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DOJ Preparing to Sue Standard & Poor's Over Pre-Crash Ratings
The National Law Journal
The U.S. Justice Department is preparing to file a civil suit against Standard & Poor's Financial Services LLC for its positive reviews of collateralized debt obligations in advance of the financial collapse, the ratings firm announced on February 4.
The suit would be the first by the federal government against one of the ratings agencies since the crisis hit. According to Standard & Poor's, a subsidiary of McGraw-Hill Companies Inc., the Justice Department's civil division is looking at claims associated with its ratings in 2007 of collateralized debt obligations. The Securities and Exchange Commission has said that it was also considering taking legal action against Standard & Poor's.
"A DOJ lawsuit would be entirely without factual or legal merit," the firm said on its website. "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 market appeared to be contained and that every CDO that DOJ has cited to us also independently received the same rating from another rating agency.
"S&P deeply regrets that our CDO ratings failed to fully anticipate the rapidly deteriorating conditions in the U.S. mortgage market during that tumultuous time," the company continued. "However, we did take extensive rating actions in 2007 ahead of other ratings agencies on the residential mortgage-backed securities ("RMBS") which were included in these CDOs. As a result of these actions, more collateral or other protection was required to support AAA ratings on CDOs. With 20/20 hindsight, these strong actions proved insufficient but they demonstrate that the DOJ would be wrong in contending that S&P ratings were motivated by commercial considerations and not issued in good faith."
Three firms are representing S&P: Cahill Gordon & Reindel, Morrison & Foerster and Keker & Van Nest, a spokesman for the ratings service said. Cahill litigation partner Floyd Abrams, who has represented S&P in litigation over its ratings, directed an email seeking comment to S&P.
The agency took particular aim at the department's possible use of the 1989 Financial Institutions Reform, Recovery, and Enforcement Act statute, passed following the savings and loan scandal. Federal prosecutors have cited that statute in numerous lawsuits accusing federally insured banks including Wells Fargo & Co. and Bank of America Corp.'s Countrywide Financial unit of lying to the Federal Housing Administration about the quality of their mortgages. Standard & Poor's said that applying the statute against it would be "unprecedented" and without legal merit.
"In an attempt to end run well-established legal precedent, the DOJ plans to use a questionable legal strategy by suing S&P under the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) a statute enacted in 1989 to stabilize and reform the savings and loan industry," Standard & Poor's said. "If DOJ does bring suit, we will vigorously defend our Company against such meritless litigation."
The ratings agency underscored that the financial crisis was "unprecedented." Standard & Poor's ratings aligned with those by other ratings agencies at the time and it also issued several negative ratings, it said.
Since 2007, Standard & Poor's said, it has invested $400 million in strengthening its ratings. Additionally, with the Credit Rating Agency Reform Act and the Dodd-Frank Act of 2010, credit ratings agencies are now regulated by the federal government.
In 2011, a U.S. congressional report concluded that Moody's Corp. and Standard & Poor's contributed to the crisis when they were forced in 2007 to downgrade their inflated ratings on mortgage backed securities and collateralized debt obligations. The report, by Senators Carl Levin (D-Mich.) and Tom Coburn (R-Okla.) chairman and ranking Republican on the Senate permanent subcommittee on investigations, concluded that the ratings agencies ignored warnings about risky financial products.
The report called on the SEC to rank credit rating agencies.
Staff reporter Mike Scarcella contributed to this report.
This article originally appeared in The National Law Journal.