Have Pensions Lost The Battle With Ratings Firms?

Blogger was down last night and I had to post my Wednesday piece on the NDP pension priority again on Friday because I lost it. Guess operational risk is present on the blogosphere as even the almighty Google can experience some slip-ups here and there.

My comment will be brief. Bruce Friesen of Global Investment Solutions sent me an article by Michael Corkery of the WSJ, Ratings Firms Notch Legal Victory:

Ratings firms won another victory against legal claims that they should be held responsible for billions of dollars in losses suffered by investors during the financial crisis.

A three-judge panel of the U.S. Court of Appeals for the Second Circuit ruled that Moody's Corp., Standard & Poor's, and Fitch Ratings can't be held liable for their ratings of mortgage-backed securities.

In a decision upholding a lower court's dismissal of the case brought by pension funds in Wyoming and Detroit, the Second Circuit judges wrote that ratings firms provided "merely opinions" about the credit-worthiness of the securities.

Opinions are protected by the First Amendment, a defense the rating firms have often used in the past.

While the ratings firms may have taken an active role in developing the mortgage-backed securities, the judges found that the companies weren't liable because they didn't act as official underwriters.

Investors lost billions of dollars when mortgage-backed securities with high credit ratings plunged in value, leading to a bevy of lawsuits and congressional hearings.

But 2½ years after the financial crisis, the credit-ratings industry has mostly avoided costly legal settlements.

"The rating firms have done quite well defending themselves against claims emanating from the subprime meltdown, and I would add this ruling to the list," said Michael Meltz, an analyst at J.P. Morgan Chase.

"The rating agencies have said all along that they have a strong defense and the legal scorecard is starting to reflect that," he said.

Moody's said on an investor conference call last month that about 20 lawsuits against the firm have been dismissed or withdrawn since the financial crisis.

The unanimous ruling by the Second Circuit, a court that is considered highly influential on corporate matters, could discourage other similar appeals or lawsuits, said Mr. Meltz.

The case at the heart of the ruling involved a pool of mortgage-backed securities underwritten by Lehman Brothers Holding Inc. The pension funds argued that the ratings firms not only provided ratings, but also had assisted in the creation of the securities.

The Second Circuit ruled this argument "fell well short" of the statutory definition of an underwriter, which is involved in the selling of the securities.

"Like all the district courts to have considered similar claims, we conclude that structuring or creating securities does not constitute the requisite participation in underwriting," the judges wrote.

Lawyers for the plaintiffs Wyoming Retirement System and Police and Fire Retirement System of the City of Detroit, couldn't be reached.

S&P spokesman Edward Sweeney said in a statement that the Second Circuit's ruling is "unambiguous in concluding that credit-rating agencies offer forward-looking opinions about credit risk and cannot be sued as underwriters."

Spokesmen for Moody's and Fitch said separately that they were "pleased" with the ruling.

The ratings firms still face numerous lawsuits in various state courts.

"There are some big cases out there that are out there that are still a risk," said Douglas Arthur, an equity analyst at Evercore Partners.

The ratings firms were a prime target of the sweeping Dodd-Frank legislation that was passed last year. The act allows investors to sue the agencies for intentional or reckless failures, while setting up a much tougher oversight regime. Among other measures, the Securities and Exchange Commission has the power under Dodd-Frank to examine and to fine agencies.

"Is anything going to dramatically change? Not likely, but it is going to be tougher place to operate,'' said Mr. Arthur.

Nothing has dramatically changed after the financial crisis. The ratings agencies are still running the same operation except now they're also rating public pension plans. I think ratings agencies got off scot-free with these legal decision because while they didn't underwrite these mortgage backed securities, they did assist the underwriters by slapping AAA ratings on what was essentially garbage.

Having said this, it's up to pension fund managers to do their own due diligence on every single investment and stop passing the buck onto rating agencies and underwriters. When the non-bank asset backed commercial paper crisis hit us in Canada, I had lunch with a senior pension fund manager from a private company who told me something I'll never forget. He said: "I got calls from brokers, many of which told me it's a non-brainer since DBRS slapped a AAA credit rating on this paper. I told them all, yeah, it's a no-brainer because you have to have no brains whatsoever to invest pension money in this garbage." Very simply, pension fund managers have a fiduciary responsibility to protect pension assets. Period.

You can watch the video clip below and decide for yourself where ratings rage should be directed. There is plenty of blame to go around, but at the end of the day, we still have not implemented the measures to make sure this never happens again.