Can rating agencies invoke the protection of the First Amendment? The answer is: it depends. On February 4, 2013, the Department of Justice (“DOJ”) brought civil suit against McGraw-Hill and its subsidiary, S&P LLC (“S&P”), under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”). The complaint alleges that from 2004-2007, S&P defrauded federally insured financial institutions by falsely representing its ratings of Residential Mortgage Backed Securities (“RMBS”) and Collateralized Debt Obligations (“CDOs”) as objective, independent, and uninfluenced by conflicts of interests. According to the complaint, those representations caused federally insured financial institutions to invest in unstable financial products at artificially low rates of return, exposed them to actual losses and increased risk of losses, and provided a windfall to S&P, which earned fees that were incorporated into the price of the allegedly overrated financial product.

Although the suit has made headlines, it is not the first of its kind. Since Enron’s collapse in 2001, rating agencies, including S&P, have defended suits predicated on similar theories, at least in part, by arguing that their ratings are protected speech. Within the last month, S&P asserted this defense preemptively in South Carolina,1 requesting judicial determinations that the First Amendment bars consumer protection claims based on S&P’s ratings.

Rating agencies have had mixed success asserting the First Amendment defense against claims based on their ratings of financial products. The defense has worked best in suits alleging that the agencies’ ratings constituted some form of negligent misrepresentation.2 Most courts that have considered the issue have held that ratings receive the same level of protection as other forms of journalism because the process of rating an investment is similar to publishing an opinion piece in a newspaper or blog in that each involves complex and subjective considerations of large amounts of data. That level of First Amendment protection precludes tort and contract claims unless the plaintiff can show “actual malice.” The precise contours of “actual malice” vary, but the standard usually requires showing that the defendant had serious doubts about the accuracy of the reporting. Negligence is not enough to carry that burden. Consequently, the First Amendment shields the rating agencies from liability where the only issue is the ratings’ reasonableness, or where the plaintiff cannot show the rating agencies acted with heightened culpability.

Nevertheless, plaintiffs have circumvented the rating agencies’ First Amendment defense, either by attacking the comparison to journalism or by showing “actual malice.” Courts have been more willing to jettison the journalism privilege where the rating agencies allegedly distributed their ratings to a select group of investors, rather than the general public. The rationale for denying rating agencies the journalist privilege in those cases is that, by limiting the potential beneficiaries of the ratings, the speech is “private,” rather than a “matter of public concern.” Private speech is not subject to the heightened First Amendment protection given to other forms of reporting. Without that level of protection, the First Amendment offers no defense against allegations based on negligence. For a similar reason, that defense has also been less successful where the rating agencies allegedly misled investors about their opinions. Even opinions may receive reduced First Amendment protection where the speaker does not genuinely and reasonably believe the opinion, or where the opinion has no basis in fact.

The DOJ’s most recent suit against S&P attempts to exploit these potential weaknesses in S&P’s prospective First Amendment defense. First, by bringing a cause of action based on the FIRREA, the DOJ limited the universe of potential victims to a handful of federally insured financial institutions. By itself, that does not resolve the question of whether the ratings were sufficiently disseminated to permit a defense based on the First Amendment. However, limiting the potential victims to a circumscribed group of companies who are in the same industry and who are, presumably, all major customers of the defendants suggests that DOJ may argue that the ratings at issue in this case were targeted at a select group of investors.

More importantly, the complaint alleges fraud, which satisfies the “actual malice” requirement and thus is not protected by the First Amendment. The DOJ contends, essentially, that S&P knew the rated entities were not as sound as their ratings suggested. If proven, these allegations would not be defensible on First Amendment grounds.

As prior precedent supports, the First Amendment is not a one size fits all defense available to rating agencies. In fact, as more case law develops concerning the interplay between the rating of financial products and the First Amendment, it is likely that plaintiffs will tailor complaints to avoid the defense altogether.