In mid-December, Lehman Brothers Australia – in Liquidation (LBA) filed a lawsuit against Fitch Ratings Inc (Fitch) alleging Fitch made misleading representations in assigning credit ratings to synthetic CDO products. These CDO’s were distributed by LBA and ultimately defaulted causing losses to both LBA and its former clients. It is alleged had Fitch not made mis-leading representations, LBA would not have under-written and distributed the CDO’s and so no losses would have occurred.
At the heart of the case is a Significance Table which was undisclosed by Fitch and hidden and password protected to prevent user discovery. The Significance Table mapped the output of Fitch’s VECTOR model using much higher probabilities of default at the AAA and AA ratings level. Had the default probabilities used by Fitch for all other assets and as published in the model’s user manual been applied, this would have resulted in much lower ratings being assigned and so the CDO’s would never have been issued. LBA is claiming $40 million of losses in its lawsuit.
As detailed by Amicus previously there are a number of law firms attempting to sign up end investors in these products to potential lawsuits against Fitch. Amicus has several concerns regarding these law suits including:
- Litigation funding agreements generally make it extremely difficult for the investor to reverse their decision post their signing of the funding agreement without having to still pay the funder a percentage of any monies recovered by the client. This can occur even if the funded lawsuit never proceeds and the investor decides to sign up for an alternative lawsuit that is proceeding
- Amicus is not aware of any lawsuits other than the LBA one being filed in relation to these products at this stage, hence there is a real risk investors isolate themselves in a lawsuit with a funder that is not going to proceed and forgo the opportunity of joining one that is proceeding
- There is no urgency to sign up to any legal actions as Fitch is unlikely to be rushing to look to settle legal actions when there is no case to settle as yet. As far as Amicus is aware, Fitch has not rushed to settle the LBA case even though this is the only one that has been formally filed
- The terms of funding agreements vary and without comparisons available it is impossible to determine whether a funding agreement is reasonable for the risk involved or is “uncommercial”
Our advice for all our retained clients last month was not to sign up any lawsuit, but to wait to see what emerges if anything as a result of the LBA action. The LBA action is likely to prompt a closer examination of the merits of the overall case amongst law firms and funders because LBA clearly has received sufficiently strong legal advice regarding its own case to give it sufficient confidence to file its claim.
Amicus expects other lawsuits to emerge over the next few months (if they are going to emerge at all) and hopefully investors will have a choice with some competitive tension in the market-place. We therefore feel it would be unwise for investors to sign a funding agreement now that locks them into a lawsuit that may never end up even being filed or progressed.