The First Amendment Defense Fails – Standard & Poor’s Misled Investors

The Market Ticker – The First Amendment Defense Fails (In Australia)

It’s about damn time….

The New South Wales councils, including Bathurst and Corowa, brought a class action against S&P, investment bank ABN AMRO and Local Government Financial Services (LGFS).

The councils claimed they were misled into losing almost $16 million in the financial crisis, saying S&P led them to buy complex investments called constant proportion debt obligation notes (CDPOs), which the agency had given a AAA rating.

Today’s ruling found that rating was misleading and deceptive.

Federal Court Justice Jayne Jagot described the ABN AMRO products as “grotesquely complicated” and said that the LGFS breached its fiduciary duty to the councils by not properly investigating the products.

She said S&P had been “sandbagged” while ABN AMRO “simply bulldozed the rating through”.

Now it may be fine and well for someone to opine and be entitled that opinion.

But S&P, Moody’s and other NRSROs do more than just “opine.” They hold out their opinions as expert opinions, and more-so they lobby for and are the beneficiary of laws and regulations that in many cases require their ratings before some entity can purchase a given security.

Never mind that while there is certainly a valid First Amendment argument that one has the absolute right to free speech it is also well-within the boundaries of the law that one does not have a shield against knowingly false speech.

In other words there is a huge difference between being wrong and knowingly being wrong, either through willful blindness or deliberate falsehood.

This, incidentally, is the same issue I have with a number of the investment banks, who created products at the behest of some client who wanted to take a short position and then marketed them as good long investments without disclosing that the reason they existed was that someone wanted the other side — in other words, that they were created by someone expecting them to fail.

This weekend I had an interesting conversation with a “registered investment advisor” (but not for my account; off-the-record) and our conversation turned to the markets. He and I are on decidedly opposite sides when it comes to what we think is going to happen, and his closing argument was simply “you’re wrong.”

Ok, we shall see. My retort of course is “sold to you!” and that’s what makes a market — two people with opposing ideas of what value is. One of us will be right and one of us will be wrong.

But neither of us has a fiduciary duty to the other; in the case where I was his paying client things change. In that case there is a fiduciary duty.

S&P, Moody’s, Fitch and others argue that they have no such duty. I disagree; if your models are going to be required before someone can buy something, effectively going from a voluntary advisory position to that of a mandatory rating, then I argue that you have a fiduciary duty to those who rely on those ratings — because without those consumers of your product, whether you’re paid by them or not, you are out of business.

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