The Department of Justice (DOJ) has
released details of the suit it has filed against Standard and Poor's (S&P)
Ratings Services and its parent company McGraw Hill. The lawsuit alleges that investors, many of
them federally insured financial institutions, lost billions of dollars on
residential mortgage-backed securities (RMBS) and collateralized debt
obligations (CDO) for which S&P provided inflated ratings misrepresenting
the securities' credit risks.
DOJ maintains that S&P represented
its rates as objective and independent when "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." DOJ says that S&P weakened those criteria
and models from what S&P's own analysts believed was necessary to make them
more accurate and that, from at least March to October 2007 and because of this
same desire to increase market share and profits, S&P issued inflated
ratings on hundreds of billions of dollars' worth of CDOs. At the time, according to the allegations in
the complaint, S&P knew that the quality of non-prime RMBS was severely
impaired, and that the ratings on those mortgage bonds would not hold. The
government alleges that S&P failed to account for this impairment in the
CDO ratings it was assigning on a daily basis.
As a result, nearly every CDO rated by S&P during this time period
failed, causing investors to lose billions of dollars.
The suit was filed in the Central
District of California, home to the now defunct Western Federal Corporate
Credit Union (WesCorp), which was the largest corporate credit union in the
country. Following the 2008 financial crisis, WesCorp collapsed after suffering
massive losses on RMBS and CDOs rated by S&P. Also joining the Department of Justice in
making this announcement were the attorneys general from California,
Connecticut, Delaware, the District of Columbia, Illinois, Iowa and
Mississippi, all of whom have filed or will file civil fraud lawsuits against
S&P alleging similar misconduct in the rating of structured financial
products. Additional state attorneys
general are expected to make similar filings today.
The complaint seeks civil penalties
under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989
(FIRREA) based on three forms of alleged fraud by S&P: (1) mail fraud
affecting federally insured financial institutions; (2) wire fraud affecting
federally insured financial institutions; and (3) financial institution fraud. FIRREA authorizes the Attorney General to seek
civil penalties up to the amount of the losses suffered as a result of the
alleged violations. To date, the government 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.
had preemptively issued a press release in anticipation of the court filing
denying the allegations. Its statement
was abstracted in MND's
earlier story on the suit.
"Put simply, this alleged conduct is
egregious - and it goes to the very heart of the recent financial crisis," said
Attorney General 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. It is just
the latest example of the critical work that the President's Financial Fraud
Enforcement Task Force is making possible."