CalPERS Sues Credit Rating Agencies Over Structured Investment Vehicles

January 28, 2010

The nation’s largest public pension fund has filed a lawsuit seeking to hold the major credit rating agencies accountable for issuing unjustifiably high ratings for opaque structured investment vehicles, which the agencies knew included risky subprime mortgages.

In the lawsuit, the California Public Employees’ Retirement System accuses three credit rating agencies of “negligent misrepresentation” under California state law. Berman DeValerio represents CalPERS in the suit, which was filed July 9 in San Francisco Superior Court.

Leading the litigation team for CalPERS are attorneys Joseph Tabacco and Todd Seaver of Berman DeValerio’s San Francisco office.

“The complaint, based on a very thorough investigation, lays out a grisly story in which the same rating agencies that are supposed to act as watchdogs ran amok in search of profits,” Tabacco said. “The failure of the rating agencies to do their job had negative ramifications for CalPERS and many other investors, both large and small.”

The New York Times reported the lawsuit “is the latest sign of renewed scrutiny over the role that credit ratings agencies played in providing positive reports about risky securities issued during the subprime boom that have lost nearly all of their value.”

The complaint names the three major credit rating agencies as defendants: Moody’s Corp. and its affiliate, Moody’s Investors Service Inc.; The McGraw Hill Companies Inc., which owns Standard & Poor’s; and Fitch Inc. and its affiliate, Fitch Ratings Ltd.

It says the agencies issued the ratings of three structured investment vehicles, or SIVs, after knowingly working with issuers to structure the deals “so they could rate them as highly as possible,” maximizing their fees. But the ratings were “wildly inaccurate and unreasonably high,” and the investments collapsed.

CalPERS justifiably relied on the ratings because only the issuers and the credit rating agencies knew the underlying contents, the complaint said. In fact, CalPERS wouldn’t have invested in the SIVs – and the agencies wouldn’t have collected their large fees – without the high ratings, a fact the complaint says created a conflict for the agencies.

In 2006, CalPERS invested a total of $1.3 billion in the SIVs – named Cheyne Finance LLC, Stanfield Victoria Funding LLC and Sigma Finance LLC. The vehicles collapsed in 2007 and 2008, defaulting on their payment obligations to the pension fund and resulting in losses of “hundreds of millions, and perhaps more than $1 billion,” according to the suit.

The three agencies gave AAA ratings to the investment vehicles, despite knowing that their underlying assets included high levels of securities backed by risky subprime mortgages, the complaint said. The agencies’ flawed methodology, in fact, ended up ensuring the SIVs would collapse once a recession occurred.

CalPERS argued that the ratings agencies were inherently conflicted because their active role in structuring the deals meant they were effectively “rating their own work.” In addition, because they earned higher fees for rating the most complex securities, like SIVs, the credit rating agencies had “every incentive to give high ‘investment grade’ ratings or else they couldn’t receive their full fee,” the lawsuit said.

*In August 2017, our firm name changed to Berman Tabacco. Case references and content published before that date may refer to the firm under our prior name, Berman DeValerio.