Feds file suit over S&P mortgage bond ratings

Kevin McCoy, USA TODAY | USATODAY

The Justice Department late Monday hit Standard & Poor's with civil fraud charges, alleging the nation's largest credit rating firm gave overly rosy appraisals to securities that led to the national financial meltdown.

The government said in its complaint that S&P misled investors by stating that its ratings were objective and "uninfluenced by any conflicts of interest." It said S&P's desire to make money and gain market share caused S&P to ignore risks posed by the investments between September 2004 and October 2007.

The charges mark the first enforcement action the government has taken against a major rating agency involving the worst financial crisis since the Great Depression.

Earlier Monday, S&P issued a statement saying it expected the lawsuit and denying any culpability. The stock price of McGraw-Hill (MHP), owner of S&P, plunged 14% Monday. That was its biggest one-day drop since the stock market crash of 1987, 25 years ago. The stock was down an additional 8.4% around 10 a.m. Tuesday.

Filed in Los Angeles federal court, the lawsuit focuses on the firm's ratings of some mortgage-backed bonds in 2007, the year before defaults of many of those financial instruments caused the housing market crash and crippled the national economy.

"S&P's desire for increased revenue and market share ... led S&P to downplay and disregard the true extent of the credit risks ... in order to favor the interests of large investment banks and others... who selected S&P to provide credit ratings," the government charges in the lawsuit filed against S&P's parent, McGraw-Hill Companies.

S&P said earlier that such a lawsuit — marking a significant expansion of government efforts to hold financial firms accountable for the crisis — " would be entirely without factual or legal merit."

"It would disregard the central facts that S&P reviewed the same subprime mortgage data as the rest of the market — including U.S. government officials who in 2007 publicly stated that problems in the subprime (mortgage) market appeared to be contained — and that every (mortgage-backed bond that the Department of Justice) has cited to us also independently received the same rating from another rating agency," the company said.

Investors relied on the high ratings on the bonds, which signified low default risk. But the Financial Crisis Inquiry Commission's report in 2011 said the ratings were wrong and added "we conclude the failures of credit rating agencies were essential cogs in the wheel of financial destruction."

Department of Justice spokeswoman Adora Andy declined to comment on the lawsuit, which is expected to be joined by legal officials in several states. Spokesmen for the attorneys general offices in California and New York declined to comment Monday on whether they planned to join.

Attorney General Eric Holder planned a Tuesday news conference with legal officials from California, Connecticut, Delaware, Mississippi, Illinois, Iowa and the District of Columbia.

It was not clear whether the government plans similar action against S&P's credit-rating rivals, Moody's and Fitch Ratings. Moody's did not respond to a call seeking comment. Fitch spokesman Daniel Noonan said, "We have no reason to believe Fitch is a target of any such action."

S&P argued that a number of court rulings had rejected challenges "made with 20/20 hindsight to a credit agency's opinions of creditworthiness." As a result, the government plans to sue under a 1989 statute enacted to stabilize and reform the savings and loan industry, a move the ratings firm called an "end run" around "established legal precedent."

"We will vigorously defend our company against such meritless litigation," S&P said Monday.

Defending its pre-crisis actions, the firm said it acted ahead of its peers in downgrading residential mortgage-backed securities included in the debt obligations. Those actions required posting of additional collateral or other protection to maintain AAA ratings on the debt, S&P said.

The company said it has spent roughly $400 million since 2007 to tighten safeguards against potential conflicts of interest with entities it rates, improve methodologies and monitor risks to global credit systems.

Contributing: Associated Press; Bloomberg News