Moody’s, S&P Say Calpers Looking for Ratings Scapegoat

Moody’s Investors Service Inc. says the California Public Employees Retirement System can’t blame it for almost $800 million in losses on top-rated investments that later collapsed because its assessments are opinions and not guarantees or facts.

Moody’s and McGraw Hill Financial Inc.’s Standard & Poor’s unit accuse Calpers, the largest U.S. pension fund, of trying to shift responsibility for losses that occurred after it outsourced investment decisions to money managers who put $1.3 billion into three vehicles backed by subprime mortgages in 2006 and 2007. The investments crumbled amid the housing crisis. Calpers sued the ratings companies in 2009.

Ratings are predictions about the likelihood that investors will receive expected payments, Floyd Abrams, an attorney for McGraw Hill, said today in state appeals court in San Francisco. The ratings companies are seeking to overturn a California judge’s 2012 ruling that they must face Calpers’s claims that they made negligent representations.

“Ratings are by their very nature future-oriented,” Abrams told a three-judge appellate panel.

Two of the three judges asked whether ratings provide investors with an assessment about an investment’s health at the time they were given.

‘Ongoing Slice’

“Is there at least an inference that can be drawn that the representation” given by a rating “was as to an ongoing slice in time?” asked Justice Martin Jenkins.

“I don’t think so,” Abrams said. “The ratings say what they say.”

Ratings matter to investors “at the time they write that that check,” so aren’t they about “the current health of the investment?” Justice Peter Siggins asked.

“The current health plus historical data about how the markets move,” Abrams said. “That’s all part of the ratings process.”

S&P is being sued separately for fraud in federal court in Santa Ana, California, by the U.S. Justice Department, which accuses the company of lying about its ratings being free of conflicts of interest and may seek as much as $5 billion in penalties. It also faces similar lawsuits by U.S. states, including one by California Attorney General Kamala Harris. A state judge in San Francisco refused in March to dismiss claims in that lawsuit.

Retaliation Law

In the Calpers case, S&P and Moody’s base part of their arguments on a California law that they say protects them against retaliation for expressing opinions.

Calpers alleges S&P and Moody’s did more than merely rate the structured investment vehicles, or SIVs, bought by the pension fund’s managers. It said the companies helped create the SIVs with issuers that paid for ratings, had access to information about them that was hidden from investors, and bent the rules to give them their best ratings to boost profits.

The SIVs raised money from investors to put in long-term debt assets, including other structured-finance securities such as residential mortgage-backed securities linked to subprime loans.

“They were in the kitchen stirring the pot,” Joseph Tabacco, an attorney for Calpers, said at the hearing. With the intimate knowledge the ratings companies had about the SIVs, their assessments weren’t like “predicting who’s going to win next year’s Super Bowl,” he said.

The ratings that investors rely on “are given in the present tense, there’s no way around that,” Tabacco said. “They are not guesses about the future.”

Only 28 SIVs were ever created, with 11 coming to market between 2005 and 2007, Calpers said. All of them failed.

The court will rule within 90 days.

The case is Calpers v. Moody’s, A134912, California Court of Appeals, First District (San Francisco).

(Corrects to say Abrams represents McGraw Hill in third paragraph of story published yesterday.)
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