000
individuals would be governed — an inherently political question of vital importance to
each individual and to the community as a whole”].)
Likewise, in this case, even focusing on the ratings published in the private SIV
offering materials or the subscription-only Rating Agency websites, the record
nonetheless reflects that the ratings themselves concerned an ongoing discussion
regarding the financial well-being of a significant investment opportunity that was of
interest to a definable portion of the public – to wit, the large group of QIBs/QPs eligible
to invest millions of dollars or more on behalf of an even greater number of individual
pensioners or investors. As such, we conclude the public issue/issue of public interest
requirement of section 425.16, subdivision (e) has been satisfied. (See Equilon, supra, 29
Cal.4th at p. 67 [defendant need only make a prima facie showing that the acts providing
the basis for plaintiff’s claim were performed in furtherance of the constitutional right of
free speech in connection with a public issue]; see also ComputerXpress, Inc. v. Jackson
(2001) 93 Cal. App. 4th 993, 1008.)
While the Rating Agencies’ conduct with respect to the SIV ratings may or may
not be worthy of First Amendment protection, an issue we address in Section IIA of this
opinion, “ ‘[t]he Legislature did not intend that in order to invoke the special motion to
strike the defendant must first establish her actions are constitutionally protected under
the First Amendment as a matter of law. If this were the case then the [secondary] inquiry
as to whether the plaintiff has established a probability of success would be superfluous.’
[Citations.]” (Navallier v. Sletten, supra, 29 Cal.4th at pp. 94-95.) Accordingly, we
14
Church of Scientology v. Wollersheim, supra, 42 Cal. App. 4th 628 was overruled
on another ground in Equilon, supra, 29 Cal. 4th 53.
13
stand by the trial court’s finding that this lawsuit, at minimum, falls within the scope of
the anti-SLAPP statute and, thus, continue on to prong two.
B. Has CalPERS made a prima facie case of negligent misrepresentation?
“ ‘Where the defendant makes false statements, honestly believing that they are
true, but without reasonable ground for such belief, he may be liable for negligent
misrepresentation, a form of deceit.’ (5 Witkin, Summary of Cal. Law (9th ed. 1988)
Torts, § 720 at p. 819; see also [Civ. Code,] § 1572, subd. 2 [‘[t]he positive assertion, in a
manner not warranted by the information of the person making it, of that which is not
true, though he believes it to be true’]; [Civ. Code,] § 1710, subd. 2 [‘[t]he assertion, as a
fact, of that which is not true, by one who has no reasonable ground for believing it to be
true’].)” (Bily v. Arthur Young & Co. (1992) 3 Cal. 4th 370, 390, 407-408 [Bily]. See
also Small v. Fritz Companies, Inc. (2003) 30 Cal. 4th 167, 174 (Small) [negligent
misrepresentation “encompasses ‘[t]he assertion, as a fact, of that which is not true, by
one who has no reasonable ground for believing it to be true’ [citation], and ‘[t]he
positive assertion, in a manner not warranted by the information of the person making it,
of that which is not true, though he believes it to be true’ [citations]”].)
As such, a claim for negligent misrepresentation requires the plaintiff to prove
each of the following: “(1) the misrepresentation of a past or existing material fact,
(2) without reasonable ground for believing it to be true, (3) with intent to induce
another’s reliance on the fact misrepresented, (4) justifiable reliance on the
misrepresentation, and (5) resulting damage.” (Apollo Capital Fund LLC v. Roth Capital
Partners, LLC (2007) 158 Cal. App. 4th 226, 243 [Apollo Capital].) We address
CalPERS’ showing with respect to each of these essential elements below.
1. Are ratings actionable statements?
Credit ratings, in CalPERS’ words, “reflect the particular rating agency’s expert
opinion of the underlying financial strength of the security. Typically, ratings may take
into consideration various factors, but usually consider the issue of the likelihood of
default. Ratings are based on the aggregate of relevant factors and are expressed in the
form of combinations of letters indicating the relative safety or risk of the security. In
14
addition, ‘+’ and ‘-’ signs are employed to signify shades of risk within a given rating
score.” Or, as the Rating Agencies describe these ratings: “Broadly speaking, ratings
express [their] opinion regarding the likelihood that a holder of a particular bond will
receive its expected principal and interest payments through the bonds maturity date.”
At first glance, resolving whether ratings are actionable misrepresentations for
purposes of this tort seems quite straightforward given the oft-stated rule that a speaker’s
opinion about a future event is not a statement about a past or existing material fact. “It is
hornbook law that an actionable misrepresentation must be made about past or existing
facts; statements regarding future events are merely deemed opinions.” (San Francisco
Design Center Associates v. Portman Cos. (1995) 41 Cal. App. 4th 29, 43-44 [San
Francisco Design]; see also Apollo Capital, supra, 158 Cal.App.4th at pp. 241, 244 [“the
statement that eNucleus would be cash flow positive at the end of the first quarter 2000”
is “nonactionable as opinion or prediction”]; Nibbi Bros. Inc. v. Home Fed. Sav. & Loan
Assn. (1988) 205 Cal. App. 3d 1415, 1423 [“In tort law, a representation ordinarily will
give rise to a cause of action for fraud or deceit only if it is a representation of fact rather
than opinion. (Civ. Code, §§ 1572, 1710)”].) Here, for example, the complaint describes
the SIV ratings as “ ‘address[ing] the likelihood that investors will receive payments as
promised’ and ‘address[ing] the expected loss posed to investors in relation to timely
payment of interest (if applicable) and timely payment of principal at par on the final
legal maturity date,’ ” allegations that appear to place the ratings within this
nonactionable realm of opinion or prediction. (Italics added.)
However, as CalPERS is quick to note: “Under certain circumstances, expressions
of professional opinion are treated as representations of fact. When a statement, although
in the form of an opinion, is ‘not a casual expression of belief’ but ‘a deliberate
affirmation of the matters stated,’ it may be regarded as a positive assertion of fact.
(Gagne v. Bertran (1954) 43 Cal. 2d 481, 489 [275 P.2d 15].) Moreover, when a party
possesses or holds itself out as possessing superior knowledge or special information or
expertise regarding the subject matter and a plaintiff is so situated that it may reasonably
rely on such supposed knowledge, information, or expertise, the defendant’s
15
representation may be treated as one of material fact. (Gagne v. Bertran, supra, 43 Cal.2d
at p. 489; Cohen v. S & S Construction Company (1983) 151 Cal. App. 3d 941, 946 [201
Cal. Rptr. 173]; see also 5 Witkin, Summary of Cal. Law, supra, Torts, § 680 at pp. 781-
782; BAJI No. 12.32.)” (Bily, supra, 3 Cal.4th at p. 408; see also Anderson v. Deloitte &
Touche (1997) 56 Cal. App. 4th 1468, 1476-1477 [same]; Ogier v. Pacific Oil & Gas Dev.
Corp. (1955) 132 Cal. App. 2d 496, 506-507 [same]; Neu-Visions Sports, Inc. v.
Soren/McAdam/Bartells (2000) 86 Cal. App. 4th 303, 308 [same].)
Relying on this exception to the general rule, CalPERS argues the ratings in this
case are not merely “casual statements of belief,” but rather “deliberate assertions based
on analysis of non-public, confidential information, and assigned after the Ratings
Agencies participated in structuring the SIV’s.” As such, CalPERS reasons, the ratings
should be deemed actionable expressions of professional opinion rather than
nonactionable predictions regarding future events.
To support its theory that ratings are more akin to deliberate affirmations of fact
based on special knowledge or expertise than mere opinions or predictions, CalPERS
offers several declarations, including that of Jean-Baptiste Carelus, the former Standard
& Poor’s Director in the Structured Finance Rating Group involved in rating the SIVs.
As Carelus explains, “Standard & Poor’s (in conjunction with the other rating agency(s)
participating in the deal) sets the requirements for portfolio composition, capitalization,
capital sufficiency, and the management of market and liquidity risk associated with the
asset portfolio.[¶] With regard to [SIVs,] Standard & Poor’s actively influenced the
structure and amount of the debt issued.” Further, “[i]f the [S&P] criteria was not applied
as directed by [S&P], then the issuer could not achieve its desired rating of AAA/A-1+,
which in practice meant the SIV would not be rated at all.”
