dealbook.nytimes.com | November 11, 2013
By Peter Lattman
The collapse of two Bear Stearns hedge funds in 2007 was among the earliest signs of the impending financial crisis. More than six years later, lawyers continue to fight over the cause of their demise.
On Monday morning, liquidators seeking to recover money for investors in the funds filed a fraud lawsuit against three major credit rating agencies.
The action, filed in New York State court, accuses Standard & Poor’s, Fitch Ratings and Moody’s Investors Service of assigning artificially high credit ratings to the mortgage bonds in the funds. When those bonds collapsed, the funds failed, resulting in more than $1 billion in investor losses.
In a 141-page complaint, the liquidators cite a trove of emails – some of which had already surfaced in earlier cases – which they say show that the agencies knew their high-quality ratings on the mortgage bonds were a sham.
“It could be structured by cows and we would rate it,” an S.&P. employee said to a co-worker in a text message from 2007.
“We sold our soul to the devil for revenue,” a Moody’s employee said in an internal document.
In an email, another S.&P. employee called the firm’s ratings practices a “scam.”
James C. McCarroll, a lawyer representing the liquidators, said that by giving risky mortgage bonds misleading ratings, the agencies were enriching themselves at the expense of investors in the Bear hedge
funds that owned these bonds.
“It is time for these organizations to be accountable for their misdeeds,” said Mr. McCarroll, a partner at Reed Smith.
The liquidators, Geoff Varga and Mark Longbottom, had signaled the action against the agencies in July with the filing of a four-page summons and notice, an effort to beat a six-year legal deadline for fraud cases in New York State.
Representatives for S.&P., Fitch and Moody’s have said the charges were without merit.
The lawsuit is hardly the first seeking to hold the ratings agencies accountable for losses incurred during the financial crisis. The Justice Department filed a civil fraud action this year against S.&P., the first federal enforcement action against a credit rating firm. Numerous state attorneys general have also sued S.&P. over similar claims in Federal District Court in Manhattan. S.&P. has denied wrongdoing; Fitch and Moody’s were not named as defendants in those lawsuits.
It is also hardly the first legal action related to the two Bear funds, which collapsed in July 2007. Federal prosecutors brought criminal securities fraud charges against the funds’ managers, Ralph R. Cioffi and Matthew M. Tanin. The two fought the charges and a jury found them not guilty after a trial. Federal securities regulators also filed civil lawsuits against Mr. Cioffi and Mr. Tanin, and they both settled the cases without admitting wrongdoing.
The rating agencies are not the only ones the liquidators have blamed in the collapse of the funds. In August, JPMorgan Chase, which acquired Bear in 2008, reached a settlement with the liquidators, who had accused Bear of failing to properly structure the hedge funds and provide them with adequate oversight. It also settled with the funds’ directors, including Mr. Cioffi and Mr. Tanin. The terms of both settlements were undisclosed.
S.&P., Moody’s and Fitch have come under widespread criticism in the wake of the financial crisis. Questions have been raised about their business practices and whether their independent analysis was compromised in the pursuit of profit.
During the housing boom, S.&P., Fitch and Moody’s made millions of dollars by issuing ratings on the complex pools of home loans being packaged and sold by the banks. These pools, called residential mortgage-backed securities and collateralized debt obligations, collapsed in value when the financial crisis struck.
A report by the Financial Crisis Inquiry Commission concluded that the credit ratings firms were “key enablers of the financial meltdown.”
Mortgage bond investors have had mixed results bringing civil lawsuits against the ratings agencies. S.&P. and the other agencies have argued that their ratings are speech protected by the First Amendment. A number of judges have agreed with the ratings agencies and tossed out these lawsuits. Others have said the ratings were not opinions, but misrepresentations that were possibly the result of negligence or fraud.
S.&P. also said its ratings were not to be relied upon, in part because the investors had the same information as it did.
In July, a federal judge denied S.&P.’s motion to dismiss the government’s case and called its defense “deeply and unavoidably troubling.”
The judge, David O. Carter of Federal District Court in Los Angeles, asked, “If no investor believed in S.&P.’s objectivity, and every bank had access to the same information and models as S.&P. is S.&P. asserting, as a matter of law, the company’s credit ratings service added absolutely zero material value as a predictor of creditworthiness?”
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