Court: CalPERS Can Sue Credit Rating Agencies Over Investment Losses

CalPERS lost over $10 billion during the financial crisis, and many of those losses stemmed from financial instruments given top-notch ratings by ratings agencies Moody’s and Standard & Poor’s.

CalPERS filed a lawsuit against the agencies for assigning ratings that misrepresented the quality of the failed investments, but the lawsuit had been held up for months as the agencies appealed the suit’s legitimacy in the lower courts.

But on Wednesday, the California Supreme Court ruled that CalPERS could indeed sue the agencies. From the San Francisco Chronicle:

The lawsuit involved its $1.3 billion investment in 2006 in three financial products – Cheyne Finance, Stanfield Victoria Funding and Sigma Finance – that had gotten the highest ratings from Moody’s and Standard & Poor’s. They were securities issued by banks and management companies and available only in private offerings to a limited number of institutional investors, including the pension system.

Only after all three went bankrupt in 2007 and 2008, CalPERS said, did investors learn that the products’ assets consisted largely of high-risk subprime mortgages. The suit also alleged that the rating agencies’ fee agreements had a built-in bias, entitling them to full fees only if they issued passing grades.

The ratings agencies had argued that their ratings were a form of free speech. The court agreed, but pointed out an important qualifier:

While investment ratings are a form of free expression, said the First District Court of Appeal in San Francisco, they are not mere expressions of opinion or predictions of success, which are immune from negligence suits. Instead, the court said, the ratings are factual assertions, issued “from a position of superior knowledge” about the investments’ financial health, and thus can be challenged if made falsely and carelessly.

And while federal law prohibits states from regulating credit-rating agencies, damage claims for misrepresentation are “within a field traditionally occupied by the states,” Justice Martin Jenkins said in the 3-0 appellate ruling.

Both ratings agencies appealed the decision Wednesday, but the court denied their appeals.