Adding to this evidentiary showing is the declaration of Jack Chen, the former
Moody’s Senior Credit Officer, who describes the overall SIV industry as existing in a
“shroud of secrecy.” Noting that “the typical CP and MTN program documents for a SIV
discuss only in general broad strokes the potential asset composition of the SIV’s
portfolio,” Chen explains that, “[i]n fact, actual portfolio composition is a highly held
16
secret for SIV’s, and even within Moody’s such information is only shared on an as-
needed basis.”
And, similar to Carelus’s description of S&P’s role in constructing SIVs, the Chen
declaration attests that, “[w]hile Moody’s analysts would not build or personally review
the SIV’s capital model, they would request the manager to run various permitted
portfolio compositions and stress scenarios until Moody’s judged that the model showed
reliable results within the specifications Moody’s required.” Further, while the
operational requirements of the SIVs were set forth in legal documents to which the
Rating Agencies were not party, the Agencies nonetheless “required that the actual
parties to such documents not adopt any substantive or material amendments without
obtaining a prior written confirmation from each of them that such proposed amendment
or change would not cause them to downgrade or withdraw any of its ratings by altering
the structure of the SIV that the agencies had approved.”
We agree with CalPERS this evidence reflects that the Rating Agencies published
the ratings from a position of superior knowledge, information and expertise regarding
the SIVs’ composition, underlying structure and function that was not generally available
in the market. More specifically, we conclude this evidence reflects not only that the
Agencies employed superior knowledge and special information and expertise to assign
ratings to the SIVs, they employed their special knowledge, information and expertise to
participate in, and exert control over, the very construction of the SIVs. As such, we
agree with CalPERS a prima facie case has been made that the ratings are actionable as
“professional opinions” or “deliberate affirmations of fact” regarding the nature and
quality of the SIV product. (E.g., Bily, supra, 3 Cal.4th at p. 408, citing Gagne v.
Bertran, supra, 43 Cal.2d at p. 489.)
In so concluding, we briefly address the Rating Agencies’ argument that, even
assuming some professional opinions are actionable as negligent misrepresentations,
other professional opinions, like ratings, that speak to future events or conditions like an
investment’s future creditworthiness or value are nonactionable. (See Neu-Visions
Sports, Inc. v. Soren/McAdam/Bartells, supra, 86 Cal.App.4th at p. 310 [“Value is
17
quintessentially a matter of opinion, not a statement of fact”].) According to the
Agencies, CalPERS reliance on Bily is misplaced. In Bily, the Agengies argue, the
California Supreme Court did not reach the question of whether a statement relates to “ ‘a
past or existing fact’ because the auditor’s opinions at issue unquestionably addressed
‘past or existing’ matters – namely, the company’s statement of its then-current financial
condition.”
Putting aside the scope of Bily’s holding with respect to actionable professional
opinions, we decline, at least at this stage of the proceedings, to read the ratings in this
case in such a narrow fashion. Quite simply, CalPERS has provided sufficient evidence
to make a prima facie showing that the representations embodied in the ratings reflect not
just professional opinions regarding an event in the future such as the likelihood of
default, but also regarding a past or existing fact – namely, the then-current composition
and quality of the SIV product. As set forth above, the Chen and Carelus declarations
make quite clear the Rating Agencies were deeply involved in the very creation of the
SIV product. (Pp. 16-17, above.) And, as Carelus adds, the SIVs, by nature, are
“perpetual financing vehicles” designed to “continuously roll[] paper.” As such, the
Ratings Agency continuously monitor the SIVs to ensure ratings remain accurate,
withdrawing any rating no longer representative of the SIV’s financial condition.15 Thus,
the evidence adequately supports CalPERS contention that ratings do not speak only to
the SIVs’ likelihood of default or anticipated value at some future date; rather, they speak
more generally to the SIVs’ present overall financial health, providing confirmation with
15
Indeed, in recognition of the fact that the SIVs were designed to be “perpetual
financing vehicles,” the SIV ratings were considered “outstanding rating[s].” The Rating
Agencies would typically require the SIVs to undergo a “periodic rating confirmation”
(usually annually) in order to validate the rating, and would typically charged a
“surveillance fee” for its ongoing monitoring of the rating (calculated as a percentage of
the amount of CP/MTN the SIV had outstanding). As this information demonstrates, the
Rating Agencies, in publishing a rating, did not simply offer investors their best
prediction, at the precise time the SIV product was first marketed, as to whether they
would eventually be paid in full on their investment. Rather, the Agencies continuously
examined the SIV’s market performance to ensure the rating was currently valid.
18
at least some degree of certainty that a particular SIV, as constructed, is capable of
performing predictably in the market.16 (Cf. Nibbi Bros. v. Home Fed. Sav. & Loan
Ass’n, supra, 205 Cal.App.3d at p. 1423. [“[t]he most that we can derive from the
vaguely worded language is that [defendant] optimistically assessed the developer’s
capacity to sustain continued financing. A representation of this sort constitutes a
nonactionable expression of opinion”]; Neu-Visions Sports, Inc. v. Soren/ McAdam/
Bartells, supra, 86 Cal.App.4th at pp. 310-311[no factual issue existed as to whether
representations were actionable where “inequality of knowledge was not shown” with
respect to plaintiffs themselves and the person who made the representations based on
allegedly superior knowledge]. See also Cansino v. Bank of America, 2014 Cal.App.
LEXIS 277, No. H038713, __ Cal.Rptr.3d __ (Sixth App. Dist., March 26, 2014)
[differentiating between representations regarding “a business’s financial statements
during a discrete period covered by [an] audit,” which can be actionable, and
“prediction[s] of the business’s future performance,” which generally are
nonactionable].)
We thus agree with CalPERS that the record supports the inference that the ratings
were not merely predictions regarding the SIVs’ future value, but affirmative
representations regarding the present state of their financial health and, more specifically,
regarding their capacity to provide payments to investors as promised (which capacity
they did not in fact have). (See Abu Dhabi Commer. Bank v. Morgan Stanley & Co.
(S.D.N.Y. 2012) 888 F. Supp. 2d 431, 455 [“When a rating agency issues a rating, it is not
merely a statement of that agency’s unsupported belief, but rather a statement that the
rating agency has analyzed data, conducted an assessment, an reached a fact-based
conclusion as to creditworthiness”].) While the Rating Agencies may dispute the extent
16
As CalPERS notes, S&P itself described the AAA rating as representing the
agency “is comfortable that the minimum capital requirements ensure that under the
tested scenarios the senior liabilities will be repaid in full,” and that “[the] obligor’s
capacity to meet its financial commitment on the obligation is extremely strong.”
Moody’s, in turn, defined its Aaa rating as representing the “[o]bligations . . . are judged
to be of the highest quality with minimal credit risk.”
19
of their involvement in constructing the SIVs, their ability to verify the SIVs’ financial
health, or the information they intended to convey through their ratings, we are
nonetheless confident the requisite prima facie showing has been made regarding this
element.
2. Was there a reasonable basis for believing the ratings were accurate?
Next, with respect to whether the Rating Agencies had the requisite reasonable
basis for believing in the integrity of the ratings at the time of their publication, the
complaint describes the following circumstances. First, the SIVs were structured in such
a way that they relied on an “asset-liability mismatch” to generate profits, with the SIVs
buying long-term assets paying a certain interest rate with funds generated from its sale
of short-term commercial paper (CP) and medium-term notes (MTN) to SIV investors
like CalPERS. When these shorter-term obligations became due to be paid, the SIVs
would “roll” or finance more CP or MTN such that investors would receive new notes
rather than payment on original notes. While the Rating Agencies (and SIV managers)
correctly presumed a market interruption could occur capable of preventing the SIVs
from seamlessly rolling more CP or MTN, they incorrectly and unreasonably presumed
they would nonetheless be able to pay investors by liquidating their long-term assets. In
fact, the SIVs were structured in such a way that automatic liquidation of long-term
assets would be triggered if certain stress levels were met. However, according to
CalPERS, the Agencies (and SIV managers) should have presumed and accounted for a
market interruption with the capability of disrupting both the CP/MTN market and the
long-term asset market.17 The occurrence of this sort of market interruption allegedly
caused CalPERS’ losses.
