Battered by critics who blame them for helping to foment the U.S. subprime mortgage meltdown, credit raters are now trying to fend off lawsuits — including fraud claims brought by their own shareholders.
Many financial companies, including banks and lenders, have been sued following the housing market bust; but the cases against ratings agencies may be among the most closely watched.
That’s because the three biggest agencies — Moody’s Corp , McGraw-Hill Cos Inc’s Standard & Poor’s division and Fitch Ratings, part of Fimalac SA — have drawn fire from some politicians and investors for awarding top marks to subprime-linked securities that later disintegrated. They’ve also been criticized as being too close to issuers who foot the bill for their ratings.
Based on how prior cases have played out, the plaintiffs could face an uphill battle in court — and ratings firms say they will vigorously defend themselves against the lawsuits. Plaintiffs lawyers, though, say that their claims are strong and that a government report unveiled this week finding “serious shortcomings” at the raters could bolster their cases.
“No one has really crossed the threshold to try to hold the rating agencies accountable for their faulty ratings,” said Christopher Keller, a lawyer at law firm Labaton Sucharow LLP, who represents some of the plaintiffs in a shareholder case against Moody’s.
“Without their complicity in this process (of rating mortgage-backed debt pools), most of these securities would never have come to market,” he said.
The agencies have agreed to institute some reforms. Last month the three top agencies struck a pact with New York’s attorney general to change how they charge fees for reviewing mortgage-backed securities. A separate probe by Connecticut’s attorney general is ongoing.
Rating agencies have found themselves in court before. When they were sued by Enron investors for allegedly being too slow to downgrade the energy trader’s debt, a federal judge dismissed the claims, saying the ratings analysts deserved the same kinds of First Amendment protections that shield journalists because their work was in essence opinion and not a guarantee.
Under a barrage of criticism in Washington, the raters also argued that they, too, were victims of the Enron fraud, saying they weren’t told the truth about the company’s finances.
In another case, Orange County, California sued S&P for $2 billion after poor investments triggered its 1994 bankruptcy.
S&P settled the case for $140,000 but admitted no wrongdoing. The $140,000 represented a partial refund of the ratings fees paid by the county.
Each of the three leading raters is a defendant in at least one new lawsuit brought by investors seeking to hold them liable for the ratings on mortgage-related securities. That suit was brought by a union fund on behalf of investors in several mortgage loan trusts that issued bonds that fell sharply.
Also, Moody’s, S&P and Fitch all face purported class-action cases in U.S. District Court in Manhattan that contend they deceived their own shareholders and applied lax ratings criteria to keep lucrative fee revenue going,
The claims revolve around “representations made directly by the senior insiders of these companies to the market,” said Darren Robbins, a lawyer at law firm Coughlin Stoia Geller Rudman & Robbins LLP, which has sued S&P and Fitch.
Fitch’s parent has called a shareholder lawsuit filed by the Indiana Laborers Pension Fund “totally without merit” and said it would “fully and vigorously defend against it.”
McGraw-Hill said the various suits against S&P “are completely without merit” and it “will be moving to dismiss each of them.”
A Moody’s representative did not immediately respond to a phone message seeking comment.
The lawsuits are still in the early stages. Court trials — which are highly unusual in class-actions, because most are ultimately dismissed or settled — could be years away.
Meanwhile, the plaintiffs want to get their hands on documents cited in a U.S. Securities and Exchange Commission report this week that uncovered poor disclosure and conflicts-of-interest practices.
The report cited e-mails suggesting that the raters knew that collateralized debt obligations (CDOs)– pools of debt linked to subprime mortgages — were headed for problems.
The SEC report did not identify the specific agencies or individuals who wrote the documents. It would likely be up to the courts overseeing the lawsuits to determine whether plaintiffs should get access to more details.
One e-mail from an agency analyst said that her firm’s ratings model did not capture “half” of one deal’s risk, but that “it could be structured by cows and we would rate it.” In another e-mail, a ratings agency manager called the CDO market a “monster” and said: “Let’s hope we are all wealthy and retired by the time this house of cards falters.”
Plaintiffs’ lawyer Keller said he and his colleagues “would certainly love to know the origin of that e-mail” as they press their claims. He said the SEC report “really gives a window into what was going on.”
(Reporting by Martha Graybow, editing by Gerald E. McCormick, Leslie Gevirtz)
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