Contracts Law In Action

Moody’s Says Don’t Inhale the Smoke It’s Puffing: Jonathan Weil

Commentary by Jonathan Weil

March 12 (Bloomberg) — Just as the cover-up often is worse than the crime, sometimes the defense is even worse than the allegation.

So it is with Moody’s Corp. Over the years, the credit- rating company’s constant refrain has been it’s an independent body that publishes its opinions accurately and impartially. Never mind that it gets paid by the same companies it rates. Moody’s says it can manage that conflict of interest.

“The market’s trust in and reliance upon Moody’s” are part of the “raw materials that support our business,” the company said in its 2005 annual report. “Independence. Performance. Transparency,” it went on. “These are the watchwords by which stakeholders judge Moody’s.” Moody’s also cites its code of professional conduct , through which it seeks “to protect the quality, integrity and independence of the rating process.”

Now compare that with what Moody’s told a federal judge in New York last September in response to accusations made in a shareholder lawsuit, which said Moody’s claims of independence were false.

“Generalizations regarding integrity, independence and risk management amount to no more than puffery,” Moody’s said in court papers. As such, alleged “misstatements of this nature are insufficient to sustain a claim under the securities laws.”

Puffery, huh?

Making Sense

Finally, Moody’s has delivered a sensible explanation for how its ratings became so unreliable: It didn’t believe its own platitudes, or at least it didn’t think they would be binding in court. The defense hasn’t worked, though. On Feb. 18, the judge in the case rejected Moody’s puffery argument, and ordered that the lawsuit proceed.

In legalese, puffery refers to an expression of opinion by a seller that isn’t made as a representation of fact. It may be a salesperson’s exaggeration about a product’s quality that isn’t a legally enforceable promise. Or it might be an ad that claims a company’s product is superior, as Black’s Law Dictionary explains it. Think of a dealer who says a car “drives great,” or a beer commercial with the slogan “less filling.”

For all the toxic mortgage-backed securities and structured- finance garbage that Moody’s rated as AAA, I never imagined Moody’s would use the word puffery to characterize the principles it brought to the job of grading investments that wind up in the portfolios of retirement funds and money-market accounts. It would be like the pope revealing that his belief in God was just fluff, or Mister Rogers complaining that small children were awful to be around.

‘Legal Term’

Even worse was the way a Moody’s P.R. man, Anthony Mirenda , tried to talk his way out of the company’s doublespeak.

“To clarify, the word ‘puffery’ is a legal term that was used to describe a category of statements that cannot be the basis of a lawsuit,” Mirenda told me. “Our legal team’s use of that term does not suggest that these statements are in any way false and does not in any way diminish Moody’s long-standing commitment to the integrity and independence of our ratings.”

Uh, right. Just to be sure, I asked Mirenda if what he told me was puffery. “No, that statement is not puffery,” he said. Somehow, Moody’s statements about integrity and independence are puffery when the company is writing to a judge, yet not when its spokesman is talking to a nosy journalist.

The plaintiffs in the suit, led by a Teamsters union pension fund, cited newspaper articles chronicling occasions when Moody’s changed its rating in response to a customer’s complaint to keep the client’s business, replaced analysts seen as too cautious, or reassigned others after complaints by bankers.

Inevitable Complacency

In one instance, reported last year by the Financial Times , when Moody’s employees found a computer error had caused some debt ratings to be inflated, the company responded by changing the methodology it used rather than cutting the ratings.

In an October 2007 presentation to Moody’s directors, released last year by congressional investigators , Moody’s Chief Executive Officer Raymond McDaniel said adding more safeguards “does NOT solve the problem” of erosions in ratings integrity, and that “a certain complacency about ratings quality is inevitable.”

Taken together, U.S. District Judge Shirley Wohl Kram wrote in her order, the facts as alleged by the plaintiffs “belie defendants’ claims of independence and ratings integrity.” Similarly, she wrote, “the revelations that it altered ratings at the request of issuers called into question Moody’s claim that it ‘maintains independence in its relationship with issuers and other interested entities.’”

Speaking Truth

Since February 2007, Moody’s share price has fallen about 75 percent. And at its core, the plaintiffs say their case is about Moody’s disclosures. Had investors known that “Moody’s fastest growing and most lucrative business segment was operating in contravention of defendants’ representations,” their evaluation of the stock would have been different, the plaintiffs said in their June 2008 amended suit.

As bad as Moody’s missteps have been, though, it’s hard to think of anything potentially more damaging to the company’s reputation than its own claim that its talk of independence and integrity was just smoke.

The problem for Moody’s is that, this time, the public might believe it was speaking the truth.

(Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Jonathan Weil in New York at jweil6@bloomberg.net

To read Judge Kram’s opinio0n go to 2009 WL 435323