California Public Employees’ Retirement System v. Moody’s Investors Service, Inc.

Facts

In 2006 and early 2007, CalPERS, through its agents, invested approximately $1.3 billion in medium-term notes and commercial paper issued by three structured investment vehicles (SIVs) that had received the highest “AAA” or equivalent ratings from the Rating Agencies. SIVs are special-purpose investment entities that issue debt and purchase mainly medium and long-term assets for their portfolios. The Rating Agencies played an unusually active role in creating and structuring these SIVs, helping to design both the vehicles themselves and the structured-finance securities that made up their portfolios. The Rating Agencies were paid fees contingent on the SIVs receiving high ratings and being offered to investors. Despite portfolios containing significant amounts of subprime mortgage-backed securities, the Rating Agencies assigned their highest ratings to the SIVs. CalPERS alleges the Rating Agencies used flawed methodologies that failed to adequately capture market risk, particularly the possibility that market interruptions could simultaneously affect both the SIVs’ ability to roll over short-term debt and to liquidate their underlying assets. When the financial crisis hit in 2007-2008, the SIVs entered bankruptcy or receivership, causing CalPERS to lose “hundreds of millions, and perhaps more than $1 billion.”