BROOKE GLADSTONE: And I'm Brooke Gladstone. We've all heard of the toxic assets bound up in subprime mortgages that turned out to be worthless. Part of the reason why people and pension funds invested so heavily in them is because they earned top marks from credit rating agencies.

DAVID GRAIS: It can be a triple A. It can be down to a triple C. There are about 18 grades in the middle.

BROOKE GLADSTONE: Attorney David Grais.

DAVID GRAIS: They look at a bond, which is a promise to pay money, and they decide how likely it is that the owner of the bond is going to get his or her money, and then they give the bond a grade. And when you decide to buy the bond, you look at the grade, and the better the grade, the better you feel.

BROOKE GLADSTONE: The three biggest and best known rating agencies are Moody’s, Fitch and Standard and Poor’s, and now they're taking a lot of heat for highly rating worthless bonds. Last week, Rhode Island Democratic Senator Jack Reed introduced a bill that would, among other things, make it easier to sue the rating agencies for potentially billions of dollars. So how is this a media story? Well, the rating agencies say that their ratings are opinions, speech that should be protected under the First Amendment, like an editorial. David Grais, a securities lawyer who’s argued against this defense, says that he can buy that argument, sometimes. When an agency rates, say, a municipal bond it can remain detached and impartial in its assessment. But, he says, rating agencies made most of their money in the arena of what’s called “structured finance.” That’s where investment banks sold bonds made up of subprime loans and other debt. Grais says he’s spoken with former employees of rating agencies who says that the agencies felt pressure, in those cases, to help the banks restructure their bonds to earn the higher ratings. Not so for cities or companies. When they call to complain about a rating:

DAVID GRAIS: The rating agencies can pretty much blow them off because no one client or customer of theirs amounts to a significant part of their revenue. So, if a company calls up and says, we're really unhappy that you gave us a single A, we think we're a double A, Standard and Poor’s or Fitch or Moody’s can say, well, that’s tough.

BROOKE GLADSTONE: So, what’s different with the structured bonds?

DAVID GRAIS: All the business comes from a very small number of investment banks, and when somebody calls up and says, I accounted for 15 percent of your revenue in structured finance last year, then all of a sudden the rating agencies have to listen. I think there is no serious question that the investment banks were pressing the rating agencies to give bonds higher ratings than the rating agencies would otherwise have done.

BROOKE GLADSTONE: And so, now there are lawsuits pending against these ratings agencies. Can you sum up this First Amendment argument that the ratings agencies are making?

DAVID GRAIS: The rating agencies are saying that they're sort of like a restaurant critic. In their opinion, this bond is worth a triple A, just like a restaurant critic may say that that dinner was worth three stars. Restaurant critics are entitled to the protection of the First Amendment because they're journalists, so the rating agencies say that their three-letter ratings should be protected the same way as the three-star rating from the restaurant critic.

BROOKE GLADSTONE: And you believe that, in some instances, this is a valid defense.

DAVID GRAIS: I do. In every case where the rating agency is not in the kitchen helping to prepare the meal, I think it’s a reasonable defense. So, for example, when a municipality or a state or a corporation issues a bond, you won't find an analyst from the rating agency in the board room helping to structure the bond. But in the arena of structured finance, it’s as though the rating agencies are in the kitchen helping to cook the meal. And then when the meal comes out, they sit down, eat the meal and then write a rating of it, or a review of the meal. That’s when, in my opinion, they lose the protection of the First Amendment.

BROOKE GLADSTONE: And in the case of these subprime backed bonds, which has been so much at the heart of the financial collapse we've been experiencing, these ratings agencies have been in the kitchen with their chef’s hats on. Why?

DAVID GRAIS: Because the investment banks that put these bonds together insisted that the rating agencies come into the kitchen. My own opinion is that if you’re a player in the story then you can write about it, but you don't have the First Amendment protection that a true journalist has.

BROOKE GLADSTONE: I guess the other thing here to consider is that pension funds and many other companies are obligated by law to purchase only bonds that are rated, and usually they have to be triple AAA rated, right?

DAVID GRAIS: Yes. Pension funds, insurance companies and banks are all required by their regulators to buy mostly triple AAA rated bonds. So that requirement guarantees that the rating agencies will have a huge market.

BROOKE GLADSTONE: And yet, right there at the bottom of the rating that’s published, there’s a disclaimer that states that it’s merely an opinion and ought not to be taken as a factual representation of the health of the company. So aren't they having it both ways? You have to buy my rating, but we are not obligated to be accurate?

DAVID GRAIS: Yes. It’s very hard to sue them for negligence. It’s very hard to prove the case against a rating agency, even if you get past the First Amendment.

BROOKE GLADSTONE: According to a piece that you wrote, the general counsel of Fitch, a ratings agency, famously told the Senate committee investigating the collapse of Enron that the letter rating that his agency assigns a security is, quote, “the world’s shortest editorial,” therefore protected by the First Amendment. Therefore, he should enjoy the same protections that a journalist enjoys. How did the committee buy that, and has it been tested in court?

