That these funds and other plaintiffs are trying to hold the ratings agencies to account is a good thing.
And
yet, there’s a mystifying disconnect in some of these disputes. On one
hand, pension funds or state officials are telling the courts that
Moody’s and S.&P. were negligent and their ratings marred by flawed
methods and conflicts of interest. On the other hand, when the
professionals who manage state funds buy bonds or mortgage securities,
their investment policies require them to rely on the assessments of —
you guessed it — the very same ratings agencies.
Consider the $300 billion California Public Employees’ Retirement System, or Calpers.
Its 2009 lawsuit against Moody’s and S.&P. contends that the system
lost $800 million on mortgage securities it bought based on those
agencies’ positive ratings. The ratings, Calpers said in its lawsuit, were negligent misrepresentations.
In the meantime, Calpers’ Statement of Investment Policy for Global Fixed Income says the fund can invest in corporate bonds only if they are rated investment grade by “a recognized credit rating agency,” which it defines as Moody’s, S.&P. or Fitch Ratings.
I
asked Calpers why its investment staff must rely on ratings from the
same companies that it is suing for negligence. A spokesman declined to
answer my question.
Calpers
is not alone in taking this oddly contradictory stance. Seventeen
states have sued S.&P., contending that they were misled on ratings.
But many of these states have similar policies requiring that their
investment professionals — such as treasurers and pension overseers —
rely on S.&P. ratings.
For example, the Arizona State Treasury Investment Policy Statement limits its purchase of bonds to those carrying a triple-B rating or better by S.&P. or the equivalent by Moody’s.
Kevin
Donnellan, a spokesman for the Arizona state treasurer, said he saw no
conflict in the state’s investment funds relying on S.&P. ratings
even as the state’s attorney general was suing the firm. “Investment
professionals and lawyers see the world through different lenses,” he
said in an interview. “Our board of investors are not guided by the
legal actions taken by the A.G.’s office.”
Maine has a similar policy. I asked Neria Douglass, the state treasurer, why.
“Our
investors are conservative folks and they want ratings from the
agencies they are comfortable with,” she said. “I certainly have
concerns about the industry configuration that can reward the wrong
moves, but we’re not in the business of being early adapters.”
These statements, while bewildering to me, came as no surprise to Dennis M. Kelleher, chief executive of Better Markets,
a nonprofit organization that promotes the public interest in financial
reform. He said he had seen no effort by professional investment
managers to encourage the ratings agencies to change their operations or
an effort to push the Securities and Exchange Commission to do a better
job regulating the agencies.
“Given
the damage that baseless and inflated ratings did to investors, it is a
mystery why they are not in the forefront demanding that the S.E.C. use
all its authority to ensure that credit ratings agencies are
conflict-free and merit the reliance they court and induce,” he said in
an interview. “Where else in the world is it consistent with a fiduciary
duty to rely blindly on something that has an egregious and
demonstrated record of failure?”
Mr.
Kelleher suggested that ratings agencies be held liable for malpractice
as accounting firms and other experts are. Moody’s and S.&P.
contend that the grades they give bonds and securities are opinions that
carry free-speech protections. As such, they are not subject to legal
liability. Some courts, alas, have accepted this argument.
Investors could also effect change by relying on ratings firms that were not part of the problem in 2008.
Even
though 10 ratings agencies of varying sizes are currently recognized by
the S.E.C., the market is still dominated by Moody’s, S.&P. and
Fitch. The S.E.C.’s 2013 report
to Congress shows that in 2012 the big three controlled 94.7 percent of
their industry’s total revenue, up from 94 percent in 2011.
Such
a share might decline if pension fund investors either did their own
credit analysis or stopped relying solely on the big three for ratings.
Either action could have a much more meaningful impact than their
lawsuits by eliminating the agencies’ hold on determining
creditworthiness.
Even
if they prevail in the courts, investors are unlikely to recover more
than a small fraction of losses they have incurred. And payments made by
the ratings agencies to resolve these matters would amount to a
rounding error on their financial positions.
The
continued reliance on agencies that failed so many investors with their
ratings might not be a problem if securities regulators had forced the
raters to overhaul their operations. Among the problems: Companies pay
the agencies to grade the securities, and that sets up a potential
conflict of interest. States, too, pay the agencies to assign grades to
their own debt.
Still, little has been done.
All
three agencies have said in the past that they can manage these
conflicts and that they have tightened their procedures to eliminate the
potential for another fiasco involving overly optimistic ratings.
Nevertheless,
the Dodd-Frank law of 2010 directed the S.E.C. to increase its
oversight of these agencies and to issue new rules. The commission proposed rules three years ago that are still not final.
It’s
passing strange for large investors to require that their holdings
carry ratings from the very firms whose grades, they say in court
filings, were negligent. But what’s even worse is that these investors
are helping to maintain the troubling status quo. (http://www.nytimes.com)
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