Mortgage Mess Unleashes Chain Of Lawsuits

Credit agencies have maintained that they fully disclose their relationships with the issuers they rate and that this setup does not compromise their work. They say they were warning of problems well before the subprime meltdown.

"Our rating criteria is publicly available, non-negotiable and consistently applied," said Frank Briamonte, a spokesman for McGraw-Hill, which owns Standard & Poor's rating agency. What is taking place now is "repricing of risk, not an upsurge in defaults, and it's the latter that our ratings speak to," Briamonte said.

A Moody's Investors Service spokesman said the company intends to "fully assist" ongoing government inquiries.

The obstacles to winning a case against credit-rating agencies are particularly daunting, according to John C. Coffee, a law professor at Columbia University. In past cases, the raters have invoked constitutional protections of free speech, comparing their evaluations of a company's debt to judgments made in a newspaper editorial.

"Credit-rating agencies have never been held liable in any class-action suit since the beginning of time," Coffee said. "They have had virtual legal immunity to any kind of statement."

In the Enron case, wherein raters failed to downgrade the Houston energy trader until four days before it filed for bankruptcy protection in 2001, a massive class-action lawsuit did not target or wrest any money from the nation's largest credit-rating firms, Coffee noted.

Steven Caruso, an attorney in New York who represents investors, is preparing to take legal action in coming weeks against Bear Stearns, operator of two hedge funds that collapsed this summer after investing in subprime securities.

He says his clients -- six individual and institutional investors with $1 million to $14 million in investments -- were not told of material facts, such as the funds' performance, that would have kept them from investing or prompted them to pull out of the funds.

The claims echo those made in an arbitration claim with the Financial Industry Regulatory Authority, the largest non-governmental regulator for securities firms. The investor, co-represented by Jacob Zamansky, a New York attorney, said he was misled by fund managers during their monthly conference calls with investors.

Russell Sherman, spokesman for Bear Stearns, said the allegations are "unjustified and without merit.

"We intend to defend ourselves vigorously," he said. "The accredited, high-net-worth investors in the fund were made very aware that this was a high-risk, speculative investment vehicle."

Just how successful some of these lawsuits are likely to be is unclear. A 1994 Supreme Court precedent precludes investors from suing companies that aided and abetted fraud, instead requiring them to go after the central players in a scheme. Government lawyers can continue to bring lawsuits under a lower standard.

A law passed by Congress in 1995 requires plaintiffs to allege improprieties that "give rise to a strong inference of fraud" in order to proceed with a case and access corporate documents. The law amounts to something of a Catch-22 for shareholders who have a hunch about malfeasance but little direct evidence to support it, said Christopher Keller, a plaintiff lawyer at Labaton Sucharow in New York.

His law firm is suing Countrywide Financial, the country's largest independent mortgage lender, for allegedly misleading investors about the strength of its finances and its underwriting standards.

Countrywide could not be reached for comment last night but has said that it has taken steps to strengthen the company and ensure the quality of its loans.

Keller's law firm also has been retained by hedge funds that lost tens of millions of dollars in the collapse of the Bear Stearns funds, but it has not sued the investment bank, Keller said. Five full-time investigators, including former FBI agents, are gathering data about the issues.

"There's hearing it, and then there's getting real direct evidence like internal e-mails," Keller said.