To support this theory, CalPERS offers the declaration of Ann Rutledge, an expert
in the field of structured finance. Among other things, Rutledge formerly had senior
ratings responsibilities at Moody’s and authored two professional reference books
17
CalPERS also alleges other structural problems with the SIVs, including the lack
of diversification in their underlying assets, which made them more susceptible to losses
from any one kind of investment (such as sub-prime CDOs or RMBS).
20
relating to structured securities. Based on her knowledge and experience regarding credit
ratings, Rutledge opines “there was not a reasonable basis for representing [in the SIV
literature] that SIV CP/MTNs could repay investors with the certainty represented by an
AAA/A-1+ rating from [S&P], an Aaa/Prime-1 rating from Moody’s. . . .” Specifically,
Rutledge identifies the “basic flaw” in the SIV ratings as follows:
“SIVs had embedded market and liquidity risks that made their level of credit risk
inconsistent with top credit ratings. At bottom, the Rating Agencies failed to account for
market interruption risk. Their SIV rating methodologies anticipated that a market
interruption could cause a liquidity freeze whereby a SIV’s ability to roll commercial
paper would be halted, and the SIV would not be able to make payments to investors.
But in anticipation of such a market interruption, the Rating Agencies assumed SIVs
would be able to sell their underlying assets to raise cash in lieu of rolling commercial
paper. They had no empirical or logical basis for that assumption. In reality, the same
market interruption that caused liquidity to dry up would have a severe effect on the
SIVs’ ability to sell its assets and could cause SIVs to default on their payments to
investors. [¶] . . . [¶] [Further,] [t]he Rating Agencies’ SIV rating methodologies
anticipated market interruption serious enough to halt the ability to roll over paper, but
assumed without any support that twenty-eight SIVs holding hundreds of billions of
structured finance securities would be able to liquidate enough of those securities – and
do so at a high enough price – to pay back investors. They had no empirical or logical
basis for that assumption.” (Italics added.)
The Rutledge declaration further explains: “The Rating Agencies in the period
2002 to 2004 prescribed increasingly elaborate frameworks of criteria for SIVs. The
most significant thing the Rating Agencies did was to allow committed capital to be
replaced with cheaper, contingent protections based on tests and triggers. [¶] . . . [¶] . . .
It is my opinion that the Rating Agencies had no basis in logic, theory or experience for
promoting the concept that a SIV could repay its CP and MTN liabilities by rolling CP or
liquidating its assets when markets seized up. In their ratings on CP/MTNs from Sigma,
21
Stanfield Victoria, Cheyne, and other SIVs, the rating Agencies failed to reflect that this
increased risk exposure was being passed on to investors.” (Italics added.)
Finally, CalPERS offers evidence in the form of the Chen and Carelus declarations
of an underlying reason for the Rating Agencies’ seemingly illogical behavior in
designing and rating the SIVs – to wit, the fact that the Agencies were only paid if the
SIV deal closed, which would only happen if a top rating was assigned to the deal. In
other words, the Rating Agencies were acting pursuant to a financial incentive to highly
rate the SIVs so the securities would be sold to investors and they, in turn, would be paid
fees (which, in turn, were generally calculated as a percentage of the amount of securities
the SIV had outstanding).
This evidence presented in the Rutledge, Chen and Carelus declarations suffices to
prove a prima facie case the Ratings Agency lacked a reasonable basis for believing the
accuracy or truthfulness of their ratings.
3. Did the Rating Agencies intend to influence CalPERS?
We now turn to the issue of whether the Rating Agencies, when issuing the
ratings, intended to influence CalPERS in its decision to invest in the SIV market, such
that they assumed a legal duty to CalPERS with respect to these ratings. Where, as here,
a negligent misrepresentation claim is brought against the provider of a professional
opinion based on special knowledge, information or expertise regarding a company’s
value, the California Supreme Court requires the following:
“The representation must have been made with the intent to induce plaintiff, or a
particular class of persons to which plaintiff belongs, to act in reliance upon the
representation in a specific transaction, or a specific type of transaction, that defendant
intended to influence. Defendant is deemed to have intended to influence [its client’s]
transaction with plaintiff whenever defendant knows with substantial certainty that
plaintiff, or the particular class of persons to which plaintiff belongs, will rely on the
representation in the course of the transaction. [However,] [i]f others become aware of
the representation and act upon it, there is no liability even though defendant should
reasonably have foreseen such a possibility.” (Bily, supra, 3 Cal.4th at p. 414.)
22
Thus, “Bily creates an objective standard that looks to the specific circumstances
to ascertain whether a supplier of information has undertaken to inform and guide a third
party with respect to an identified transaction or type of transaction. If such a specific
undertaking has been made, liability is imposed on the supplier. If, on the other hand, the
supplier ‘merely knows of the ever-present possibility of repetition to anyone, and
possibility of action in reliance upon [the information] on the part of anyone to whom it
may be repeated,’ the supplier bears no legal responsibility.”18 (Glenn K. Jackson, Inc. v.
Roe (9th Cir. 2001) 273 F.3d 1192, 1200 fn. 3, quoting Bily, supra, 3 Cal.4th at p. 410.)
See also Bily, supra, 3 Cal.4th at p. 409 [“As we read section 552 of the Restatement
Second of Torts, it does not seek to probe the state of mind of the . . . supplier of
information. Rather, it attempts to identify those situations in which the supplier
undertakes to supply information to a third party whom he or she knows is likely to rely
on it in a transaction that has sufficiently specific economic parameters to permit the
supplier to assess the risk of moving forward”].
Intent to induce reliance is usually a “question of fact” for the jury. (Bily, supra, 3
Cal.4th at p. 414.) Moreover, “ ‘[i]ntent to influence is a threshold issue. In its absence
there is no liability even though a plaintiff has relied on the misrepresentation to his or
her detriment, and even if such reliance were reasonably foreseeable.’ [Citation], italics
added.)” (Bily, supra, 3 Cal.4th at p. 412.) Thus, “[i]f competent evidence does not
permit a reasonable inference that the auditor [or other professionals] supplied its report
with knowledge of the existence of a specific transaction or a well-defined type of
18
The parties accept that Bily controls on this issue, even though Bily involved an
auditor rather than a rating agency. As Bily clarifies: “Accountants are not unique in
their position as suppliers of information and evaluations for the use and benefit of
others. Other professionals, including attorneys, architects, engineers, title insurers and
abstractors, and others also perform that function. And, like auditors, these professionals
may also face suits by third persons claiming reliance on information and opinions
generated in a professional capacity.” (Bily, supra, 3 Cal.4th at p. 410. See also
Soderberg v. McKinney (1996) 44 Cal. App. 4th 1760, 1768 [while “Bily involved the
liability of accountants (or auditors), we see no reason why its discussion should be
limited to that group of professionals”].)
23
transaction which the report was intended to influence, the auditor is not placed on notice
of the risks of the audit engagement. In such cases, summary adjudication will be
appropriate because plaintiff will not, as a matter of law, fall within the class of intended
beneficiaries.”19 (Bily, supra, 3 Cal.4th at pp. 414-415.)
Here, CalPERS relies on the following evidence, much of which has already been
described, that the Rating Agencies intended through their ratings to influence it to enter
into the SIV transactions: (1) sworn testimony from former senior officers of Moody’s
and S&P, including Chen and Carelus, that the Agencies expected the SIV issuers to
prominently display their ratings in the offering materials and, in at least one instance,
gave the issuers express permission to distribute their ratings to prospective investors in
the offering materials; (2) copies of the SIV offering materials, reviewed and approved by
the Rating Agencies, that expressly state the SIV notes could only be sold to the specified
class of QIB/QPs like CalPERS; and (3) the sworn testimony of Chen, Carelus, Rutledge
and others that the Rating Agencies “played an integral role in SIVs’ structuring and
marketing,” in that, without the Agencies’ approval in the form of an AAA or equivalent
rating, the securities would not launch.
