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Flynn v. McDaniel

February 24, 2010

THOMAS R. FLYNN, DERIVATIVELY ON BEHALF OF NOMINAL DEFENDANT MOODY'S CORPORATION, PLAINTIFF,
v.
RAYMOND W. MCDANIEL, JR; BASIL L. ANDERSON; ROBERT R. GLAUBER; EWALD : KIST; CORNELIUS ALEXANDER MCGILLICUDY III; HENRY A. MCKINNELL, JR.; NANCY S. NEWCOMB; JOHN K. WULFF; JOSEPH MCCABE; MICHAEL KANEF; LINDA S. HUBER; JOHN J. GOGGINS; BRIAN CLARKSON; ANDREW KIMBALL, AND NOEL KIRNON, DEFENDANTS,
MOODY'S CORPORATION, NOMINAL DEFENDANT.



The opinion of the court was delivered by: Sidney H. Stein, U.S. District Judge

OPINION & ORDER

This action raises solely state law claims of breach of fiduciary duties, gross mismanagement, abuse of control, unjust enrichment, and constructive fraud. It was initially filed in New York State Supreme Court and was removed to this Court by defendants pursuant to 28 U.S.C. § 1441. Plaintiffs have now moved to remand this action back to state court on the grounds that the amended complaint raises nothing but state law claims and requires no construction or application of federal law. Defendants contend removal was proper because the amended complaint, while facially raising nothing but state law claims, nonetheless poses "substantial federal questions" thus giving this Court original jurisdiction. See 28 U.S.C. § 1441(b).

Because the Court agrees that the amended complaint presents no federal question, the motion to remand this matter back to New York State Supreme Court, New York County, is granted.

I. BACKGROUND

Unless otherwise noted, the following facts are taken from the amended complaint and are presumed to be true:

A. The Parties

Plaintiffs Flynn, Brockton, and Herbert M. Stein, Jr., are, and were at all relevant times, shareholders in Moody's Corporation. (Am. Compl. ¶¶ 66-68.) Nominal defendant Moody's is a Delaware corporation with its principal place of business in New York. According to the complaint, the "lion's share" of Moody's business is the provision of credit ratings which is done through its credit ratings division, Moody's Investor Service. (Id. ¶¶ 27, 70.)

Defendants Raymond W. McDaniel, Basil L. Anderson, Robert R. Glauber, Ewald Kist, Cornelius Alexander McGillicuddy III, Henry A. McKinnell, Jr., Nancy S. Newcomb, and John K. Wulff were all directors of Moody's for all or part of the time relevant to the complaint and are referred to, at times, by the complaint as the "Director Defendants." (Id. ¶¶ 71-78, 86.) Defendants Joseph McCabe, Michael Kanef, Linda S. Huber, John J. Goggins, Brian Clarkson, Andrew Kimball, and Noel Kirnon were all high level Moody's executives. (Id. ¶¶ 79-85.)

B. The Moody's Credit Rating Process

The complaint centers on alleged flaws in Moody's credit ratings process, and specifically, its process for rating "structured finance securities" such as Collateralized Debt Obligations ("CDOs") and Residential Mortgage-Backed Securities ("RMBS"). These securities, many of which were tied directly or indirectly to the housing market, posed far more significant risks than Moody's or its ratings suggested, and, when the housing market collapsed, the result was not only a massive market decline but, according to the complaint, a huge blow to Moody's reputation, and, by implication, its stock price and corporate value. Indeed, as the complaint alleges in vivid, arguably purple, prose, because "Moody's [was] directly complicit in the greatest scam Wall Street has yet perpetrated on the world's financial markets," its reputation has been "tarnished . . . for the foreseeable future (if not irreparably)." (Id. ¶ 4.)

According to the complaint, structured finance securities were rated by Moody's pursuant to the "Issuer Pays" model whereby the bank or issuer of the security would pay Moody's for the rating. That model, the complaint contends, created an "inherent conflict of interest" because Moody's, rather than seeking to provide objective ratings, aimed to please the paying customer which wanted the strongest rating possible for the security it sought to issue. (Id. ¶¶ 46-48.) Nevertheless, despite that conflict of interest, and despite the fact that defendants were operating in the "post-Enron world," defendants "failed to design and implement even the most basic system of internal controls that would address the endemic conflicts of interest inherent in Moody's business." (Id. ¶ 18).

Moreover, according to the complaint, defendants then made significant misrepresentations to Moody's and the investing public regarding the internal policies that did exist, Moody's credit rating process more generally, and the risks that the structured finance securities business posed to Moody's in light of the impending economic downturn (Id. ¶¶ 157-231.) The complaint additionally contends defendants breached their fiduciary duties to the companies in a series of additional respects, including by failing to follow their duty to "ensure that [Moody's] complied with its legal obligations . . . including . . . disseminating truthful and accurate information to shareholders, the investing public, and the SEC." (Id. ¶ 304.)

According to the complaint, as a result of those failures, Moody's "over-rated" many structured finance securities, leading defendants to have to "downgrade" those ratings in 2007 and 2008 as the housing market began to collapse. (Id. ΒΆΒΆ 237-257.) Those downgrades, in turn, led to a series of investigations by state and federal regulators along with a slew of negative publicity for the company. As a result, the complaint contends, Moody's stock ...


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