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Ronald M. Grassi and Sally Grassi v. Moody's Investor's

August 5, 2011



This case came before the court on July 9, 2010, for hearing of defendants' joint motion to dismiss plaintiffs' first amended complaint with prejudice pursuant to Federal Rule of Civil Procedure 12(b)(6). Attorneys Joshua Rubins*fn1 and David A. McCarthy appeared for defendant Moody's Investors Service, Inc. Attorneys Floyd Abrams and David Taro Biderman appeared for defendant The McGraw-Hill Companies, Inc., sued as Standard & Poor's. Attorneys Jonathan A. Patchen and Andrew Erlich appeared for defendant Fitch, Inc. Plaintiffs Ronald Grassi and Sally Grassi, proceeding pro se, appeared on in propria persona. The parties' arguments were heard, and defendants' motion to dismiss was submitted.

Having considered all written materials filed in connection with defendants' motion, the parties' arguments at the hearing, and the entire file, and after conducting extensive research, the undersigned will recommend that defendants' motion be granted and this case be dismissed.


Plaintiffs filed a pro se complaint in Placer County Superior Court on January 26, 2009. On the form used in California state courts to allege claims for personal injury, property damage, and wrongful death, plaintiffs alleged claims of (1) negligence and (2) fraud and deceit against defendants described as "Moody's Investor's Services, Standard and Poor's, Fitch" and DOES 1 to 10. (Def'ts' Notice of Removal, Ex. B.) The three named defendants joined in removing the case to federal court by notice filed February 25, 2009. Defendants asserted federal jurisdiction based on complete diversity of citizenship, with an amount in controversy exceeding $75,000.

Plaintiffs' motion for remand was denied by order filed May 15, 2009. (Doc. No. 41.) On March 29, 2010, the defendants' separate motions to dismiss plaintiffs' original pleading were granted with leave to amend. (Doc. No. 79.) Plaintiffs' First Amended Complaint was filed on April 8, 2010. (Doc. No. 80.) Defendants responded by filing the joint motion to dismiss now before the court. (Doc. No. 85.)


In their amended pleading, plaintiffs allege three causes of action: (1) negligent misrepresentation, (2) intentional misrepresentation, (3) aiding and abetting. (First Am. Compl. (Doc. No. 80).) Plaintiffs allege that they are co-owners of two bonds issued by Lehman Brothers and that the bonds were rated by all three defendants. (Id. at 1.)

In a section of their amended complaint titled "Background Leading up to How and Why the Defendants Over-Rated Lehman Brother's [sic] Corporate Bonds Which Were Then Sold to Plaintiffs and Are Now Worthless," plaintiffs present conclusory assertions, opinion, and argument concerning mortgage-backed securities, corporate bonds, and the role of the rating agencies in the sale of corporate bonds backed by mortgages. (Doc. No. 80 at 3-8.) In the final sentences of this section of the amended complaint, plaintiffs allege that they were not aware of Lehman Brothers' failing financial health, believed in the credibility and reputation of the rating agencies, purchased two corporate bonds carrying an investment grade rating by each defendant, and lost the value of their bonds and the income stream "promised" in connection with those bonds, in the amount of $145,000.00. (Id. at 8.)

I. Claim 1: Negligent Misrepresentation

Plaintiffs allege negligent misrepresentation by all defendants as follows:

defendants assigned materially false and misleading investment grade credit ratings to the Lehman Brothers bonds purchased by plaintiffs; when the ratings were assigned, defendants knew or should have known that their representations were false and misleading because Lehman Brothers was in severe financial distress; Lehman Brothers' financial statements reflected millions of dollars of toxic and unsellable assets as well as unrealistically high valuations of several assets on Lehman Brothers' books; the rating agencies failed to downgrade their ratings of the bonds when it became common knowledge on Wall Street that Lehman Brothers was in a tenuous and declining financial condition and there was little reason to expect Lehman Brothers to avoid bankruptcy; in rating Lehman Brothers' bonds, defendants ignored or failed to take into consideration the unduly high and extremely risky leverage of approximately 44 to 1 employed by Lehman Brothers; defendants ignored or failed to take into consideration indications of financial irregularities in Lehman Brothers' financial statements from 2004-2008; defendants ignored or failed to take into consideration the fact that Lehman Brothers was carrying its assets at "fair value" despite the fact that their actual values had dropped by as much as 50% and did not support assignment of investment grade ratings to the bonds at issue; defendants did not examine the mortgages supporting the bonds that were being rated but instead used outmoded models based on mortgage default data from the 1990's through 2002 for conventional mortgages; defendants failed to note in their analysis that Lehman Brothers was having increasing difficulty in obtaining credit by the first quarter of 2008; defendants ignored the need for, or failed to require, Lehman Brothers to increase its collateral to justify an investment grade rating; defendants failed to disclose to the public that there was a conflict of interest between defendants and Lehman Brothers, who was paying defendants extraordinary fees for the highest ratings possible; defendants lacked the manpower to complete a professional analysis of the risks inherent in the bonds at issue, given the complexity and high volume of bonds they were asked to rate on a weekly basis; defendants ignored or failed to consider in their risk analysis the rapidly escalating defaults of subprime-backed securities in contrast with their outdated business model based on default rates pre-2003 for traditional loans. (Id. at 8-13.)

Plaintiffs further allege that defendants communicated their false and misleading ratings to brokerage houses throughout the United States, including plaintiffs' brokers, knowing that the brokers would rely on the ratings and communicate them to their clients; defendants knew that their ratings would provide assurance of the creditworthiness of Lehman Brothers, which was information needed by plaintiffs and other conservative bond investors who were likely purchasers of these particular bonds; communication of false ratings to brokers created privity and a business and fiduciary relationship between defendants and the conservative bond investing public, including plaintiffs; defendants knew that investors looking for safe investment grade bonds would also be apprised of Lehman Brothers' bonds from information widely available on the internet and in financial magazines and newspapers and knew that the targeted investors would rely on the false and misleading ratings assigned by defendants for the purpose of aiding Lehman Brothers in selling the over-priced bonds needed to shore up Lehman Brothers' faltering financial condition and for the purpose of earning large sums of money in exchange for assigning false and misleading ratings to the bonds. (Id. at 13-14.)

Plaintiffs allege that defendants targeted a specific and limited class of investors consisting of those investors looking for safe investment grade corporate bonds issued from investment banks not likely to fail and likely to pay to maturity all that was promised under the terms of the bonds; such investors seek safe corporate bonds paying a modest rate of return rather than investments that might yield a higher return but at a greater risk of default; for such investors, the primary goals are safety and preservation of capital; defendants knew that their ratings would be communicated to such investors seeking safe investment grade bonds and intended their ratings to benefit and guide these investors, who would be likely to factor defendants' ratings into their purchase decisions; defendants knew that conservative bond investors would rely on defendants' ratings in purchase decisions often involving thousands of dollars because the targeted group has no realistic alternative to such reliance, given (a) the complexity of the subject bonds, (b) the cost to any individual investor who retains the services of an outside valuation firm to value bonds and their risk of default, (c) the ratings companies' access to information not available to the average investor, and (d) the ratings companies' claim that their ratings were made after careful, professional, objective, thorough, and honest examination of extensive and complex financial records. (Id. at 14-16.)

Plaintiffs allege that defendants had a duty to publish accurate information and this duty was owed to the public at large and in particular to the conservative bond investors targeted for sale of Lehman Brothers' corporate bonds; defendants engaged in a campaign to attract investors like plaintiffs and in so doing were not independent analysts but acted to assist Lehman Brothers in its sale of bogus securities instead of providing neutral, professional, and objective analysis to the targeted investors, thereby breaching defendants' duty to plaintiffs as members of the targeted group; defendants represented to the public that they would monitor the companies whose bonds they rated and would adjust ratings if warranted; defendants breached their duty to downgrade Lehman Brothers' corporate bonds prior to Lehman Brothers' bankruptcy. (Id. at 16-17.)

