Moody's, McGraw-Hill hit by free speech loss

* Judge rejects absolute First Amendment defense

* Moody's shares down 7.1 pct, McGraw-Hill off 10.2 pct

* Warren Buffett's Berkshire Hathaway sells Moody's shares

(Adds Berkshire sale of Moody's shares, closing prices)

By Jonathan Stempel

NEW YORK (Reuters) - Moody's Corp and McGraw-Hill Cos shares slid Thursday after a court ruling that may make it harder for credit rating agencies to argue their opinions deserve free speech protection.

In an order issued late Wednesday, U.S. District Judge Shira Scheindlin in Manhattan said ratings on notes sold privately to a "select" group of investors were not "matters of public concern" deserving of traditionally broad protection under the First Amendment of the U.S. Constitution.

The judge said the plaintiffs may pursue fraud claims accusing Moody's Investors Service, McGraw-Hill's Standard & Poor's unit and Morgan Stanley, which marketed the notes, of making false and misleading statements about the notes, which were backed by subprime mortgages and other debt.

In a 68-page ruling, she said credit ratings could be subject to challenge "if the speaker does not genuinely and reasonably believe it or if it is without basis in fact."

The ruling may aid lawsuits by pension funds and other investors seeking to hold banks and rating agencies responsible for inflating the value and safety of debt in order to win fees.

Moody's shares closed down 7.1 percent at $24.26, while McGraw-Hill fell 10.2 percent to $29.01 on the New York Stock Exchange. Both companies are based in New York.

"This is potentially a very significant opinion," said Joseph Mason, a finance professor at Louisiana State University's business school in Baton Rouge. "It seems they have found a hole in the First Amendment defense, the agencies' primary line of defense."

After the market closed, Warren Buffett's Berkshire Hathaway Inc said in a regulatory filing that its National Indemnity Co unit sold 794,000 Moody's shares on Sept. 1 and 2. The sale reduced Berkshire's ownership stake in Moody's to 39.22 million shares, or 16.6 percent, from 17 percent. The stake had been 20.4 percent in mid-July.

The New York case involved losses that Abu Dhabi Commercial Bank and King County in Washington state, which includes Seattle, said they suffered from the Cheyne Structured Investment Vehicle.

Scheindlin said Cheyne issued notes with ratings as high as "triple-A," and the rating agencies were paid above-normal fees that were in part "contingent upon the receipt of desired ratings." The Cheyne vehicle would go bankrupt in August 2007.

The judge did not decide the merits of the plaintiffs' case and dismissed several claims, including all claims against another defendant, Bank of New York Mellon Corp .

McGraw-Hill spokesman Frank Briamonte and Moody's spokesman Michael Adler expressed confidence their companies would prevail. Morgan Stanley spokeswoman Jennifer Sala declined to comment. The plaintiffs did not return requests for comment.

The nation's largest public pension fund, the California Public Employees' Retirement System, in July sued Moody's, S&P and Fimalac SA's Fitch Ratings for $1 billion over their ratings, including for the Cheyne vehicle. CalPERS spokesman Clark McKinley declined to comment.

Frederic Ruffy, an strategist at WhatsTrading.com, said options traders Thursday bet Moody's and McGraw-Hill shares would fall, with "put" options outpacing "call" options by a greater than 3-to-1 ratio for both. As to Moody's, he said "the catalyst for the put trading was the court ruling."

The case is Abu Dhabi Commercial Bank v. Morgan Stanley, U.S. District Court, Southern District of New York (Manhattan), No. 08-7508. (Reporting by Jonathan Stempel; Additional reporting by Doris Frankel in Chicago; Editing by Tim Dobbyn)