Thursday, July 12, 2007

The Credit Market Fall-Out #5 – The Potential Lawsuits

In addition to the investigation being done on the Attorney General of Ohio concerning the rating agencies there are the inevitable class action lawsuits. Whether you like it or not it is part of the process. From Reuters.

U.S. class-action lawyers who have sued subprime mortgage lenders are now scrutinizing Wall Street banks that sold packages of risky loans to investors and credit analysts that served up top ratings on the securities.

Litigation stemming from the collapse of the subprime mortgage market is expected to grow as more investors run for cover after suffering losses on bonds tied to mortgage-backed securities.
Plaintiffs' lawyers say they want to know more about the relationship between the credit rating services and investment banks that assembled complex debt structures known as collateralized debt obligations, or CDOs, tied to risky mortgages. Two leading rating services this week downgraded billions in subprime debt, but critics say they should have acted earlier.

. . . . Legal experts say that any lawsuits against banks involved in underwriting subprime securities and against credit rating agencies could be particularly difficult to prove. That's largely because buyers of the bonds were primarily sophisticated investors like pension and hedge funds that should have known the risks.

"My guess is people will be looking for monies wherever they can," said Mark Neubauer, a partner at law firm Steptoe & Johnson LLP in Los Angeles who represents corporations in securities law cases.

But, he said, "what courts are unwilling to do is make the rating companies insurers, if you will, for the investing public."

The three leading rating agencies, Fitch Ratings, Moody's Investors Service, and Standard & Poor's Ratings Service, a unit of McGraw-Hill Cos. Inc., declined to comment when asked about potential litigation. Rating services have said that they only issue opinions, not investment advice.
Rating agencies have successfully fought off lawsuits in other areas in the past, often citing First Amendment issues in their defense.

But while the rating services argue that they are merely offering opinion, they are involved in a lot more, said Joseph Mason, an associate professor of finance at Drexel University in Philadelphia.

He said they work directly with underwriters to determine the size of each tranche, or group of debt, and are active in the entire structuring of CDOs to achieve a rating target.

"The rating companies view is we offer an editorial opinion," Mason said. "That's clearly not the case. Rating companies are involved in financial engineering."

"You've got to show that they've made a false or misleading statement, and that they made it intentionally or at least recklessly," he said. "That's going to be relatively difficult to do here."

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