Opinion

Alison Frankel

Will CDO investors’ deal boost litigation against rating agencies?

By Alison Frankel
April 29, 2013

This is a rare sentiment, but thank goodness for Congress. Were it not for reports issued in 2011 by theFinancial Crisis Inquiry Commission¬†(an expert panel created by federal statute) and the¬†Senate Subcommittee on Investigations, we’d have precious little public-record testimony about the role that the credit rating agencies Standard & Poor’s, Moody’s and Fitch played in the near collapse of the economy. With¬†Friday’s settlement¬†between S&P, Moody’s and two groups of investors in collateralized debt obligations known as Cheyne and Rhinebridge, we’ve lost one of our last remaining chances to see the rating agencies answer to private investors.

I want to emphasize that the deal is a landmark. It is apparently the first time that S&P and Moody’s have settled accusations that investors were misled by their ratings. That’s unquestionably a great result for the CDO purchasers in the case and for their lawyers at¬†Robbins Geller Rudman & Dowd, who have battled since 2008 to keep $700 million in fraud and negligence claims alive. Unlike investors in more than three dozen other cases claiming the credit rating agencies facilitated the issue of toxic mortgage-backed securities, Abu Dhabi Bank, the Kings County pension fund and their fellow CDO purchasers survived preliminary motions, beating back the agencies’ argument that their ratings were opinions protected by the First Amendment. Then, through discovery, Robbins Geller¬†uncovered hot documents¬†- even more than the rating agencies produced to Congress – that helped investors withstand defense requests for summary judgment.

Lead counsel¬†Luke Brooks¬†and¬†Daniel Drosman of Robbins Geller declined to disclose the terms of the CDO settlement but told me Monday that their clients are very pleased with “what we view as an extraordinary result.” (An S&P representative declined to comment; a Moody’s spokesman told Reuters that the agency wanted to put the CDO litigation behind it.)

I’m sure, however, that Robbins Geller also felt a twinge of disappointment that it wouldn’t get to try the case, which was scheduled for jury selection on May 6. They and the rest of us will not have the chance to witness rating agency officials attempting to justify internal emails in which analysts appear to deride their own procedures for rating mortgage-backed instruments nor hear them explain why CDOs with AAA ratings defaulted in a matter of months. That’s a shame. As best I can tell, there are only a few remaining investor cases against the rating agencies, including¬†claims in San Francisco Superior Court¬†by the California Public Employees’ Retirement System, a¬†fraud suit by the Federal Home Loan Bank of Pittsburgh¬†in the Allegheny County Court of Common Pleas and a fraud litigation in Massachusetts federal court by the Federal Home Loan Bank of Boston. And S&P and Moody’s don’t seem terribly concerned that pending private litigation will produce any great revelations. They didn’t even bother describing the Calpers or FHFB suits in their most recent annual reports.

Of course, S&P is knee-deep in the Justice Department’s civil fraud suit in California federal court, which builds upon evidence and legal theories laid out in the Cheyne and Rhinebridge CDO cases. The agency¬†moved to dismiss¬†the Justice Department’s suit last week. S&P is also¬†facing deceptive trade practices claims¬†by more than a dozen state attorneys general; in the most recent development in the AG litigation, a federal judge in Connecticut rebuffed the rating agency’s attempt to remove Connecticut’s 3-year-old case from state court, where it has already survived a dismissal motion. (The Connecticut AG has brought an illegal trade practices suit against Moody’s as well.)

But those cases won’t bring accountability to private investors who based decisions about mortgage-backed certificates and CDOs on the ratings conferred by S&P and Moody’s. “In terms of the publicly issued securities, they’ve succeeded in eluding liability under the federal securities laws,” said¬†Joel Laitman¬†of¬†Cohen Milstein Sellers & Toll, who tried and failed (along with everyone else in the plaintiffs’ bar) to bring class action claims against S&P and Moody’s for their supposedly fraudulent ratings. The rating agencies’ settlement with CDO investors, who sued as individuals rather than as a class, put Laitman in an elegiac mood. “We have federal securities laws and they failed with respect to the rating agencies,” he said. “How is it that we have the Securities Act, we have the Exchange Act, yet there is no classwide relief for investors? Why is it that a critical player in the financial crisis has essentially escaped scot-free?” (The rating agencies would surely say that they haven’t been held liable because they, like many others in the financial industry, were blindsided by the housing crisis. They have always contended that they published legitimate, good-faith assessments of the securities they rated and, moreover, had no duty to investors.)

Despite Laitman’s requiem for claims against the rating agencies, there’s still time – though not much – for some individual investors to attempt to capitalize on the Cheyne and Rhinebridge CDO settlements and the judicial rulings by U.S. District Judge¬†Shira Scheindlin¬†that permitted the case to end in the landmark deal. New York has a 6-year statute of limitations for fraud and negligence. There’s a borrowing provision that would bar claims by investors whose states have shorter statutes. Investors also can’t bring class actions based on common-law causes of action.

But for New York residents who bought CDOs and mortgage-backed securities, the Cheyne and Rhinebridge cases hacked out a trail for claims against the rating agencies – and Friday’s settlement showed that the trail doesn’t have to lead to a dead end.

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For the record, Cheyne and Rhinebridge are not CDOs, they were structured investment vehicles, a type of operating company. It is unfortunate that the general public will not get a chance to get the facts related to this case. I believe it would have gone a long way to dispelling the woefully uninformed inferences that have permeated throught the political, punditry and general public space. For example, the plaintiffs in this case were not ‘grandma & grandpa”, they are what’s called qualified institutional buyers, the most sophisticated institutional investment management firms in the market (some of which actually issued CDOs as part of their business). These QIBs as they are called are not allowed to outsource their primary duty to a no-cost provider like a rating agency, as such, the QIBs retain absolute authority for investment decisions hence they retain absolute accountability for the results of those decisions. To those that actually work in the capital markets, credit ratings are simply indices, like the S&P 500. It is no more appropriate to sue a rating agency for losing money on a bond that happened to have a AAA rating than it would be to sue S&P for losing money investing in a stock that happened to be in the S&P 500 index. The truly accountable investment firms either settled out quick (Schwab/Yield Olus), went out of business or are barely standing…hence the only deep pockets to go after are the banks and rating agencies. Toss in the fact that the rating agencies were the most transparent entities in the market and now you have low hanging fruit for firms like Robbins Geller. An extra bonus for the DoJ is that S&P does not pose a systemic risk should it be successful in its complaint, as opposed to their decision to not penalize HSBC for its decade of money laundering. Make no mistake, the defendents in these “SIV” cases were far from any true peer assessment of fraud or negligence…but it must be difficult to gamble on a jury pool of non-peers that have been trained for years to place blame on the banks/agencies. The only winners…lawyers.

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