California Court of Appeals, First District, Third Division
CALIFORNIA PUBLIC EMPLOYEES' RETIREMENT SYSTEM, Plaintiff and Appellant,
MOODY'S INVESTORS SERVICE, INC. et al., Defendants and Appellants.
Superior Court, San Francisco County No. CGC-09-490241 Hon. Richard A. Kramer.
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Berman DeValerio Pease & Tabacco Joseph J. Tabacco Jr. Todd A. Seaver and Daniel E. Barenbaum for Plaintiff and Appellant.
Wilson Sonsini Goodrich & Rosati Keith E. Eggleton David A. McCarthy Satterlee Stephens Burke & Burke Joshua M. Rubins James J. Coster James I. Doty for Defendants and Appellants Moody's Investors Service, Inc. et al.
Perkins Coie David Biderman Joren S. Bass Judith B. Gitterman Cahill Gordon & Reindel Floyd Abrams Dean Ringel and Whitney M. Smith for Defendant and Appellant The McGraw-Hill Companies, Inc.
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) against plaintiff California's Public Employees’ Retirement System (CalPERS) pursuant to the so-called anti-SLAPP statute (Code Civ. Proc., § 425.16). The trial court reached this decision after finding that, although CalPERS's 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 Rating 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.
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) (2014); 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 Web sites and distribute it to financial reporting services such as Bloomberg and Reuters. 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' Web sites 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 Web sites 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. According to the complaint, in the case of SIVs,
and in particular the SIVs at issue in this lawsuit, the Rating 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. 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.
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.  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 Agencies. According to CalPERS, those ratings, on which it relied, were negligent misrepresentations.
At the time, the Rating 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. In 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 Rating 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. 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 Rating 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 (June 28, 2010, Al28793), petn. den.)
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. 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.
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 Rating 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 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.” (§ 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, p. 1291; see Ketchum v. Moses (2001) 24 Cal.4th 1122, 1130 [104 Cal.Rptr.2d 377, 17 P.3d 735].)
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 [124 Cal.Rptr.2d 507, 52 P.3d 685] (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 [34 Cal.Rptr.2d 898, 882 P.2d 894].) "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, supra, 29 Cal.4th at p. 89.)
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 [124 Cal.Rptr.2d 519, 52 P.3d 695].) 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 [81 ...