Way back when, I mentioned there was a surprise coming S&P’s way. Since it is now out there officially, I can discuss it publicly.

After the brouhaha with McGraw Hill began, I was contacted by numerous people — mostly readers emailing words of support. But a few West Coast lawyer types seemed to be asking lots of questions, and revealing little.

I poked around with some law firms in California, and started to pick up the rumor that California Public Employees’ Retirement System (CALPERS) was going to drop the bomb on S&P, Moody’s and Fitch. No one would say anything on the record, but it was clear that litigation was being considered as an option against the Ratings Agencies.

Here is the money quote:

The AAA ratings given by the agencies “proved to be wildly inaccurate and unreasonably high,” according to the suit, which also said that the methods used by the rating agencies to assess these packages of securities “were seriously flawed in conception and incompetently applied…” “The ratings agencies no longer played a passive role but would help the arrangers structure their deals so that they could rate them as highly as possible,” according to the Calpers suit.

Now, here comes the fun part: Calpers doesn’t give a rat’s ass about the money. Sure, the financial instruments at hand (Cheyne Finance, Stanfield Victoria Funding and Sigma Finance) have defaulted on their payment obligations. The losses to Calpers are ~!$1 billion.

But that’s not what’s going on here: These Left Coasters want their pound of flesh. They don’t care for the Ratings Agency folks, and consider them a blight on the investment landscape.

The goal of the litigation (as I see it) isn’t to make the rating agencies pay a financial penalty; rather, it is to publicly try them just as the regulatory rules are being rewritten. I also predict that CALPERS is going to attempt to not just win, but humiliate these agencies, call them out in the most embarrassing way possible, trash the senior executives, and make things very uncomfortable in general for these firms.

They don’t want them to merely suffer — they want to destroy their unique position as an Oligopoly, to remove them from having a special status under the SEC rules.

In these sorts of litigations, plaintiff can be very often bought off cheaply. In this case, that won’t happen. An offer a few million dollars — or a few 100 million — won’t tempt them into taking the money and going away. They have as much money as they need to finance this litigation to the long, drawn out, bitter end.

If I was a Rating Agency lawyer, I would be very, very nervous . . .

Some of the additional details:

– Conflicts of interest by the rating agencies are rife. They are paid by the companies issuing the securities — an arrangement that prevents the agencies from issuing negative ratings; – Structured investment vehicles generated lucrative fees for rating agencies, above and beyond normal fees. They were paid as consultants who helped structure the deals — not as neutral 3rd parties. The fees ranged from $300,000 to $500,000 and up to $1 million for each deal; -These fees were in addition to revenue generated by the agencies for their more traditional work of issuing credit ratings; -By actively creating these instruments, CALPERS owed a different duty of care as an underwriter, not merely a 3rd party firm protected by 1st Amendment Free Speech; -By then rating them AAA, what the Ratings Agencies did amounted to Fraud.

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Source:

Calpers Sues Over Ratings of Securities

LESLIE WAYNE

NYT, July 14, 2009

http://www.nytimes.com/2009/07/15/business/15calpers.html

Raters Sued by Calpers Over Losses

RICK BROOKS

WSJ, JULY 15, 2009, 8:38 A.M.

http://online.wsj.com/article/SB124763258772743653.html