The U.S. Department of Justice went ahead Tuesday with its planned lawsuit against credit rating agency, Standard & Poor’s Ratings Services, over its rating performance amid the financial crisis.
The federal government, and several states, are alleging that S&P engaged in a scheme to defraud investors in structured financial products (residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDOs)) by issuing inflated ratings and misrepresenting its independence in providing those ratings.
Justice says that its lawsuit alleges that investors, many of them federally insured financial institutions, lost billions of dollars on CDOs for which S&P issued inflated ratings that misrepresented the securities’ true credit risks. It also alleges that S&P falsely represented that its ratings were objective, independent, and uninfluenced by its relationships with investment banks when its desire for increased revenue and market share led it to favour the interests of the banks over investors.
“Put simply, this alleged conduct is egregious – and it goes to the very heart of the recent financial crisis,” said attorney general, Eric Holder. “Today’s action is an important step forward in our ongoing efforts to investigate – and – punish the conduct that is believed to have contributed to the worst economic crisis in recent history.”
The allegations have not been proven, and S&P has said that it intends to vigourously contest them. “The DOJ and some states have filed meritless civil lawsuits against S&P challenging some of our 2007 CDO ratings and the underlying RMBS models. Claims that we deliberately kept ratings high when we knew they should be lower are simply not true. We will vigorously defend S&P against these unwarranted claims,” it said in a statement.
“At all times, our ratings reflected our current best judgments about RMBS and the CDOs in question. Unfortunately, S&P, like everyone else, did not predict the speed and severity of the coming crisis and how credit quality would ultimately be affected,” it adds, “Although we deeply regret that these 2007 CDO ratings did not perform as expected, 20/20 hindsight is no basis to take legal action against the good-faith opinions of professionals.”
State attorneys general joining the feds in their suit include California, Connecticut, Delaware, the District of Columbia, Illinois, Iowa and Mississippi, and, other states are expected to make similar filings.
The complaint seeks civil penalties based on alleged mail fraud, wire fraud, and financial institution fraud. The attorney general is authorized to seek civil penalties up to the amount of the losses suffered as a result of the alleged violations, and it says that it has identified more than $5 billion in losses suffered by federally insured financial institutions in connection with the failure of CDOs rated by S&P from March to October 2007.
“Many investors, financial analysts and the general public expected S&P to be a fair and impartial umpire in issuing credit ratings, but the evidence we have uncovered tells a different story,” said acting associate attorney general, Tony West. “Our investigation revealed that, despite their representations to the contrary, S&P’s concerns about market share, revenues and profits drove them to issue inflated ratings, thereby misleading the public and defrauding investors. In so doing, we believe that S&P played an important role in helping to bring our economy to the brink of collapse.”