Proving a Case in Litigation Against Rating Agencies Standard & Poor’s, Moody’s, and Fitch
The author, renowned nationwide banking and mortgage banking expert witness Don Coker, explains from a banker's and valuation professional's viewpoint how to analyze one of the major supporting issues that impacts Rating Agency Litigation involving mortgage-backed securities.
Governmental and civilian lawsuits against the three major rating agencies, Standard & Poor’s Financial Services, LLC (a unit of The McGraw Hill Companies which trades as MHP on the NYSE), Moody’s Corporation (which trades as MCO on the NYSE, and whose largest shareholder is Warren Buffett’s Berkshire Hathaway, Inc.), and Fitch (a majority-owned subsidiary of Fimalac, S.A., in Paris, France, which trades as FIM on the Euronext Paris), are plowing new ground in terms of corporate responsibility for the quality of their work.
● The gravamen of the claims against them is whether the rating agencies essentially granted unwarranted high credit ratings on some mortgage-backed financial investments that clearly were doomed to fail. Unfortunately, it appears that they did.
● The rating agencies have had some past success in making the Constitutional argument that their ratings of investments amount to “opinions” that are protected by the First Amendment. While making statements of Constitutional law should be reserved for attorneys, you have to wonder how this argument would be received by the court when applied to a similar case on an individual level where a credit bureau sold a credit report to a lender reflecting a stellar credit history for someone who had no chance of paying his bills, regardless of the directional movement of the economy. It seems more reasonable than not that the Court would be receptive to a claim that the credit bureau failed to do what it was paid to do. Why shouldn’t this same logic apply on the commercial level?
● The value of a mortgage-backed investment, such as a tranche of a residential mortgage-backed security or a commercial mortgage-backed security, rated by a rating agency is determined by the quality of the underlying mortgages that produce the cash flow that will pay an investor a return on their investment as well as a return of their investment. These are analyses that can be performed by an experienced mortgage and valuation professional, and presented so that they will be clearly understandable in court.
● The rating agencies also hold the opinion that the failure of the investments that they rated high were due solely to the overall decline in the economy. Dealing with this claim requires both sides to project what more likely than not would have happened to the investments involved if the economy did not take a nosedive. An eye-opening analysis that can be performed in this situation is what would have to happen in order for the AAA rated investment to perform successfully to the point that it was truly deserving of a AAA rating, and then compare that to what actually happened with the investments.
● And taking a step back, the analysis must also consider whether the rating agencies’ faulty ratings were the proximate cause, or a major causal factor, of the economic downturn.
● As a financial services professional with over forty years’ experience, it is my professional opinion that these agencies did a poor job of investment analysis that resulted in inaccurate ratings on certain investments.
● Given that some of these mortgage-backed investments were so poorly underwritten that it was foreseeable that their value would be less than anticipated, it raises the issue of whether the rating agencies – who compete with each other for business - were engaging in this over-rating practice in order to win business from the issuers of the investments. It is my opinion that it is reasonable to assume that some of these artificial ratings were assigned to earn a fee that otherwise would not have been earned.
● It is my professional opinion that the erroneous and false ratings that were issued by the rating agencies served to encourage, enable, and promote the originators and issuers to issue many more mortgage-backed securities that would not have been issued but for their artificially-boosted marketability due to their artificially high ratings. Thus, the issuers of the mortgage-backed securities were also victims of the rating agencies.
● From the results that we have seen produced by many of these highly rated investments, it is my professional opinion that it is clear that the rating agencies did not observe normal nationwide industry standard practices in their investment analysis for many of these investments.
● In my opinion as an experienced financial services industry professional, the rating agencies failed to exhibit good faith, fair dealing, ordinary care, honesty in fact, and reasonable commercial standards in their analysis of some of these mortgage-backed investments and the ratings that they decided to assign to them.
● It is my professional opinion as an experienced financial services industry professional that it is reasonable to assume, and more likely than not, that the ratings issued by the rating agencies were relied upon by the companies that structured the investments as well as by the investors that purchased the investments.
● It is my professional opinion as an experienced financial services industry professional that it was foreseeable by the rating agencies that their issuance of erroneous ratings for investments very likely would cause severe economic damages to the purchasers of investments who relied upon the ratings assigned by the rating agencies.
● It is my professional opinion as an experienced financial services industry professional that the erroneous ratings assigned to many of these investments were the proximate cause of many of the losses sustained by the investors that relied upon those ratings in making their investment decisions.
A close and detailed analysis of the mortgage loans that underlie all of these disputed ratings will provide a clear indication of the accuracy and professionalism of the ratings “opinions” provided by the various rating agencies.
ABOUT THE AUTHOR: Banking, Financial, Investment, Securities and Economic Damages Expert Witness Don Cokerr
Expert witness and consulting services. Over 500 cases for plaintiffs & defendants nationwide, 120 testimonies, 12 courthouse settlements, all areas of banking and finance. Listed in the databases of recommended expert witnesses of both DRI and AAJ. Clients have included numerous individuals, over 75 banks, and governmental clients such as the IRS, FDIC.
Employment experience includes Citicorp, Ford Credit, and entities that are now JPMorgan Chase Bank, BofA, Regions Financial, and a two-year term as a high-level governmental banking regulator. BA degree from the University of Alabama. Postgraduate and executive education work at Alabama, the University of Houston, SMU, Spring Hill College, and the Harvard Business School.
Called on by clients in 31 countries for work involving 61 countries. Widely published, often called on by the media.
Copyright Don Coker
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.