SACRAMENTO AND LOS ANGELES — California's giant public pension fund is suing the nation's three top bond credit-rating companies for issuing "wildly inaccurate" rankings on investments that it said cost pensioners "perhaps more than $1 billion."
The California Public Employees' Retirement System on Wednesday drew plaudits and skepticism for raising legal questions about the firms' gold-plated AAA rankings for investment funds that collapsed in 2007 and 2008.
"It's very exciting when someone has the fortitude and the capital to pursue these kind of claims," said Paul Lapides, director of the Corporate Governance Center at Kennesaw State University in Georgia. "If in fact there's a pattern and practice of bad behavior that they knew or should have known about, then the rating agencies should be held accountable in state court."
But critics wondered whether CalPERS, the nation's largest pension fund, might be trying to evade responsibility for failing to perform enough of its own diligence before sinking $1.6 billion into so-called structured investment vehicles that held mainly mortgage-backed securities.
Spokesmen for the rating firms -- Standard & Poor's, Moody's Investors Service and Fitch Ratings -- called the allegations in the lawsuit filed last week in San Francisco Superior Court meritless and said they would seek a dismissal as quickly as possible.
The CalPERS suit alleges that the rating firms negligently misrepresented the financial strength of three structured investment vehicles the companies oversaw.
The rating firms, which were compensated by the investment funds they rated, gave the vehicles -- Cheyne Finance, Stanfield Victoria Funding and Sigma Finance Inc. -- top scores that "ultimately proved to be wildly inaccurate and unreasonably high," the lawsuit said.
The ratings relied on "flawed assumptions" and failed to note the potential danger that "the underlying assets consisted in large part of risky subprime mortgages," the lawsuit said.
What's more, the rating firms played important roles in "the creation and ongoing operation" of the investment funds and commanded steep fees for giving them high marks, the lawsuit said.
A Moody's executive, Anthony Mirenda, countered that his firm does not "engage in designing, structuring or marketing securities of any type," and that its "role in the market is simply to offer reasoned, forward-looking opinions on credit risk."
Markets are paying attention to the suit because CalPERS is "a 600-pound gorilla" with a $178-billion portfolio, said John Jay, senior analyst for Aite Group, a Boston-based independent financial research and accounting firm.
But the pension fund's complaint about "misrepresentation comes way after the fact," Jay said. "There should have been some sort of validation along the way" to make sure that the triple A rating was deserved.
CalPERS' lawsuit, if it survives early dismissal efforts, could face an uphill battle. Litigants have had a poor record of collecting losses from rating firms after investments have soured.
"The whole rating industry has gotten off pretty much scot-free, but they are under so much scrutiny right now that the courts may be rougher on them," said Alan Bromberg, a securities law professor at Southern Methodist University.
CalPERS' chances of collecting any money would improve if it could get the case to a jury trial, Bromberg said. Jurors, influenced by the poor economy and public angst over Wall Street's role in the financial collapse, might be a sympathetic audience, he said.
The pension fund also was smart to file the lawsuit in a state court, which "may be more skeptical" of the rating firms than federal courts would be, Bromberg said.
Giant CalPERS, which provides healthcare and pensions for 1.6 million government workers, retirees and their families, never has been shy about going to court over perceived financial wrongdoing.
Last year, it was one of the plaintiffs in a class-action lawsuit against UnitedHealth Group Inc. that resulted in an $895-million settlement.
The complaint alleged that UnitedHealth executives approved a plan to give themselves windfall payments by backdating stock options as part of a corporate incentive program.
In recent years, CalPERS has also taken legal action against long-distance service provider WorldCom Inc.; investment banks and law firms that helped Enron Corp. create off-the-books partnerships; and the New York Stock Exchange and specialist firms that handle transactions.
The latest suit against the rating firms is about more than recovering losses, said Joseph Dear, CalPERS' chief investment officer. "If we win and establish accountability, it will be an extremely important development in the history of rating agencies."