This evidence, in our view, supports a reasonable inference that the Agencies
supplied its ratings with knowledge of the existence of a well defined type of transaction
which the ratings were intended to influence. As the Carelus declaration succinctly
states: “[T]he audience for the rating was the select class of QIB/QP investors.” As
such, consistent with the holding of Bily, we conclude that CalPERS has met its burden
19
In adopting this standard, which is derived from section 552 of the Restatement
Second of Torts, the California Supreme Court reasoned as follows: “[C]onfining what
might otherwise be unlimited liability to those persons whom the engagement is designed
to benefit, the Restatement rule requires that the supplier of information receive notice of
potential third party claims, thereby allowing it to ascertain the potential scope of its
liability and make rational decisions regarding the undertaking. The receipt of such notice
justifies imposition of auditor liability for conduct that is merely negligent. [¶]
Moreover, the identification of a limited class of plaintiffs to whom the supplier itself has
directed its activity establishes a closer connection between the supplier’s negligent act
and the recipient’s injury, thereby ameliorating the otherwise difficult concerns of
causation and of credible evidence of reliance.” (Bily, supra, 3 Cal.4th at p. 409.)
24
under section 425.16 to show CalPERS and the other QIB/QP investors constitute a
sufficiently narrow and circumscribed class that would have access to and rely upon the
ratings when deciding whether to purchase the SIV products. This is particularly true
given the obscure and complex nature of the SIV product and the active role the Agencies
assumed in creating and marketing it. (See Rest.2d Torts, § 552, com. (h) [noting the
“risk of liability to which the supplier subjects himself by undertaking to give the
information . . . is vitally affected by the number and character of the persons, and
particularly the nature and extent of the proposed transaction”] [italics added]. See
Nutmeg Securities, Ltd. v. McGladrey & Pullen (2001) 92 Cal. App. 4th 1435, 1445
[concluding defendant auditor owed a legal duty to a class of IPO underwriters
potentially exposed to its audit where such class, no matter how large, had “sufficiently
specific parameters” to constitute a “narrow and circumscribed class of persons” for
purposes of Bily] [Nutmeg Securities]; Anschutz Corp. v. Merrill Lynch & Co. (N.D. Cal.
2011) 785 F. Supp. 2d 799, 826 [“although the class of QIBs might number in the
thousands, it is still a circumscribed and identifiable group that the Ratings Defendants
not only knew would have access to the ratings but who necessarily rely on the ratings in
order to purchase investment grade securities”].)
Quite simply, this is not a case where it is alleged the defendant “merely knew” of
the possibility its professional opinions were being shared with third parties. This is a
case where CalPERS alleges the Rating Agencies, first, helped create the underlying
products and, second, assigned and published ratings on those products that were then
prominently featured in marketing materials given to investors interested in purchasing
them. (Compare Nutmeg Securities, supra, 92 Cal.App.4th at p. 1444 [“where an
‘outside’ or ‘independent’ accountant prepares as well as audits a corporation’s financial
records it is liable for negligent misrepresentation to those third parties who reasonably
and foreseeably relied on the financial records, the audit, or both”].)
Accordingly, we decline to hold, at this stage of the litigation, that, as a matter of
law, the Rating Agencies owed no duty to CalPERS with respect to the ratings under
California law. (Bily, supra, 3 Cal.4th at p. 408.)
25
4. Did CalPERS actually and justifiably rely on the SIV ratings?
We now address the fourth element of the negligent misrepresentation tort – to
wit, whether CalPERS actually and justifiably relied on the ratings when purchasing the
SIVs. “Actual reliance occurs when a misrepresentation is ‘ “an immediate cause of [a
plaintiff’s] conduct, which alters his legal relations,” ’ and when, absent such
representation, ‘ “he would not, in all reasonable probability, have entered into the
contract or other transaction.” ’ [Citations.] ‘It is not . . . necessary that [a plaintiff’s]
reliance upon the truth of the . . . misrepresentation be the sole or even the predominant
or decisive factor in influencing his conduct. . . . It is enough that the representation has
played a substantial part, and so has been a substantial factor, in influencing his decision.’
[Citation.]” (Engalla v. Permanente Med. Grp., Inc. (1997) 15 Cal. 4th 951, 976-977.)
A. Actual Reliance.
To make a prima facie showing of actual reliance, CalPERS offered declarations
from several witnesses, including Phillip Picariello, former Vice President of Portfolio
Management for eSecLending, CalPERS’ outside investment manager which, along with
Credit Suisse First Boston (CSFB), purchased the SIVs on CalPERS’ behalf. While
Picariello did not himself investigate and purchase the SIVs, he personally observed his
co-worker, Saffet Ozbalci, eSecLending’s ABS Portfolio Manager, do so.20 According to
Picariello’s declaration, “eSecLending did in fact rely on the SIVs’ credit ratings in
making the SIV investments for CalPERS’ portfolio . . . . Indeed, I know that
Mr. Ozbalci was only looking at SIVs because they were rated triple A by the rating
agencies and in addition they were secured and they offered a minimum yield premium
over unsecured investments that had a lower credit rating.”
CalPERS also offered a declaration from Daniel Kiefer, CalPERS’ Opportunistic
Portfolio Manager of the Fixed Income Unit who was involved in the oversight of the
SIV purchases. Consistent with Picariello’s testimony, Kiefer averred that CalPERS’
investment policy, set forth in a document entitled Delegated Lending and Cash
20
Ozbalci left his position with eSecLending in 2008.
26
Collateral Reinvestment Guidelines (Reinvestment Guidelines), only permitted CalPERS
and its authorized agents, including eSecLending and CSFB, to invest in short-term and
low duration securities such as the SIV notes if the securities carried certain minimum-
level credit ratings.
These restrictions on CalPERS’ investment strategy were reiterated by Shurla
Warner-George, eSecLending’s Compliance Manager, who was aware of, and in fact
verified, the company’s strict compliance with CalPERS’ investment policies for the
relevant SIV purchases. As the Warner-George declaration explains: “When the
CalPERS’ investment guidelines require credit ratings of a minimum level, the portfolio
manager is prevented from executing a securities trade for CalPERS if the credit ratings
for the security are below that level or are absent. [¶] With respect to each SIV purchase
made for CalPERS’ account by eSecLending, the required credit ratings were entered in
accordance with the pre-trade compliance process.”
The Rating Agencies dispute the adequacy of CalPERS’ evidentiary showing on
the ground that Picariello’s testimony as to Ozbalci’s alleged reliance on the ratings is
inadmissible because it “relate[s] to another person’ state of mind without any showing of
personal knowledge thereof.” (See Evid. Code, § 702.) They further contend that, even if
CALPERS’ internal policy restricted investments to notes with Aaa/AAA ratings, this
fact would not prove CalPERS actually followed its policy when investing in the SIVs.
However, whatever the merits of the Agencies’ arguments, CalPERS’ evidence of actual
reliance is, at a minimum, sufficient to make a prima facie case that it would not have
invested in the SIVs if the representations reflected in the ratings had not been made.
Moreover, while the Agencies will no doubt challenge the extent of Picariello’s personal
knowledge of Ozbalci’s due diligence and execution of trades at trial, we agree with the
trial court the necessary foundation for admitting his testimony has been made.
Specifically, Picariello’s declaration reflects that, not only did he “work[] with Mr.
Ozbalci in [the] Boston office, sharing the same workspace almost literally shoulder to
27
shoulder, for just over three years,” he also personally observed Ozbalci’s work,
including his investigation of and reliance on the SIV ratings.21
B. Justifiable Reliance.
“ ‘Besides actual reliance, [a] plaintiff must also show “justifiable” reliance, i.e.,
circumstances were such to make it reasonable for [the] plaintiff to accept [the]
defendant’s statements without an independent inquiry or investigation.’ [Citation.] The
reasonableness of the plaintiff’s reliance is judged by reference to the plaintiff’s
knowledge and experience. (5 Witkin, Summary of Cal. Law, supra, Torts, § 808,
p. 1164.) ‘ “Except in the rare case where the undisputed facts leave no room for a
reasonable difference of opinion, the question of whether a plaintiff’s reliance is
reasonable is a question of fact.” [Citations.]’ [Citation.]” (OCM Principal Opportunities
Fund, L.P. v. CIBC World Markets Corp. (2007) 157 Cal. App. 4th 835, 864-865 [OCM
Principal].)
