MIAMI A federal court this week agreed to temporarily halt a suit against Standard & Poor’s Ratings Service, Moody’s Investor Service and a handful of Wall Street banks over the sale of $150 million of risky mortgage-backed securities known as CDOs that caused the 2009 collapse of Eastern Financial Florida CU, the biggest non-corporate credit union failure ever.
The U.S. District Court for the Southern District of Florida agreed to stay the case while it reviews the ratings agencies’ and the banks’ motion for dismissal. S&P has argued that contracts signed by Eastern Financial in 2007 when it bought the failed securities require that any disputes be heard in New York, where the securities were created, rated and sold.
The suit was brought a year ago by Space Coast CU, which acquired the remnants of the credit union giant after it was seized by regulators in 2009. Space Coast, based 150 miles north in Melbourne, Fla., alleges that the Wall Street entities engaged in fraud when they sold $150 million worth of CDOs mortgage derivatives created by combining other mortgage derivatives to Eastern Financial that went sour within months of their issuance. Eastern Financial, the one-time Eastern Airlines employees’ credit union, ended up losing a staggering 99% of its CDOs investment and was pushed into insolvency.
Yesterday’s court action comes as the U.S. Department of Justice has filed suit against several of the same entities, including S&P, over the Eastern Financial deals and others costing investors such as WesCorp FCU and several banks billions of dollars in losses.
The Space Coast suit names Merrill Lynch (now a unit of Bank of America); Bear Stearns (now a unit of JP Morgan Chase); Wachovia Securities (now part of Wells Fargo Securities); UBS Securities; Barclay’s Capital, S&P and Moody’s Investors Service as defendants. The claims in the suit are similar to those in a separate action filed in 2010 by Space Coast against Barclay’s Capital over a $10 million slice of the CDOs. That suit is still pending.
According to S&P, the contract with Eastern Financial governing the CDO ratings is governed by New York law and the two parties agreed to hear any disputes over the CDOs in a New York court. The rating agency also asserts that Space Coast brought the suit too late to satisfy the one-year contractual timeline on ratings disputes.
Eastern Financial and WesCorp, which collapsed in March 2009, are the only two credit unions that were authorized to invest in CDOs. WesCorp lost more than 95% of its $600 million CDO investment.
The Justice Department’s suit, filed this week, claims that S&P knowingly assigned false high ratings to the CDOs because its Wall Street customers were paying it to do so. The government claims S&P was so concerned with the possibility of losing market share and profits that it limited, adjusted and delayed updates to the ratings criteria and analytical models it used to assess the credit risks posed by RMBS and CDOs. According to the complaint, S&P weakened those criteria and models from what S&P’s own analysts believed was necessary to make them more accurate.
