O.C. Suffers Blow in Bankruptcy Suit Against S&P;

After collecting $800 million in settlements over its 1994 financial debacle, Orange County has suffered a severe legal defeat in its final major case, which attempts to blame the Standard & Poor’s bond-rating agency for failing to sound alarms about the investments that toppled the county into the biggest municipal bankruptcy in history.

U.S. District Judge Gary L. Taylor in Santa Ana has ruled that S&P;’s work while assessing the county’s ability to repay its bondholders was covered by the 1st Amendment. S&P; gave its highest ratings to more than $600 million in county bond debt issued in 1993 and nearly $1 billion in 1994.

Taylor’s order means the county cannot recover damages if S&P; was merely negligent, only if the agency acted with “actual malice” by knowingly publishing false statements or recklessly disregarding the truth. It is the same high standard the courts have established to protect news organizations reporting on public figures or issues of high public interest.

“The order will have a dramatic impact on the trial of this action,” the county said in its legal papers. “It substantially raises the bar on the county’s burden of proof.”

Exactly how much the ruling will affect Orange County’s ability to recover damages is unclear. The county had been seeking $3 billion in losses, bankruptcy costs and interest from S&P;, but S&P; has always said it was confident of victory at trial.

Taylor also narrowed the case--and the potential damages--by ruling that the agency’s work in connection with its 1993 debt ratings did not meet the actual malice threshold.

The rejection of the claims for 1993, when the county treasury first started losing money, “dramatically reduces the county’s damages,” according to the county’s appeal of the ruling. Its attorneys declined to elaborate Wednesday.

S&P;, part of New York-based McGraw-Hill Cos., rates thousands of bonds that corporations and governments issue to raise funds. The ratings help determine how much interest the issuers must pay to bondholders, and they are used by investors to gauge the risks involved in purchasing the securities.

A Columbia University law professor specializing in securities litigation, John C. Coffee, said he was not surprised by Taylor’s ruling because courts have always made it hard to sue bond-rating firms over mistakes. He said the agencies’ fees are low compared with those earned by big financial and accounting firms that help issue securities and audit public companies.

“They rate thousands of classes of debt, and have very broad obligations to figure out the debt of many companies, including a lot that don’t have public stock,” Coffee said. “They stand in a very special position, and I don’t think they would be viable if they were subject to liability based on negligence.”

The county maintains that S&P;’s contract required the agency to evaluate proposed bond issues competently and inform the county of potential risks. Had that been done, the suit contends, the bonds never would have been issued and the county could have stopped its then-treasurer, Robert L. Citron, from making such huge bets on low interest rates.

The county filed for bankruptcy protection in December 1994 after rates shot up, and the treasury ultimately lost $1.64 billion. The county’s bonds went into default, although the bondholders got their money back, with interest, after a year’s delay. John M.W. Moorlach lost the 1994 election but was named treasurer after Citron resigned and pleaded guilty to criminal fraud charges.