In disputing that CalPERS has made a prima facie showing of justifiable reliance,
the Rating Agencies rely on the comprehensive disclaimers of liability accompanying
their ratings. For example, Moody’s and S&P’s provided disclaimers in both the SIV
offering documents and their subscription websites advising readers that ratings are not
recommendations to “buy, sell or hold” any securities. Another such disclaimer on
Moody’s subscription website (which CalPERS could and did access) advised: “[A]ny
user of the information contained herein should not rely on any credit rating or other
opinion contained herein in making any investment decision.” In addition, the SIV
offering documents expressly provide that, by entering into a transaction to buy SIV
notes, the purchaser represents that it has independently investigated the notes by, among
other things, seeking out any additional information required to permit it to make an
informed purchasing decision.
21
For example, Picariello averred that he personally observed Ozbalci conduct
research on SIVs through the Rating Agencies’ subscription websites, among other
sources, and then prepare an Excel file matrix to capture his research. This matrix
consisted of a chart comparing certain characteristics of different SIVs, including their
credit ratings.
28
While the language in these disclaimers may indeed be comprehensive, as
CalPERS points out, it does not speak to the allegations at hand: mainly, that the Rating
Agencies promulgated ratings despite lacking a reasonable basis to believe in the ratings’
accuracy. We agree. (E.g., Genesee County Emples. Ret. Sys. v. Thornburg Mortg. Secs.
Trust 2006-3 (D.N.M. 2011) 825 F. Supp. 2d 1082, 1206 (Genesee County).) Indeed, the
law is clear that, generally speaking, “ ‘[a] plaintiff will be denied recovery only if his
conduct is manifestly unreasonable in the light of his own intelligence or information. It
must appear that he put faith in representations that were ‘preposterous’ or ‘shown by
facts within his observation to be so patently and obviously false that he must have closed
his eyes to avoid discovery of the truth.’ [Citation.] Even in case of a mere negligent
misrepresentation, a plaintiff is not barred unless his conduct, in the light of his own
information and intelligence, is preposterous and irrational. [Citation.]’ [Citation.].) The
effectiveness of disclaimers is assessed in light of these principles. [Citation.]” (OCM
Principal, supra, 157 Cal.App.4th at p. 865.) In this case, the presence of certain
disclaimers does not necessarily render CalPERS’ investment decisions preposterous or
irrational.
The Rating Agencies also make much of CalPERS’ high level of market
sophistication in arguing their reliance was unjustified. However, CalPERS’
sophistication, on our record, does not preclude a finding of justifiable reliance.
CalPERS has presented evidence that the SIV market existed in a “shroud of secrecy”
and very few persons, even within the Agencies themselves, were privy to the SIVs’
composition. As such, it is hardly surprising the relevant investor class may have
significantly relied on the ratings. In fact, as CalPERS notes, Vicki Tillman, S&P’s
Executive Vice President of Credit Market Services, acknowledged publicly that: “I
want to be clear. Ratings matter; as the individual who oversees S&P’s ratings business I
would be the last person to suggest to you that they do not.” And, in an even more frank
acknowledgement, Raymond McDaniel, Moody’s President and CEO, told Congress in
September 2009 testimony: “Unlike in the corporate market, where investors and other
market participants can reasonably develop their own informed opinions based on
29
publicly available information, in the structured finance market, there is insufficient
public information to do so. . . . [¶] In the absence of sufficient data, investors are unable
to conduct their own analysis and develop their own independent views about potential or
existing investments.” (Cf. U.S.T. Private Equity Inv. Fund, Inc. v. Salomon Smith
Barney (App. Div. 1st Dep’t 2001) 288 A.D.2d 87, 733 N.Y.S.2d 385, 386 [“As a matter
of law, a sophisticated plaintiff cannot establish that it entered into an arm’s length
transaction in justifiable reliance on alleged misrepresentations if that plaintiff failed to
make use of the means of verification that were available to it, such as reviewing the files
of the other parties”]; See Murphy v. BDO Seidman (2003) 113 Cal. App. 4th 687, 704-
705 [“regardless of whether investors should rely solely on an auditor’s report when
investing, it seems unassailable that they may assume an auditor’s statements are
truthful”].)
Accordingly, for the reasons stated, we affirm the trial court’s finding that a prima
facie case of reliance exists on this record.22
II. Affirmative defenses.
The Rating Agencies further contend CalPERS cannot prevail on the merits given
two affirmative defenses they insist completely bar its negligent misrepresentation claim:
the First Amendment and preemption.
As set forth above, a special motion to strike should be granted “if the defendant
presents evidence that defeats the plaintiff’s claim as a matter of law. [Citation.]
Generally, a defendant may defeat a cause of action by showing . . . there is a complete
defense to the cause of action. . . . [A]lthough section 425.16 places on the plaintiff the
burden of substantiating its claims, a defendant that advances an affirmative defense to
22
As CalPERS notes, to make a prima facie showing of reliance, it was not required
to provide separate evidence regarding Credit Suisse First Boston’s reliance on the
ratings when purchasing SIV notes on its behalf. “If the plaintiff ‘can show a probability
of prevailing on any part of its claim, the cause of action is not meritless” and will not be
stricken; “once a plaintiff shows a probability of prevailing on any part of its claim, the
plaintiff has established that its cause of action has some merit and the entire cause of
action stands.’ [Citation.]” (Oasis West Realty, LLC v. Goldman (2011) 51 Cal. 4th 811,
820.)
30
such claims properly bears the burden of proof on the defense. [Citations.]” (Peregrine
Funding, supra, 133 Cal. App. 4th 658, 676.) We address the Rating Agencies’
affirmative defenses in light of these principles.
A. The First Amendment.
The Rating Agencies invoke the First Amendment right to freedom of speech as a
complete defense to CalPERS’ action based on what they describe as the broad public
interest in credit ratings. Specifically, the Agencies contend CalPERS’ negligent
misrepresentation cause of action fails as a matter of law because CalPERS does not
allege and, in any event, could not prove they acted with “actual malice” when issuing
the ratings. (See New York Times v. Sullivan (1964) 376 U.S. 254, 280 [under the First
Amendment, a publisher is protected against liability for a false statement regarding a
matter of public concern unless the statement was made with “actual malice,” i.e., “with
knowledge that it was false or with reckless disregard of whether it was false or not”]; see
also Stewart v. Rolling Stone, LLC (2010) 181 Cal. App. 4th 664, 681 [“ ‘ “Publication of
matters in the public interest, which rests on the right of the public to know, and the
freedom of the press to tell it, cannot ordinarily be actionable. [Citations.]” [Citation.]’
[Citations.]”].)
In asserting this defense, the Rating Agencies direct us to several non-California
cases in which courts have applied the “actual malice” standard to various legal claims
challenging a defendant’s credit ratings. For example, in one such case, a federal district
court deemed it “well-established that under typical circumstances, the First Amendment
protects rating agencies, subject to an ‘actual malice’ exception, from liability arising out
of their issuance of ratings and reports because their ratings are considered matters of
public concern. [Fn. omitted.]” (Abu Dhabi Commer. Bank v. Morgan Stanley & Co.
(S.D.N.Y. 2009) 651 F. Supp. 2d 155, 175, italics added. See also Time, Inc. v. Hill
(1967) 385 U.S. 374, 389 [actual malice standard protects against liability for “innocent
or negligent misstatement”].) In another case, Compuware Corp. v. Moody’s Investor
Servs. (6th Cir. 2007) 499 F.3d 520, 526, the Sixth Circuit Court of Appeals applied the
actual malice standard before ultimately affirming the dismissal of a defamation claim on
31
the separate ground that the credit ratings of a publically-traded company (which a SIV is
not) are “predictive opinions” that do not “communicate[] any provably false factual
connotation.” (See also First Equity Corp. v. Standard & Poor’s Corp. (S.D.N.Y. 1998)
690 F. Supp. 256, 258-259 [to overcome a First Amendment challenge to a fraud claim
based on alleged misstatements in defendant’s description of corporate bonds, “plaintiffs
must show either that Standard & Poor’s published the description with actual knowledge
of its falsity or with reckless disregard of its truth or falsity”].)
As the Rating Agencies correctly note, in our case, there is no allegation they
acted maliciously in issuing the relevant ratings. Rather, it is alleged they did so
negligently, which “ ‘is not enough to demonstrate actual malice. [Citation.]’ ” (Stewart
v. Rolling Stone, Inc., supra, 181 Cal.App.4th at p. 690.) The Agencies are also correct
as a general matter that, to provide the “breathing-space” required by the First
Amendment, publishers are not subject to liability for false statements unless such
statements were made with “actual malice.” (Gertz v. Robert Welch, Inc. (1974) 418 U.S.
