America's Department of Justice hopes to prove that something that in the past may have been seen as merely unfair is also a crime

IT IS beyond argument that ratings agencies did a horrendous job evaluating mortgage-tied securities before the financial crisis hit. Whether that failure was a crime has long been a matter of debate, particularly because no other entity—including America’s federal regulators—did any better. On February 5th the Department of Justice (DoJ) weighed in, filing a complaint against Standard & Poor’s (S&P) in a Los Angeles federal court. The complaint charges that the ratings agency "limited, adjusted and delayed updates to the rating criteria and analytical models" needed to evaluate risk, and, based on information from an unnamed executive, did so deliberately to protect its business. News of the pending litigation had already prompted a dramatic plunge in the share price of S&P’s parent, McGraw Hill, on February 4th. With the actual filing, its shares fell again. Moody’s, the other leading ratings agency, has also seen its share price collapse. It is unusual for such an important financial case to be filed in Los Angeles. The suit cites the Western Federal Corporate Credit Union (WesCorp), a financial firm based in Los Angeles county that collapsed under the weight of losses from mortgage-backed securities. But the DoJ may have also been hunting for a favourable jurisdiction. Losses from these sorts of bonds were spread across America. The issuing banks, ratings agencies and various witnesses are all based in New York, where such litigation is usually filed.

Since the crisis, 41 legal actions targeting S&P have been dropped or dismissed. The company and other ratings agencies have prevailed by asserting their rights under the first amendment of the constitution, which states that “Congress shall make no law...abridging the freedom of speech”.

So the DoJ is taking a new approach, accusing the firm of knowing misrepresentation, which is not covered by the first amendment. Similar cases have failed, but the DoJ's complaint is based on a law passed in 1989 in response to the savings-and-loans crisis. Called the Financial Institutions Reform, Recovery, and Enforcement Act, it has never been used in this sort of case.

S&P says it will mount a defence. It will certainly present evidence that its performance during the crisis was consistent with that of others trying to determine the validity of the troubled credits, and that it operated in good faith. As the complaint makes clear, the ratings in question were issued after intense arguments within S&P about how to evaluate complex new securities—and about how to expand the business without undermining the quality of opinions.

The firm is likely to argue that the decision-making process was inherently subjective rather than intentionally fraudulent. Implicit in this defence is the notion that the decision to invest is ultimately the responsibility of the buyer—particularly if the buyer is large, established and operating under the scrutiny of federal regulators, as was WesCorp.

In announcing the case, Eric Holder, America’s attorney general, said that S&P had misrepresented the credit risk of the securities it rated and pretended to act objectively. “S&P’s desire for increased revenue and market share," Mr Holder asserted, led it to favour the interests of investment banks issuing securities over those of investors. In the past such activity may have been seen as merely unfair, and commercially suicidal in the long run. Mr Holder hopes to establish it as a crime.