CalPERS Suit Against Rating Agencies Could 'Go the Distance'
Not likely, according to CUNA's legal staff, which looked into the case and shared opinions with Credit Union Times.
CalPERS is suing the ratings agencies over three structured investment vehicles that collapsed in 2007 and 2008 and resulted in a loss to the pension fund of $1 billion. The SIVs invested in CDOs and other investments similar to what some corporates also invested in, said CUNA Vice President Pat Keefe. However, the case would only be relevant to credit unions if corporates responsible for stabilization costs also invested in the commercial paper or medium-term debt issued by one or more of these three particular SIVs.
"We are not aware of U.S. Central, WesCorp or any other corporate credit union having invested in any SIV debt obligations of any type, especially not commercial paper or other debt that was not in the form of a security," Keefe said. Commercial paper is usually not considered a security because of its short duration.
According to court documents filed in San Francisco U.S. Superior Court, CalPERS alleges the rating firms committed "negligent misrepresentation" when they published "wildly inaccurate and unreasonably high" ratings on three SIVs: Cheyne Finance, Stanfield Victoria Funding and Sigma Finance Inc.
The three ratings agencies used "flawed assumptions," failing to consider underlying assets that consisted of, in large part, risky subprime mortgages, CalPERS said.
What's more, the rating firms played important roles in "the creation and ongoing operation" of the investment funds and commanded steep fees for giving them high marks, the lawsuit said.
Market analyst Barry Ritholtz said he thinks the suits have the potential to "go the distance" because CalPERS cares more about punishing the ratings agencies than recovering credit losses.
Ritholtz is CEO of New York-based investment software firm FusionIQ. He is also a frequent guest on CNBC shows "The Kudlow Report" and "Squawk Box." He is the author of the book Bailout Nation.
Ritholtz said he agrees with others who have called ratings agencies the "prime enablers of the credit crisis." He also said that most defendants will settle out of court to avoid potentially setting a legal precedent, but CalPERS isn't interested in a settlement.
"I think their concern is why these ne'er-do-well agencies were allowed to be so reckless and cause so much damage," he said. "My suspicion is they'll go the distance, really put the screws to these guys. Why? Because they can."
Ritholtz said ratings agencies' First Amendment defense, that ratings are protected opinions, is flawed because conflict of interest wasn't disclosed. CalPERS alleges in its suit that there was an agreement with bond issuers that ratings agencies would benefit financially if the bonds sold well.
"When you're participating in the sales of the bonds you're rating, you're no longer an objective third party. Now, you're an underwriter," Ritholtz said.
The NCUA Board discussed ratings agencies and their role in corporate losses during an Oct. 16, 2008, closed meeting. Capital markets specialist Richard Mayfield said ratings agencies "dropped the ball" when they assigned triple-A ratings to entire senior tranches, which included senior mezzanine pieces backed by alt-A and subprime mortgages.