323, 327-328 (Gertz).) In recognition of the fact certain types of speech are “less central
to the interests of the First Amendment” and, thus, deserving of less protection, the high
court has limited application of the actual malice standard to speech on “matters of public
concern.” (Dun & Bradstreet v. Greenmoss Builders (1985) 472 U.S. 749, 758-760.)
Determining whether speech involves “matters of public concern” requires careful
weighing of “the State’s interest in compensating private individuals for injury . . .
against the First Amendment interest in protecting th[e] [particular] type of expression.”
(Dun & Bradstreet v. Greenmoss Builders, supra, 472 U.S. at p. 757.) In Dun &
Bradstreet v. Greenmoss Builder, for example, the court determined a credit report made
available to just “five subscribers, who, under the terms of the subscription agreement,
could not disseminate it further” did not implicate matters of public concern and, thus,
was not entitled to special First Amendment protection under the actual malice standard,
because such speech did not involve “any ‘strong interest in the free flow of commercial
information.’ [Citation.]” (472 U.S. 762.)
32
Returning to the case at hand, CalPERS argues that, while more traditional credit
ratings of publicly-traded securities may, under normal circumstances, constitute speech
on matters of public concern, the same cannot be said of the ratings at issue here, which
were allegedly issued for private use by the limited class of investors dealing in complex
and esoteric nonregistered securities. (Cf. Compuware v. Moody’s Investor Servs., supra,
499 F.3d at p. 526.) As such, CalPERS contends, the Agencies’ speech with respect to
the SIVs is not entitled to the greater First Amendment protection afforded under the
actual malice standard. Other non-California courts faced with comparable facts have
agreed.
In Anschutz Corp. v. Merrill Lynch & Co., supra, 785 F. Supp. 2d 799, for example,
the federal district court found the actual malice standard inapplicable to a negligent
misrepresentation claim against rating agencies where the ratings at issue were
disseminated to only a select group of investors rather than to the public at large. The
court, in denying the rating agency defendants’ motion to dismiss, reasoned:
“[W]hile other Courts have applied the actual malice standard to claims against rating
agencies, they did so only where the ratings were matters of ‘public concern.’ In Abu
Dhabi Commer. Bank v. Morgan Stanley & Co., 651 F. Supp. 2d at 175, the Court held
that credit ratings for a structured investment vehicle, that were only available to a
limited group of investors, were not matters of public concern afforded the ‘actual
malice’ level of protection. Id. at 176; see also LaSalle Nat’l Bank v. Duff & Phelps
Credit Rating Co., 951 F. Supp. 1071, 1096 (S.D.N.Y. 1996) (rejecting actual malice
protection where credit rating was ‘privately contracted for and intended for use in the
private placement Offering Memoranda, rather than for publication in a general
publication’); cf. In re Enron Corp. Sec. Derivative & ‘ERISA’ Litig. 511 F. Supp. 2d at
825 (S.D. Tex. 2005) (concluding ‘that the actual malice standard should apply here
because the nationally published credit ratings focus upon matters of public concern, a
top Fortune 500 company’s creditworthiness.’). The Court in In re Nat’l Century Fin.
Enters., 580 F. Supp. 2d 630, 640 (S.D. Ohio 2008) reached the same conclusion where
the ratings were disseminated only to ‘a select class of institutional investors with the
33
resources to invest tens of millions of dollars in the notes.’ ” (Anschutz Corp. v. Merrill
Lynch & Co., supra, 785 F.Supp.2d at p. 831.) Accordingly, the court ultimately
concluded: “Plaintiff’s allegations, that the ratings at issue here were likewise only
distributed to the select group of QIBs, satisfies the Court — at this juncture — that the
First Amendment does not require [the plaintiff] to meet the ‘actual malice’ standard for
its misrepresentation claims.” (Anschutz Corp. v. Merrill Lynch & Co., supra, 785
F.Supp.2d at pp. 831-832.)
This reasoning is indeed persuasive. Similar to Anschutz Corp. v. Merrill Lynch &
Co., the record here reflects the SIV ratings were not published for or disseminated to the
general investing public, which, in any event, could not enter into the SIV market.
Rather, they were intended for, and disseminated to, the limited class of institutional
investors authorized by law to purchase the unregistered SIV securities in private
placement deals – mainly, QIBs and QPs like CalPERS. Of course the Rating Agencies
are quick to note in striving to establish their First Amendment defense that the SIV
ratings were posted on both subscription-only and public websites and in a limited
number of press releases and internet postings. However, while this fact does suggest
some public dissemination of the SIV ratings, it does not, by itself, shield the Agencies
from liability for the ratings under the First Amendment. To the contrary, given the
outstanding factual issues in our record regarding the public-versus-private nature of the
SIV ratings, and given the careful weighing required under the First Amendment to
ensure proper balance of the State’s interest in compensating private individuals for
injury and the First Amendment interest in protecting certain type of expression, we
conclude resolution of this significant issue at this juncture would be premature. (See
Dun & Bradstreet v. Greenmoss Builders, supra, 472 U.S. at pp. 757-758 [courts have
“long recognized[,] . . . not all speech is of equal First Amendment importance”].)
Accordingly, we conclude the First Amendment provides no basis for dismissing
this case on anti-SLAPP grounds. As our appellate colleagues in the Second District
have aptly stated, “section 425.16 does not apply in every case where the defendant may
be able to raise a First Amendment defense to a cause of action. Rather, it is limited to
34
exposing and dismissing SLAPP suits — lawsuits ‘brought primarily to chill the valid
exercise of the constitutional rights of freedom of speech and petition for the redress of
grievances’ ‘in connection with a public issue.’ (§ 425.16, subds. (a), (b).).” (Wilcox v.
Superior Court (1994) 27 Cal. App. 4th 809, 819, italics added, disapproved on other
grounds in Equilon, supra, 29 Cal.4th at p. 68, fn. 5.)23
B. Preemption.
The Rating Agencies next argue CalPERS’ negligent misrepresentation claim is
completely and expressly preempted by the Credit Rating Agency Reform Act of 2006
(hereinafter, the “Act” or “CRARA”), 15 U.S.C. section 78o-7. Congress enacted the
CRARA in 2006 with the express intent to “improve ratings quality for the protection of
investors and in the public interest by fostering accountability, transparency, and
competition in the credit rating agency industry.” (109 P.L. 291 [109 S. 3850] [Sept. 29,
2006].) The CRARA is designed to accomplish this goal by, among other things,
prescribing procedures by which a credit rating agency like Moody’s and S&P’s may
register with the SEC as a nationally recognized statistical rating organization (NRSRO).
(Ibid.)
Here, the Rating Agencies base their express preemption defense on two
provisions of the CRARA – to wit, the “authorization provision” in subdivision (c)(1),
which grants the Securities Exchange Commission (SEC) exclusive authority to enforce
the Act, and the “limitation provision” in subdivision (c)(2), which bars the SEC and all
States from “regulat[ing] the substance of credit ratings or the procedures and
23
While at first blush our rejection of the First Amendment as a basis for dismissing
this case on anti-SLAPP grounds may seem at odds with our earlier conclusion that the
Rating Agencies met their initial burden of proving CalPERS’ claim arises from their
exercise of constitutionally-protective speech activities, in reality our conclusions are
wholly consistent at this stage of the proceedings. As California courts recognize, a
defendant seeking to invoke the special motion to strike need not first establish its actions
are constitutionally protected under the First Amendment as a matter of law. “If this
were so the second clause of subdivision (b) of section 425.16 would be superfluous
because by definition the plaintiff could not prevail on its claim.” (Wilcox v. Superior
Court, supra, 27 Cal.App.4th at p. 820.)
35
methodologies by which any nationally recognized statistical rating organization
determines credit ratings.”24 (15 U.S.C. § 78o-7(c)(1)-(2).) With respect to the first
provision, the Rating Agencies contend “CalPERS’s claim is barred . . . to the extent [it]
alleges that the Rating Agencies violated conflict-of-interest policies or other internal
standards or procedures.” With respect to the second provision, they contend the claim is
barred “in light of the fact that it is a direct attack on the ‘procedures and methodologies’
employed by the Rating Agencies in rating the SIV notes at issue.” The following legal
principles govern their contentions.
