There is plenty of blame to go around in the credit crisis, and many investors and public officials have been placing it on the credit rating agencies that gave AAA ratings to some of the mortgage-backed financial instruments that allegedly contributed to billions in investor losses.

Attorneys general in Connecticut and Ohio have sued the big three rating agencies–Standard & Poor’s, Moody’s and Fitch–and, in May, New York Attorney General Andrew Cuomo’s office was revealed to be investigating the relationship between the ratings agencies and certain banks that peddled mortgage-backed securities. (Cuomo settled an investigation into the rating agencies’ conduct leading up to the sub-prime mortgage meltdown in 2008.) Moody’s just disclosed that it received a Wells notice indicating a forthcoming SEC action. And more stringent regulation of the rating agencies is part of the financial reform package the Senate just passed.

“People bought this stuff that was rated Triple-A, and it went up in flames right and left,” says Michael Gass, chair of the Securities Litigation and Corporate Governance Practice at Choate Hall & Stewart. “While there’s been longstanding criticism of credit rating agencies, the sub-prime market securitization debacle really brought that issue to a very fine and intense point.”

And the private litigation against the rating agencies is unfurling as well. The New York Times reported in May that of approximately 30 lawsuits against the agencies, judges have ruled on motions to dismiss in 15, with the rating agencies prevailing 12 times. Five have been dropped. But the tide may be turning.

“We’re seeing now a very small handful of cases where plaintiffs’ claims against the rating agencies are going forward,” says Kevin LaCroix, an attorney and a partner at Oakbridge Insurance Services. “At the outset of the litigation wave [against the rating agencies] there was some question of whether anybody would get anywhere because of the rating agencies’ success in past litigation.” But LaCroix emphasizes that plaintiffs’ success in recent litigation doesn’t necessarily mean a wave of huge losses is about to hit the rating agencies–plaintiffs in these cases still face numerous hurdles.

Contemporaneous Crisis

In one case in the Federal District Court for the Southern District of New York, Judge Shira Scheindlin rejected Moody’s and S&P’s motion to dismiss claims that their ratings fraudulently misrepresented the value of a structured investment vehicle named Rhinebridge, which plaintiffs called “the shortest-lived Triple-A investment fund in the history of corporate finance.” Scheindlin’s ruling at the motion to dismiss stage is a rare example of plaintiff success in litigation against the credit rating agencies.

In their motion to dismiss in King County, Washington v. IKB Deutsche Industriebank AG, et al., Moody’s and S&P argued that the plaintiffs’ losses were caused by the broader credit crisis, not their ratings of the Rhinebridge SIV.

Scheindlin didn’t buy the defense, writing in an April 26 order, “To hold that plaintiffs failed to plead loss causation solely because the credit crisis occurred contemporaneously with Rhinebridge’s collapse would place too much weight on one single factor and would permit S&P and Moody’s to blame the asset-backed securities industry when their alleged conduct plausibly caused at least some proportion of plaintiffs’ losses.”

The ruling is a big blow to the “broader credit crisis” defense being raised at the motion to dismiss stage in these suits (see “Elephant in the Room”).

Unprotected Speech

Another defense that has taken some recent hits is what Adam Savett calls “the strongest arrow in the quiver” for the rating agencies: the argument that the ratings, as the agencies’ opinions, are protected by the First Amendment.

“I have trouble recalling a single case prior to 2008 where any of the credit rating agencies wasn’t successful with the First Amendment defense,” says Savett, director of Securities Class Action Services at RiskMetrics Group. “But starting in 2008, the allegation wasn’t simply that the agency had an improper or incorrect rating, it’s that instead of simply acting as a credit rater that they are involved in the design, implementation and issuance of the securities they rated.”

In one such case in the Southern District of New York, Abu Dhabi Commercial Bank v. Morgan Stanley, Judge Scheindlin wrote that First Amendment protections may protect rating agencies because “their ratings are considered matters of public concern.”

“However,” she continued, “where a rating agency has disseminated their ratings to a select group of investors rather than to the public at large”–as was the case in Abu Dhabi Commercial Bank–”the rating agency is not afforded the same protection.”

In another high-profile case in which CalPERS, the country’s largest pension fund, is making similar claims against rating agencies, California Judge Richard Kramer also rejected a First Amendment defense on April 30, relying in part on Scheindlin’s earlier ruling in Abu Dhabi Commercial Bank.

“Even though there have only been a small number of decisions, … each time it gives plaintiffs more authority on which to rely and more to argue in future cases,” LaCroix says. Incrementally, this is helping their position in other cases.”

If the rating agencies do maintain their winning streak in the courtroom in the current wave of litigation, Gass believes they still won’t get off scot free forever.

“I think we’ll see more legislative efforts to reform the system and continue to see plaintiffs, private attorneys and AGs go after rating agencies on common law and state fraud theories,” he says. “Because federal securities claims just haven’t worked.”