The obligations of rating agencies

Eddy: The thoughtless following of rating agencies is just the same with a bank blindly following their internal risk models. Why you never expect to see this coming? Perhaps the followers believe that rating agencies are another group of entity with the "Too Big to Fail" nature? :D

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By Mustapha Kamil.

Rating agencies just can't issue an opinion and then skate scot-free, says the chief investment officer of CalPERS

WHAT was said by the chief investment officer of The California Public Employees' Retirement System (CalPERS) last Wednesday was interesting and somewhat made sense.

Speaking to Bloomberg and of the suit CalPERS is undertaking against rating agencies, Joseph Dear said: "They (rating agencies) just can't issue an opinion and then skate scot-free, even if they're totally wrong, which they were with respect to these securities".

CalPERS was taking action against three bond rating agencies for the US$1 billion (RM3.58 billion) loss the pension fund suffered as a result of what it calls "wildly inaccurate" risk assessments by the rating agencies. Besides CalPERS, other investors who suffered massive losses in the subprime meltdown crisis has also commenced legal actions against rating agencies.

Whatever the outcome of these litigations will be interesting as any one of them may form a precedent for future cases.

So far, there has been no known successful action taken against rating agencies.

But rating agencies are not the only ones that issue some form of advice on investments. Stockbroking firms do too when their research arms make calls on stocks.

Investment banks do too when they issue advice on corporate moves to minority shareholders and sometimes, there is a grey area where even the financial press may find itself in.

In the past, rating agencies in the US have successfully argued that they were protected by the first amendment in the American constitution, just as the press are when newspapers publish indices, as they were merely issuing opinions on securities.

But such argument is being challenged by lawyers who essentially said there is a limit to the protection the first amendment accord to the likes of rating agencies.

The American courts are clear on this, in that when a rating agency rates only securities it is hired to rate or when the agency itself participated in the structuring of the security (such as in the Collateralised Debt Obligation debacle) and if such security was privately placed instead of offered to the general public, then the protection accorded by the First Amendment would be lost.

Stockbroking firms too are expected to follow development in these suits against rating agencies closely as the outcome could have a bearing on them too. And so too would the financial press in their role in disseminating information that may assist investors make their investment decisions.

Perhaps, the absence of malice would be a strong defence on the part of rating agencies and stockbroking firms as do fair comment on the part of journalists.

But the litigations against the rating agencies have just begun and even if they succeeded in mounting a strong defence, it remains to be seen whether they can escape other charges irate investors like CalPERS may pile on them.

There are always other possible suits, including perhaps, for negligence.