The US Government has launched a civil lawsuit against Standard & Poor’s and parent The McGraw-Hill Companies Inc. over mortgage bond ratings, the first federal enforcement action against a credit rating agency over alleged illegal behaviour tied to the recent financial crisis.
This lawsuit is significant because it could augur future government action or, even worse for the agencies, more litigation by investors
The Government said in a court filing it was seeking civil money penalties from S&P and McGraw Hill.
“Considerations regarding fees, market share, profits and relationships with issuers improperly influenced S&P’s rating criteria and models,” the Government said.
Shares of McGraw-Hill plunged 13.8 per cent on Monday after the company said it was expecting the lawsuit, marking their biggest one-day percentage decline since the 1987 stock market crash, according to Reuters data.
The news also caused shares of Moody’s Corp., whose Moody’s Investors Service unit is S&P’s main rival, to slide 10.7 per cent.
It is unclear why regulators may now be focusing on S&P rather than Moody’s or Fimalac SA’s Fitch Ratings.
S&P, Moody’s and Fitch have long faced criticism from investors, politicians and regulators for assigning high ratings to thousands of subprime and other mortgage securities that quickly turned sour.
“This lawsuit is significant because it could augur future government action or, even worse for the agencies, more litigation by investors,” said Jeffrey Manns, a law professor at George Washington University in Washington, DC.
A civil case involves a lower burden of proof than a criminal case would, and could make it easier for investigators to uncover potential “smoking guns” through subpoenas, he added.
The New York Times reported that talks between the Justice Department and S&P broke down last week after the Government sought a settlement of more than $1 billion (€0.73 billion).
S&P said the expected Justice Department lawsuit focuses on its ratings in 2007 of various US collateralised debt obligations.
The rating agency had previously disclosed a probe by the US Securities and Exchange Commission into its ratings for a $1.6 billion (€1.18 billion) CDO known as Delphinus CDO 2007-1. It was not immediately clear whether that CDO is a focus of the case.
“A DOJ lawsuit would be entirely without factual or legal merit,” S&P said in a statement. “The DOJ would be wrong in contending that S&P ratings were motivated by commercial considerations and not issued in good faith.”
In a variety of lawsuits brought by investors, S&P has maintained that its ratings constitute opinions protected by the free speech clause of the US Constitution.
Justice Department spokeswoman Adora Andy and Moody’s spokesman Michael Adler declined to comment. Fitch spokesman Daniel Noonan said: “We are unable to comment on the S&P matter as it does not involve us, other than to say we have no reason to believe Fitch is a target of any such action.”
Several state attorneys general led by Connecticut’s George Jepsen are expected to join the case, said the person familiar with the matter, who was not authorised to speak publicly.
Previous lawsuits from Connecticut and Illinois accused S&P of violating consumer fraud laws by stating its ratings were objective, even though it ignored increasing risks of the securities in order to cater to the investment banks that provided the firm with revenue.