This past week the Wall Street Journal reported that:
Standard & Poor's Ratings Services has long declared that its letter-grade ratings are independent and objective, part of a bid to allay concerns over its business model [because] Standard & Poor's, like all major credit-rating firms, is paid by issuers to rate the securities that they sell…. Now, lawyers defending the company against the Justice Department's recent civil lawsuit say that statements about independence and objectivity are "puffery" and were never meant to be taken at face value by investors…. In its formal defense filed Monday, S&P pointed to two earlier court decisions where judges ruled that such statements by the firm were puffery and therefore can't form the basis for a fraud claim…. One of the decisions highlighted by S&P's lawyers is a March 2012 ruling by U.S. District Judge Sidney H. Stein. The judge dismissed a securities-fraud lawsuit filed by McGraw-Hill shareholders, who maintained that they bought shares in the company believing that S&P's ratings were independent and objective. "These statements were mere commercial puffery," and therefore can't form the basis for a fraud claim, Judge Stein wrote. That decision was upheld in December 2012 by the U.S. Second Circuit Court of Appeals, which S&P also highlighted in its Monday filing. "No reasonable purchaser of McGraw-Hill common stock would view statements such as these as meaningfully altering the mix of available information about the company," the three-judge panel wrote.
I have previously criticized judicial reliance on puffery as a safety valve to dismiss securities fraud claims. In “Is Puffery Material to Investors? Maybe We Should Ask Them” I noted that:
Federal securities laws make it illegal to make a material misstatement in connection with a securities transaction. Materiality is generally deemed to be a fact-intensive issue only to be resolved on the basis of pretrial motions when no reasonable shareholder could find the challenged statement material. Nonetheless, and despite assertions to the contrary, materiality is often resolved pretrial. One of the doctrines relied upon by courts to dismiss securities claims on the basis of immateriality is the puffery defense. “Puffery” has been defined as ambiguous, promotional, or hyperbolic speech commonly known as “sales talk.” While the puffery doctrine has been the subject of a great deal of criticism, it continues to be relied upon by courts--in fact, its use may be increasing…. This Article seeks to fill some of the void of empirical research in this area by reporting the results of an investor survey (the “Puffery Survey”), focusing on materiality determinations in the puffery context, and comparing these responses to judicial predictions that no reasonable investor could find the surveyed statements material. What the survey results show is that while the judges in the four surveyed cases concluded that no reasonable investor could find the statements challenged therein to be material because they constituted non-actionable puffery, between 33% and 84% of reasonable investors surveyed deemed the statements material. These results have implications for both our confidence in the accuracy of judicial determinations in this area, as well as the potential utility of survey evidence for bringing judicial conclusions more in line with actual investor behavior.
In “Immaterial Lies: Condoning Deceit in the Name of Securities Regulation” I noted that:
There are a number of problems … with overdependence on materiality safety valves. First, courts' repeated declarations that management is free to lie, so long as that lie is immaterial, arguably sends the message to executives that it is often okay to embellish the truth--and sends the message to investors that they should adopt an attitude of caveat emptor (“buyer beware”) when it comes to the statements of corporate executives. One might argue that it is overly pejorative to characterize these disclosures as lies. However, when a court grounds dismissal on a finding of immateriality, it is effectively saying that there is no basis for liability even if it were proven that an executive misstated the facts with intent to deceive (i.e., there was a lie). Second, the safety valves themselves twist the definition of materiality to the point that they seemingly make a mockery of the Supreme Court's declarations on the issue. Finally, courts' excessive reliance on these safety valves creates a conflict with the disclosure rules, which often turn on determinations of materiality. Fortunately, there is a better way: focusing on the other elements of Rule 10b-5 [like scienter].
I have not yet read the opinions cited in Journal article in their entirety, but at least my initial impression is that these opinions continue a pattern of improper over-reliance on puffery as a basis for dismissing fraud claims. In fact, to hear S&P characterize its own declarations of independence and objectivity as being nothing more than mere puffery conjures up images of the Theatre of the Absurd.