Ratings Agencies and the Financial Meltdown: California Investigates

The California Attorney General's Office has launched an investigation into the role played by ratings agencies in the financial meltdown.

In very brief sketch, when a corporation, state, municipality, or other entity issues debt, that debt often comes with a rating from a ratings agency such as Moody's, Standard & Poor's or Fitch. The rating is meant to indicate the likelihood that the debt will be repaid. The same thing happens when investment banks bundle up and issue securities, including the now loathed subprime motgaged backed securities blamed for touching off the worst financial crisis in a generation.

Like many, the question California's Attorney General wants answered is how so many of those securities backed by bundles of risky mortgages were sold with AAA ratings, and whether cozy relationships between ratings agencies and investment banks were to blame.

California is by no means the first to the party. Other states, including New York and Connecticut are investigating. Investors, including the California Public Employees Retirement System, have also sued the ratings agencies.

Here's what Attorney General Jerry Brown wants to know regarding the ratings agencies:

• Did they fail to conduct adequate due diligence in the rating process?
• Did they give high ratings to particular securities when they knew or had reason to know that high ratings were not warranted?
• Did they fail to comply with their own codes of conduct in rating certain securities?
• Did they profit from giving inaccurate ratings to particular securities?
• Did they make fraudulent representations concerning the quality or independence of their ratings?
• Did they compromise their standards and safeguards for profits?
• Did their statistical models capture the risk inherent in subprime and other risky assets and, if not, what was the rating agencies' response? and
• Did they conspire with the companies whose products they rated to the detriment of investors?

California has subpoenaed Standard & Poor's, Moody's and Fitch in search of answers.

Whether and how they would be held to account if the answer to those questions is yes remains a somewhat open question.

• A First Amendment Defense for the Rating Agencies? (WSJ Law Blog)
• Rating agencies lose a free-speech claim (Reuters)
• S.E.C. Urges Changes to Ratings-Agency Rules (NY Times)
• Securities Litigation: Claims & Defenses (provided by Law Office of Lee H Schillinger PA)
• White Collar Crime Overview (provided by Brent Horst Attorney at Law & Associates)