Suit Charges 3 Credit Rating Agencies With Fraud in Bear Stearns Case

The collapse of two Bear Stearns hedge funds 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 and Moody’s 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 â€" some of which already surfaced in earlier cases â€" that 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 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 were not immediately available for comment.

The lawsuit is hardly the first to try and hold the ratings agencies accountable for losses incurred during the financial crisis. Earlier this year, the Justice Department filed a civil fraud action 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. Fitch and Moody’s were not named as defendants in those lawsuits.

S&P has denied wrongdoing and called the government’s case “entirely without factual or legal merit.” A federal judge denied S&P’s motion to dismiss the government’s action.

The lawsuit 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 Cioffi and Matthew 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 any wrongdoing.

The liquidators have not only blamed the ratings agencies for the funds’ collapse. 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 by the pursuit of profit.

During the housing boom, S&P, Fitch and Moody’s made millions by issuing ratings to 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 these lawsuits. Others have said that ratings were not opinions, but misrepresentations that were possible the result of negligence or fraud.

The agencies have also said that their ratings were mere “commercial puffery” that were not to be relied upon, and that investors had the same information as they did.

In July, the federal judge denying S&P’s motion to dismiss the government’s case rejected this argument, calling it “deeply and unavoidably troubling.”

“If no investor believed in S&P’s objectivity, and every bank had access to the same information and models as S&P,” wrote Judge David Carter of Federal District Court in Los Angeles, “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?”