Wednesday, May 28, 2014
Court of Appeal Allows CalPERS to Sue Ratings Agencies Over Losses in Mortgage-Backed Investments
By a MetNews Staff Writer
The California Public Employees’ Retirement System has a prima facie case of negligent misrepresentation against major ratings agencies whose advice it claims it relied on in purchasing investment vehicles that later collapsed, the First District Court of Appeal has ruled.
Div. Three Friday affirmed a San Francisco Superior Court judge’s denial of the defendants’ anti-SLAPP motion.
CalPERS, the largest U.S. pension fund, put $1.3 billion into three “structured investment vehicles” or SIVs, backed by subprime mortgages in 2006 and 2007. In its 2009 complaint against McGraw-Hill Companies, Inc.—the parent company of Standard & Poor’s—as well as Moody’s Investors Services, Inc. and Fitch, Inc., CalPERS says the services gave the SIVs their highest possible rating, AAA, despite warning signs that should have been obvious to them.
At least two of the SIVs were “stuffed full of toxic, subprime mortgages, home equity loans, and other types of structured-finance securities linked to subprime mortgages,” CalPERS said, causing it to lose “hundreds of millions, and perhaps more than $1 billion.”
In an appeal brought by Moody’s and McGraw-Hill from Superior Court Judge Richard Kramer’s denial of the anti-SLAPP motion, the Court of Appeal agreed with the defendants that their ratings are a form of opinion, and thus protected activity. But CalPERS bore its burden of showing that the suit has legal merit, Justice Martin Jenkins wrote.
While the First Amendment might be a complete defense to a typical suit blaming the rating agencies for investors’ losses, “the same cannot be said of the ratings at issue here, which were allegedly issued for private use by the limited class of investors dealing in complex and esoteric nonregistered securities,” Jenkins said.
CalPERS, the justice wrote, presented sufficient evidence, including the declarations of market experts, to show that the defendants’ ratings should be treated as actionable statements of professional opinion for purposes of the negligent misrepresentation tort. Jenkins cited, among other evidence, a declaration by a former S&P executive involved in the ratings, who said that S&P and the other agencies that rated the SIVs “actively influenced the structure and amount of the debt issued,” and that if the issuers had not followed the agencies’ criteria, they “could not achieve [their] desired rating.”
“We agree with CalPERS this evidence reflects that the Rating Agencies published the ratings from a position of superior knowledge, information and expertise regarding the SIVs’ composition, underlying structure and function that was not generally available in the market. More specifically, we conclude this evidence reflects not only that the Agencies employed superior knowledge and special information and expertise to assign ratings to the SIVs, they employed their special knowledge, information and expertise to participate in, and exert control over, the very construction of the SIVs. As such, we agree with CalPERS a prima facie case has been made that the ratings are actionable as ‘professional opinions’ or ‘deliberate affirmations of fact’ regarding the nature and quality of the SIV product.”
The justice also concluded that the defendants intended that the ratings influence CalPERS and that CalPERS had presented sufficient evidence of reasonable reliance. He cited declaration testimony that CalPERS would not have considered investing in the SIVs had they not been AAA-related.
The case is California Public Employees’ Retirement System, Inc. v. Moody’s Investors Services, Inc., 14 S.O.S. 2584.
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