“Under the supremacy clause of the United States Constitution (art. VI, cl. 2),
Congress has the power to preempt state law concerning matters that lie within the
authority of Congress. [Citation.] In determining whether federal law preempts state law,
a court’s task is to discern congressional intent. [Citation.] Congress’s express intent in
this regard will be found when Congress explicitly states that it is preempting state
24
These provisions of the CRARA provide in relevant part:
“(c) Accountability for ratings procedures.
(1) Authority. The Commission shall have exclusive authority to enforce the provisions
of this section in accordance with this title [15 USCS §§ 78a et seq.] with respect to any
nationally recognized statistical rating organization, if such nationally recognized
statistical rating organization issues credit ratings in material contravention of those
procedures relating to such nationally recognized statistical rating organization,
including procedures relating to the prevention of misuse of nonpublic information and
conflicts of interest, that such nationally recognized statistical rating organization--
(A) includes in its application for registration under subsection (a)(1)(B)(ii); or
(B) makes and disseminates in reports pursuant to section 17(a) [15 USCS § 78q(a)] or
the rules and regulations thereunder.
(2) Limitation. The rules and regulations that the Commission may prescribe pursuant to
this title [15 USCS §§ 78a et seq.], as they apply to nationally recognized statistical rating
organizations, shall be narrowly tailored to meet the requirements of this title [15 USCS
§§ 78a et seq.] applicable to nationally recognized statistical rating organizations.
Notwithstanding any other provision of this section, or any other provision of law,
neither the Commission nor any State (or political subdivision thereof) may regulate the
substance of credit ratings or the procedures and methodologies by which any nationally
recognized statistical rating organization determines credit ratings. Nothing in this
paragraph may be construed to afford a defense against any action or proceeding brought
by the Commission to enforce the antifraud provisions of the securities laws.” (15 U.S.C.
§ 78o-7(c)(1)-(2), Italics added.)
36
authority. [Citation.]” (Farm Raised Salmon Cases (2008) 42 Cal. 4th 1077, 1087-1088.)
“The interpretation of the federal law at issue . . . is further informed by a strong
presumption against preemption. [Citations.] ‘[B]ecause the States are independent
sovereigns in our federal system, we have long presumed that Congress does not
cavalierly pre-empt state- law causes of action. In all pre-emption cases, and particularly
in those in which Congress has “legislated . . . in a field which the States have
traditionally occupied,” [citation], we “start with the assumption that the historic police
powers of the States were not to be superseded by the Federal Act unless that was the
clear and manifest purpose of Congress.” [Citations.]’ (Medtronic [Inc. v. Lohr (1996)]
518 U.S. [470,] 485; [citations]. We apply this presumption to the existence as well as the
scope of preemption. (Medtronic, supra. 518 U.S. at p. 485.)” (Farm Raised Salmon
Cases, supra, 42 Cal.4th at p. 1088 [italics added]. See also Rice v. Santa Fe Elevator
Corp. (1947) 331 U.S. 218, 230 [express preemption of state law can only be found
where it is the “clear and manifest purpose of Congress”].)
Applying these principles, we do not find within the CRARA the requisite “clear
and manifest” purpose of Congress to preempt state common law actions for negligent
misrepresentation against NRSROs. In so concluding, we rely on several factors. First,
such tort claims for fraud or deceit are within a field traditionally occupied by the States,
a fact that generally weighs against finding preemption. (Fenning v. Glenfed, Inc. (1995)
40 Cal. App. 4th 1285, 1298 [“actions for fraud are governed almost exclusively by state
law, and do not raise issues of great federal interest”]; Farm Raised Salmon Cases, supra,
42 Cal.4th at p.1088.) In fact, as our appellate colleagues long ago recognized:
“California’s policy is to protect the public from fraud and deception in securities
transactions.” (Hall v. Superior Court (1983) 150 Cal. App. 3d 411, 417.)
However, even more significant to our conclusion is the fact that we find nothing
in the Act’s language amounting to a clear and undeniable indication Congress was
acting to extinguish the right of private individuals to sue NRSROs in state court for
negligently or intentionally issuing false or misleading credit ratings. Specifically, with
respect to the authorization provision in subdivision (c)(1), we agree with CalPERS that
37
the Agencies’ express preemption argument ignores key language within that provision
that limits the scope of exclusive enforcement authority granted the SEC. Specifically,
the provision states:
“The Commission shall have exclusive authority to enforce the provisions of this section
. . . with respect to any [NRSRO], if such [NRSRO] issues credit ratings in material
contravention of those procedures relating to such [NRSRO], including procedures
relating to the prevention of misuse of nonpublic information and conflicts of interest,
that such [NRSRO] ─
(A) includes in its application for registration under subsection (a)(1)(B)(ii); or
(B) makes and disseminates in reports pursuant to section 17(a) [15 USCS § 78q(a)]
or the rules and regulations thereunder.” (Italics added.)
Here, there is no allegation the Rating Agencies issued ratings in material
contravention of any procedure included in their application for registration under the
CRARA or made or disseminated in any reports filed on their behalf “pursuant to section
17(a) [15 USCS § 78q(a)] or the rules and regulations thereunder.” To the contrary,
CalPERS has not raised any issue in this case with respect to the Agencies’ compliance
or noncompliance with any aspect of the CRARA. (Accord Anschutz Corp. v. Merrill
Lynch & Co., supra, 785 F.Supp.2d at pp. 829-830 [“The Authorization Provision gives
the SEC exclusive authority to enforce the provisions of the CRARA and rules issued by
the SEC, [fn. omitted] but there is no language to indicate that the SEC’s exclusive
authority extends to enforcement of claims that arise from sources other than the
CRARA”].)
With respect to the second provision relied upon by the Rating Agencies – to wit,
the limitation provision – we again do not find the statutory language sufficiently clear to
establish congressional intent to wholly eliminate our particular type of legal claim (and
to do so, we add, without any proposal for an alternative system of redress for private
victims of misleading or deceptive ratings). As CalPERS notes, this provision can, quite
reasonably, be interpreted more narrowly to prohibit the SEC and individual States from
requiring NRSROs to use a particular methodology, procedure or substantive criterion to
38
determine ratings, while continuing to permit them to address NRSRO conduct (or
misconduct) with respect to other subject matters such as issuing deceptive ratings.
While arguably the statutory text could also be interpreted in the broad manner suggested
by the Agencies, under the constitutional principles set forth above, we decline to find
express preemption in an atmosphere of such uncertainty.25 (Bates v. Dow Agrosciences,
LLC (2005) 544 U.S. 431, 449 [when a statutory preemption clause is susceptible to
multiple plausible readings, courts generally “accept the reading that disfavors pre-
emption”].)
In any event, we need not determine for purposes of this appeal whether this
lawsuit falls entirely outside the scope of the limitation provision. The Rating Agencies
may be correct certain issues or theories raised by CalPERS, such as those relating to
alleged deficiencies in rating models or data, effectively seek to “regulate the substance
of credit ratings or the procedures and methodologies by which any [NRSRO] determines
credit ratings.” (15 U.S.C. § 78o-7(c)(2).) However, the Rating Agencies will have an
opportunity after full discovery to reassert any preemption argument worthy of merit.
(See In re Nat'l Century Fin. Enters., Inc. Inv. Litig. (S.D. Ohio 2008) 580 F.Sup.2d 630,
651 [“the Court is not prepared to hold that § 78o-7(c)(2) broadly preempts state
regulation, without the benefit of fuller briefing of the issue and of what the phrase
‘regulate the substance of credit ratings’ means. See Kenneth C. Kettering, Securitization
and its Discontents: The Dynamics of Financial Product Development, 29 Cardoza L.