DAVID GRAIS: It’s just beginning to be tested in court. In one case in 2004, Fitch received a subpoena. It wasn't sued, but it was requested to produce its files about a bond that it rated. And it resisted the subpoena on the grounds that journalists don't have to comply with subpoenas in New York. For example, if someone’s investigating public corruption and receives a subpoena for his interview notes, a journalist can invoke what we call the “shield law,” which protects journalists from the intrusion of the subpoena. Fitch tried to use the shield law to protect it, but the court said that it wasn't entitled to the shield law because it was actually involved in setting up the bond, not just in commenting about it. Therefore, it wasn't really a journalist. I think that’s going to be the result in these cases on structured bonds because the rating agencies play such an important role not only in giving opinions about them, but in structuring them in the first place.

BROOKE GLADSTONE: David, thank you very much.

DAVID GRAIS: Well, it’s my pleasure, Brooke. Thank you for having me.

BROOKE GLADSTONE: David Grais is an attorney at Grais and Ellsworth in New York City. Attorney Floyd Abrams represented The New York Times in the Pentagon Papers case. He’s also argued First Amendment cases on behalf of almost every other major news outlet. Now he’s defending the credit rating agency Standard and Poor's. Floyd, welcome to the show.

FLOYD ABRAMS: Thanks very much.

BROOKE GLADSTONE: Okay, so first of all, explain to me why this is more like an editorial. To me it seems more like a clothing inspector, the people who leave the little number inside the clothing you buy. They leave their number so that if the zipper was put in backwards, for instance, they could theoretically take responsibility. Why are the ratings companies different from that?

FLOYD ABRAMS: Well, because the rating agencies use their models, use their heads, use their common sense, have ratings committees. They sit down and they come out with their best judgment as to what is likely to happen in the future about repayment of debt. And that is not subject to mathematical yes/no answers. It’s not the same as saying, my zipper is no good or a couch is no good. It’s not being an inspector. It’s not.

BROOKE GLADSTONE: Fair enough. Let's move away from that analogy and let's go to one that attorney David Grais, who we just spoke to, came up with, that in many cases rating agencies want their ratings to be protected as opinion, like, say, a restaurant critic’s. But more often, he notes, they're like critics who go into the kitchen, make the food and then come out and write about it. They help create these deals. And they have a financial stake in their own ratings ‘cause they're paid by the very companies they rate, a seemingly obvious conflict of interest.

FLOYD ABRAMS: Rating agencies have analytic standards. They apply those standards. And, yes, they discuss with the entities that they're rating why they're doing what they're doing. And if the entity asks them, well, you know, how come you’re giving us a triple BBB instead of a double AA, they tell them why. And if the entity wants to do things to get a higher rating, they can do them. And it is not inappropriate, in my view, so long as they take good steps to deal with the potential for conflict of interest. It is not inappropriate that they get paid by the entities they rate. I mean, it is not conceptually that distinguishable from, you know, a large entity which puts big ads in – what, a motorcycle magazine and then they write about the motorcycles. Do they have to be careful? Yeah.

BROOKE GLADSTONE: The fact of the matter here is that the ratings agencies, in this case, were so widely off the mark, ultimately, that it doesn't seem to have been just a series of mistakes of judgment. At least, that’s what outside people believe. You’re saying that there was sufficient division between the raters and the ratees that they can't be charged with cooking their books for them.

FLOYD ABRAMS: Well, first of all, there’s no cooking of books. And, and while some outsiders may have been prescient in predicting the future, the Federal Reserve Bank wasn't, the SEC wasn't, the President of the United States wasn't.

BROOKE GLADSTONE: Because of these ratings, a lot of people charge.

FLOYD ABRAMS: It’s not because of the ratings, it’s because of the same events that occurred in this country which affected the totality of American commercial life. The people that try to say, well, the rating agencies, they're responsible for this, I think are really looking for [LAUGHS] phantoms.

BROOKE GLADSTONE: Last question - it’s the big one. You’re Floyd Abrams, legendary defender of the First Amendment, defender of The New York Times and the Pentagon Papers case and just about every other major news outlet. So, you really believe that ratings agencies deserve the same First Amendment protection as journalists and the publishers of journalism?

FLOYD ABRAMS: I believe all sorts of entities [LAUGHS] deserve First Amendment rights, even though they're unpopular. Rating agencies [LAUGHS] express opinions and, as such, they should be as entitled to First Amendment protections as other people. And remember, there are some bad journalists out there, bad! We protect them because we think it’s a good thing for the country to protect them. And the First Amendment concludes basically it’s a good thing to protect them, even if they do some pretty bad things. Here we're talking about writing about the future, trying to give a best assessment to the world about what’s likely to happen in certain aspects of the marketplace. It’s not a bad thing to do. It’s not an ignoble thing. And, yes, I think it ought to be protected.

BROOKE GLADSTONE: Floyd, thank you very much.

FLOYD ABRAMS: It’s very good to talk to you. Bye-bye.

BROOKE GLADSTONE: Floyd Abrams is a First Amendment scholar and a partner at the lawfirm Cahill Gordon and Reindel.