Cal. Pub. Employees' Ret. Sys. v. Moody's Investors Serv., Inc.

226 Cal.App.4th 643

172 Cal.Rptr.3d 238

CALIFORNIA PUBLIC EMPLOYEES' RETIREMENT SYSTEM, Plaintiff and Appellant,

v.MOODY'S INVESTORS SERVICE, INC. et al., Defendants and Appellants.

A134912

Court of Appeal, First District, Division 3, California.

Filed May 23, 2014

See 5 Witkin, Cal. Procedure (5th ed. 2008) Pleading, § 1025 et seq.

Superior Court, San Francisco County, Hon. Richard A. Kramer (San Francisco County Super. Ct. No. CGC–09–490241)

Counsel for Plaintiff and Appellant California Public Employees' Retirement System: Berman DeValerio Pease & Tabacco, Joseph J. Tabacco Jr., Todd A. Seaver, Daniel E. Barenbaum, San Francisco

Counsel for Defendant and Appellant Moody's Investors Service, Inc. et al.,: Wilson Sonsini Goodrich & Rosati, Keith E. Eggleton, David A. McCarthy, Palo Alto, Satterlee Stephens Burke & Burke, Joshua M. Rubins, James J. Coster, James I. Doty

Counsel for Defendant and Appellant The McGraw–Hill Companies, Inc.: Perkins Coie, David Biderman, Joren S. Bass, Judith B. Gitterman, Los Angeles, Cahill Gordon & Reindel, Floyd Abrams, Dean Ringel, Whitney M. Smith

Jenkins, J.

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 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, 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 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 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 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...