25
We are not the first court to reach this conclusion with respect to the CRARA’s
limitation provision. (See Genesee County, supra, 825 F. Supp. 2d 1082, 1256 [“when a
statute used the term ‘regulate,’ the phrase ‘regulate the substance of credit ratings or the
procedures and methodologies by which any nationally recognized statistical rating
organization determines credit ratings’ does not suggest the Congress intended to
preempt claims regarding fraud or misrepresentation, particularly given the clause
reserving such enforcement authority to the SEC”]. Accord Anschutz Corp. v. Merrill
Lynch & Co., supra, 785 F.Supp.2d at p. 829 [“The Limitations Provision . . . prohibits
only laws that seek to regulate the ‘substance of credit ratings’ or the ‘procedures or
methodologies’ by which NRSROs determine credit ratings. There is nothing in the
legislative record cited by the Agencies to support their expansive preemption
argument”].)
39
Rev. 1553, 1688-1689 (2008) (noting from the legislative history that § 78o-7(c)(2) was a
‘last-minute amendment’ which appears to preempt state law ‘to some extent,’ and,
though a ‘broad reading of what it means to “regulate the substance” of a rating is
discouraged,’ the exact extent of preemption is ‘a question about which reasonable minds
might differ’ ”)].) We nonetheless are confident at this stage at least some of CalPERS’
claim is capable of surviving preemptive challenge. A fair reading of the complaint
demonstrates CalPERS does not necessarily seek to impose a legal duty to employ any
particular rating procedure or methodology within the meaning of the limitation
provision, but rather to enforce the duty to issue non-misleading ratings.
Finally, we make one additional observation. The Rating Agencies have ignored
another provision of the CRARA, the “savings provision,” that appears to further weigh
against preemption. This provision has two parts, the first of which states: “No
provision of the laws of any State or political subdivision thereof requiring the
registration, licensing, or qualification as a credit rating agency or a nationally recognized
statistical rating organization shall apply to any nationally recognized statistical rating
organization or person employed by or working under the control of a nationally
recognized statistical rating organization.” The second part then states: “Nothing in this
subsection prohibits the securities commission (or any agency or office performing like
functions) of any State from investigating and bringing an enforcement action with
respect to fraud or deceit against any nationally recognized statistical rating organization
or person associated with a nationally recognized statistical rating organization.” (15
U.S.C. § 78o-7, subd. (o).)
This language, we conclude, indicates that Congress, when enacting the CRARA,
knew exactly how to preserve certain types of laws or claims (i.e., State-brought
enforcement actions alleging fraud or deceit), while doing away with others (i.e., State
laws requiring registration, licensing or qualification of an NRSRO). And, more to the
point, the provision indicates that, if the Rating Agencies were correct that Congress
intended to also do away with private legal actions, like this one, alleging fraud or deceit,
Congress could have, and would have, simply added the necessary language to the
40
statute. As such, the provision further supports our holding. (See Medtronic Inc. v. Lohr,
supra, 518 U.S. at p. 486 [congressional intent is “discerned from the language of the
pre-emption statute and the ‘statutory framework’ surrounding it,” as well as from
“ ‘structure and purpose of the statute as a whole’ ”]. Accord Anschutz Corp. v. Merrill
Lynch & Co., supra, 785 F.Supp.2d at pp. 828-829.)
Accordingly, for all the reasons stated, the Rating Agencies have failed in their
burden to prove a complete defense to CalPERS’ cause of action. (Peregrine Funding,
supra, 133 Cal.App.4th at p. 676.)
III. Evidentiary Rulings.
Finally, CalPERS challenges the trial court’s exclusion of six exhibits relating to
certain of the defendants’ rating activities (to wit, Exhibits 20 through 22, and 24 through
26). Specifically, the exhibits, attached to the declaration of Daniel Barenbaum, consist
of Standard & Poor’s internal documents produced to the U.S. Senate subcommittee
pursuant to its investigation into the financial crisis of years 2007 and 2008.26 CalPERS
offered this evidence as part of its showing that the Rating Agencies lacked a reasonable
basis to believe the accuracy or truthfulness of their ratings. The trial court, however,
excluded it after concluding the exhibits were irrelevant and/or speculative.27
Evidentiary challenges are reviewed only for abuse of discretion. (Powell v.
Kleinman (2007) 151 Cal. App. 4th 112, 122.) As such, we will not overturn an
evidentiary ruling on appeal unless “the trial court exceeded the bounds of reason, all of
26
For example, Exhibit 20 of the Barenbaum Declaration purports to capture a 2007
electronic mail exchange between S&P’s analysts, in which one analyst states “that deal
is ridiculous [¶] . . . [¶] we should not be rating it,” and a second analyst responds: “we
rate every deal [¶] it could be structured by cows and we would rate it.”
Exhibit 22, another apparent electronic mail exchange, states in part:
“We are meeting with your group this week to discuss adjusting criteria for ratings CDOs
of real estate assets this week [sic] because of the ongoing threat of losing deals. I am
much less concerned about whether it is an actual investor attack or not. Whatever the
reason, the fact is, bonds below ‘AAA’ are pricing wider which impacts the weighted
average pricing on the deals. . . .”
27
The parties agreed not to raise hearsay or authenticity objections in connection
with the anti-SLAPP motion.
41
the circumstances before it being considered.” (In re Marriage of Connolly (1979) 23
Cal. 3d 590, 598; see also People v. Preyer (1985) 164 Cal. App. 3d 568, 573.)
Here, CalPERS contends the trial court’s ruling was an abuse of discretion
because each of the excluded exhibits is “plainly relevant” to one or both of the following
Prong Two issues: (1) whether the Rating Agencies had reasonable grounds for believing
the accuracy of their own ratings; and (2) whether the Agencies had “a culture and
attitude about profit over truthfulness and accuracy with respect to structured-finance
ratings.”
We disagree. Relevant evidence, of course, is that which has “any tendency in
reason to prove or disprove any disputed fact that is of consequence to the determination
of the action.” (Evid. Code, § 210.) Here, as the trial court noted, not one of the
excluded exhibits mentions the type of securities named in this complaint – mainly, SIVs.
Rather, they appear to relate to other types of securities such as RMBS and CDOs. While
CalPERS insists the exhibits nonetheless are relevant because those other types of
securities were found in the SIV portfolios, the fact remains there is nothing in the
exhibits to link any particular CDO or RMBS mentioned in the exhibits to the portfolios
of the SIVs identified in this lawsuit – to wit, the Cheyne, Sigma or Stanfield Victoria
SIVs. Nor does CalPERS, the party with the burden to prove error, offer any evidence of
an appropriate link between the securities identified in the exhibits and those identified in
the complaint. As such, we conclude the trial court had a reasonable basis to exclude the
exhibits as irrelevant or overly speculative. (E.g., People v. Babbitt (1988) 45 Cal. 3d
660, 682 [upholding the trial court’s exclusion of evidence where “[t]he inference which
[offering party] sought to have drawn from the [proffered evidence] is clearly
speculative, and evidence which produces only speculative inferences is irrelevant
evidence”].) We decline to second-guess the trial court’s decision in this regard given
that it appears neither arbitrary nor irrational on this record. (People v. Preyer, supra,
164 Cal.App.3d at p. 573.)
42
DISPOSITION
The trial court’s order denying the Rating Agencies’ anti-SLAPP motion is
affirmed in full. The parties shall bear their own costs on appeal.
_________________________
Jenkins, J.
We concur:
_________________________
McGuiness, P. J.
_________________________
Siggins, J.
California Public Employees’ Retirement System v. Moody’s Investors Service, Inc. et al., A134912
43
Trial Court: Superior Court, San Francisco County
Trial Judge: Hon. Richard A. Kramer
Counsel for Plaintiff and Appellant: Berman DeValerio Pease & Tabacco
California Public Employees’ Retirement Joseph J. Tabacco Jr.
System Todd A. Seaver
Daniel E. Barenbaum
Counsel for Defendant and Appellant: Wilson Sonsini Goodrich & Rosati
Moody’s Investors Service, Inc. et al., Keith E. Eggleton
David A. McCarthy
Satterlee Stephens Burke & Burke
Joshua M. Rubins
James J. Coster
James I. Doty
Counsel for Defendant and Appellant: Perkins Coie
The McGraw-Hill Companies, Inc. David Biderman
Joren S. Bass
Judith B. Gitterman
Cahill Gordon & Reindel
Floyd Abrams
Dean Ringel
Whitney M. Smith
California Public Employees’ Retirement System v. Moody’s Investors Service, Inc. et al., A134912
44