Plaintiffs allege that they relied on defendants' ratings when they purchased two Lehman Brothers bonds rated by defendants as A1, AA-1, or A and that such reliance was reasonable due to the complexity of Lehman Brothers' financial statements and the prohibitive cost of employing an outside analyst. Plaintiffs allege that they suffered injury when the bonds became worthless after Lehman Brothers filed for bankruptcy in 2008. Plaintiffs allege that their loss, including principal and promised income, was approximately $145,000.00. (Id. at 17-18.)

II. Claim 2 Intentional Misrepresentation

In their second claim, plaintiffs incorporate the allegations of their first claim and further allege as follows: defendants issued ratings that were meant to indicate the risk or likelihood of default of the bonds purchased by plaintiffs; defendants' ratings of plaintiffs' bonds indicated that the risk of default was slight; defendants represented to the public on an ongoing basis that their ratings were the result of diligent, professional, honest, and objective analysis of financial records of the companies rated; the ratings of plaintiffs' bonds were not done diligently, professionally, honestly, and/or objectively, but were instead done on information and belief, knowingly or recklessly and pursuant to defendants' marketing arrangement, either express or implied, with Lehman Brothers; Lehman Brothers required as high a rating as possible for its bonds in order to sell them with the lowest interest rates possible, while defendants sought to rate as many bonds as possible in order to receive fees of several thousand dollars for each rating; defendants had already worked with Lehman Brothers to over-rate mortgage-backed securities in order to sell them to the public and took the next step of over-rating Lehman Brothers' corporate bonds without reviewing the underlying financial records and other available information about Lehman Brothers; defendants assigned false and misleading ratings with the intent to induce the public, including plaintiffs, to purchase over-rated bonds while defendants and Lehman Brothers reaped the benefits; plaintiffs relied on defendants' ratings and paid $20,000 each for two bonds; when Lehman Brothers filed for bankruptcy in September 2008, the bonds were rendered worthless; plaintiffs were injured in the sum of approximately $145,000, consisting of the face value of the bonds and the estimated stream of income promised with respect to the purchased bonds but not received; plaintiffs seek punitive damages for defendants' intentional and tortious misconduct. (Id. at 18-20.)

III. Claim 3 Aiding and Abetting

In their third claim, plaintiffs incorporate the allegations of their first and second claims and further allege as follows: defendants participated in a plan to advertise and sell Lehman Brothers' over-rated bonds to the public and received thousands of dollars in fees for issuing false ratings of worthless bonds that Lehman Brothers could not have sold without defendants' help; defendants knew or should have known that the bonds were worthless or of little value because defendants knew Lehman Brothers was over-leveraged; defendants aided and abetted Lehman Brothers in selling worthless bonds and caused damage to plaintiffs, who were persuaded to purchase bonds in reasonable reliance on defendants' misrepresentations; plaintiffs suffered damages of approximately $145,000.00 as a result of defendants' misconduct in aiding and abetting Lehman Brothers in the selling of worthless bonds. (Id. at 20-21.)

IV. Prayer for Relief

Plaintiffs seek compensatory and punitive damages with interest, their costs and expenses, and unspecified injunctive relief. (Id. at 21-22.)


Once a case has been removed from state court, it is subject to the Federal Rules of Civil Procedure.*fn2 Fed. R. Civ. P. 81(c)(1) ("These rules apply to a civil action after it is removed from a state court."). The "expansive language" of Rule 81(c) "contains no express exceptions and indicates a clear intent to have the Rules . . . apply to all district court civil proceedings." Willy v. Coastal Corp., 503 U.S. 131, 134-35 (1992). "After removal, repleading is unnecessary unless the court orders it." Fed. R. Civ. P. 81(c)(2). However, a pleading removed from state court is subject to dismissal ...

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