Watchdog Offers to Fund Class-action Motion Over Bonds Backed by Lehman

The Israel Securities Authority made a rare decision to help fund a class-action suit.

The NIS 85 million suit names as defendants the Israeli credit rating agency Standard & Poor Maalot, the Excellence Nessuah investment house, Bank Leumi Trust Company and the company World Currencies, as well as its directors and controlling shareholder.

The request for a class-action was filed a year ago, in Tel Aviv District Court, by Amiram Deutsch. He claimed that S&P Maalot, headed by CEO Dorit Salingar, was negligent in not downgrading World Currencies' structured bonds, which were based on underlying assets secured by Lehman Brothers, an American investment bank that collapsed in September 2008.

Deutsch, no relation to Gil and Avi Deutsch, chairmen of Excellence Nessuah, says the suit represents investors who bought structured bonds issued by World Currencies, which is a subsidiary of Excellence Nessuah.

World Currencies had raised about NIS 400 million from Israeli investors. It transferred that money to Lehman Bankhaus in exchange for a note promising interest of 8.75% a year. Repayment of the principal, due to mature in March 2010, would be based on the performance of a basket of currencies against the U.S. dollar. But with doubt swirling about Lehman Bros.' survival, doubt had to rise about Lehman Bankhaus' ability to pay that interest and the principal, says Deutsch.

Deutsch claimed that there were many clear warnings well before September 2008 that Lehman Brothers' condition was deteriorating, but Maalot nonetheless neglected to downgrade World Currencies' bonds. The bonds retained their blue-chip rating until the day Lehman fell, at which point Maalot scrambled to downgrade them to D for default.

The plaintiff claims Maalot was duty-bound to regularly monitor the assets backing the bonds, and adjust the ratings appropriately.

After the downgrade, the price of the bonds plunged, between September 3 and 15, 2008, and their yields rocketed from 10% to more than 70%.

Deutsch charges that World Currencies committed securities fraud by neglecting to advise the investing public of the extent to which the bonds' value depended on the state of Lehman Brothers.

The ISA, headed by chairman Zohar Goshen, is legally allowed to help finance class-action suits. The criteria include that the case be in the public interest. Also, there must be a "reasonable chance" that the court will approve the request for a class-action.

"The approval for funding is only in principle. The sum and conditions will be determined by the ISA in the future. The level of funding will be set in relation to specific funding requests, including details of the expenses required for the suit," wrote the ISA's deputy general counsel in a letter to the plaintiff's attorney.

The ISA said that it was not committing itself to funding the suit fully or in part, and that if the plaintiffs won the case and were awarded compensation, the money would be returned to the ISA with linkage and interest.

ISA General Counsel Samson Albek told a conference on class-action suits four months ago, "If a class-action suit is handled the way we think it should be handled, we will finance 80% of the legal costs."

S&P Maalot stated that the lawsuit is baseless. It said it would defend itself decisively in court. "We are happy for any dialogue with the Israel Securities Authority, which did not join as a party to the suit," the agency added.