In an earlier post (here), I examined recent academic research questioning whether the rating agencies have played a blameworthy role in the subprime lending industry, and speculating on the rating agencies’ possible litigation exposure. On July 19, 2007, the rating agencies potential litigation risk moved from supposition to reality when a shareholder of Moody’s filed a purported class action lawsuit (here) alleging that Moody’s failed to disclose that it “assigned excessively high ratings to bonds backed by risky subprime mortgages,” and that Moody’s maintained the ratings “even as the downturn in the housing market caused rising delinquencies of the subprime mortgages.”
The Complaint also alleges that on July 11, 2007,
Moody’s shocked investors when it announced that the Company was downgrading 399 mortgage-backed securities issued in 2006 and reviewing an additional thirty-two for downgrade, affecting approximately $5.2 million of bonds. The Company also disclosed that it had downgraded 52 bonds issued in 2005.
A July 11, 2007 Wall Street Journal article discussing Moody’s downgrade of the mortgage-backed securities can be found here.
There are a number of odd things about this Complaint. First, there is the fact that it is Moody’s shareholders who are bringing the lawsuit, not, as you might suppose, investors who purchased the mortgage-backed securities that supposedly were assigned excessively high ratings. The lawsuit is brought on behalf of “all purchasers of the common stock of Moody’s between October 25, 2006 and July 10, 2007. ” I guess the wrongdoing Moody’s is alleged to have committed affected a wide variety of arguably aggrieved persons, even including Moody’s shareholders. As I noted in my recent post (here), subprime lending related litigation is arising in an ever-increasing variety of forms. It’s just that the investors whose investments supposedly were misleadingly rated would seem to be the ones more likely to assert a grievance about supposedly excessive ratings Moody’s allegedly assigned.
The second odd thing about the Complaint is that the lawsuit names as the sole defendant Linda Huber, Moody’s CFO. The Complaint does not name Moody’s itself or any of its other officers or directors as defendants. The Complaint alleges that Huber was in possession of “adverse undisclosed information about the company’s business.” There is of course no requirement that any plaintiff name any particular defendant in a lawsuit, but there is something, well, unusual about just naming the CFO and no one else. (UPDATE: Alert reader Avi Wagner of the Stoock $ Stroock & Lavan law firm suggests that the explanation for the complaint only naming the CFO might be that the attorney hopes to bury the notice; by not naming a corporate defendant, a notice might catch fewer eyes and might not be registered with people searching courthouse news or other litigation filing reports.)
Another odd thing about the Complaint is that it involves Moody’s, rather than another of the rating agencies. Of course, that is who Moody’s shareholders would sue, if in their status as Moody’s shareholders they would sue anybody. But the Complaint was filed just a day after Moody’s own rather public whinge that, as the Wall Street Journal put it in its July 18, 2007 article “Moody’s Says It is Taking a Hit” (here, subscription required), it is “paying a high price for its tough stance on lax lending standards for commercial mortgage backed securities.” According to the Journal article, Moody’s claims that it was “passed over and not hired to 75% of the commercial mortage-backed securities rating assignments” because the securities issuers “were hiring competitors that would hand out higher ratings on securities.” In other words, by Moody’s account, if there were excessively high ratings for mortgage-backed securities, it wasn’t Moody’s doing, thank you very much.
To be sure, even by Moody’s own account, it was not until this past April 10 that it announced that it was (according to the Journal) “raising subordination levels of commercial mortgage-backed securities in an effort to enhance credit quality and further reduce the possibility of widespread defaults.” The negative inference is that prior to April 10, Moody’s did not have these heightened requirements.
Whatever the merits and ultimate fate of this recently filed lawsuit, the purported class of Moody’s shareholders who acquired their stock between October 2006 and July 2007 would not include Moody’s most prominent shareholder, Warren Buffett. According to Berkshire Hathaway’s 2006 Annual Report (here), Berkshire owned 48 million Moody’s shares – or 17.2% of the company – as of December 31, 2006. These shares have been reported in every Berkshire annual report since 2001, suggesting that Berkshire acquired the shares some time during 2001 — in any event, well before the beginning of the class period.
It is probable in any event that Buffett has much more positive feelings about Moody’s than does the plaintiff who initiated the lawsuit. According to Berkshire’s 2006 Report, its Moody’s shareholdings cost only $499 million, but as of December 31, 2006, were worth $3.315 billion. (Assuming Berkshire still holds the same number of Moody’s shares, the stock would be worth about $2.832 billion today.) As I have noted more than once in this blog, you do have to admire Buffett’s touch.
Hat tip to the WSJ.com Law Blog (here) for the link to the Moody’s Complaint.
UPDATE: On August 29, 2007, shareholders of McGraw-Hill filed a lawsuit (refer here) alleging that the company failed to disclose that its Standard & Poor’s subsidary “assigned excessively high ratings to bonds backed by risky subprime mortgages — including bonds packaged as collateralized debt obligations — which was materially misleading to investors concerning the quality and relative risk of these investments.”
In keeping with the Harry Potter theme of my prior post, it may be worth noting here that one of the ill-fated Defense Against Dark Arts teachers at Hogwarts was none other than Alastor “Mad Eye” Moody. “Mad Eye” Moody has no known relationship with the rating agency, however. Nor as far as I know did he have any role in the subprime lending mess.