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Raters Sued by Calpers Over Losses

Source: NY Times/WSJ

Posted on 16 Jul 2009

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Calpers filed a lawsuit against the three biggest credit-ratings agencies, accusing them of issuing "wildly inaccurate and unreasonably high" ratings on structured investment vehicles that saddled the California pension fund with at least hundreds of millions of dollars in losses.

The suit, filed last week in California Superior Court in San Francisco by the nation's largest public pension fund, ratchets up the unflattering scrutiny of Moody's Corp.'s Moody's Investors Service, the Standard & Poor's unit of McGraw-Hill Cos. and Fimalac SA's Fitch Ratings over their culpability for the financial crisis.

The California Public Employees' Retirement System alleges that the methodology used by all three companies to rate the complicated mortgage-backed securities was "seriously flawed in conception and incompetently applied," according to the suit. In 2006, Calpers invested $1.3 billion in three separate SIVs, all of them awarded top triple-A ratings by the ratings agencies.

As the financial crisis deepened in 2007 and 2008, Cheyne Finance LLC, Stanfield Victoria Funding LLC and Sigma Finance Inc. defaulted on their payment obligations. Calpers said the resulting losses on its investment could be more than $1 billion.

Calpers didn't indicate how much in damages it is seeking. A cover sheet filed by a lawyer representing the pension fund indicated only that the amount "exceeds $25,000." Moody's, S&P and Fitch officials couldn't be reached for comment late Tuesday night.

Ratings agencies have been pilloried by lawmakers and investors for failing to cast a more skeptical eye toward mortgage securities that got the firms' highest ratings during the real-estate boom but then collapsed. While the companies are facing other lawsuits and tighter oversight, they generally have avoided moves that would fundamentally change how they do business, including the controversial practice of being paid by the issuers of securities.

The lawsuit by Calpers, which has about $173 billion in assets and manages the retirement benefits of more than 1.6 million California employees, retirees and their families, sheds light on how heavily even the most sophisticated investors relied on Moody's, S&P and Fitch to analyze mortgage securities and other complex investment vehicles

Calpers accuses the ratings agencies of acting "in a morally blameworthy fashion by failing to exercise reasonable care in their rating actions," according to the suit. The California pension fund claims that "no amount of due diligence" by its own analysts could have given Calpers "actual knowledge" of how conflicts of interest at the ratings agencies affected their assessment of SIVs or how heavily exposed the securities were to subprime loans, according to the lawsuit.

Joseph J. Tabacco Jr., a partner at law firm Berman DeValerio representing Calpers in the lawsuit, couldn't be reached for comment.

Like many other pension funds, Calpers has been hammered by the market's turmoil. The fund suffered a 27% decline in 2008, with its overall size shrinking to $183.3 billion from $253 billion a year earlier.