New Jersey has followed 18 states and the U.S. government in suing Standard & Poor’s for allegedly allowing the interests of investment banking clients affect its independence in rating securities.
The suit, filed Wednesday in Essex County Chancery Division, accuses S&P of violating the state Consumer Fraud Act by making false representations about its rating services, deceiving the structured finance markets and violating advertising regulations.
S&P’s ratings were allegedly impacted by an underlying conflict between its supposed independent analysis of complex investments and its own revenue goals, along with favoritism toward the investment banks that paid it fees for rating securities.
“These fees were a significant and increasing source of revenue to S&P,” according to the complaint, Hoffman v. McGraw-Hill Financial Inc. McGraw-Hill is the parent of New York based-S&P.
As a result of the importance of that revenue, “the threat of losing market share to competitors such as Moody’s Investors Service or Fitch Ratings caused S&P to utilize out-of-date and incomplete creditworthiness modeling analytics,” it continued.
Further, S&P allegedly devoted insufficient resources and support to monitoring already rated securities.
In an accompanying press release, Acting Attorney General John Hoffman stated that New Jersey consumers “placed their trust in the company’s supposedly objective analysis,” but that trust was misplaced.
The suit, filed on behalf of New Jersey investors, states no damages figure. But it seeks disgorgement of S&P’s gains for actions that violated the Consumer Fraud Act, restitution to those affected and maximum statutory penalties of $10,000 for the first violation and $20,000 for each succeeding one.
It also asks for injunctive relief, an accounting and attorney fees.
Division of Law Director Christopher Porrino says the litigation is focused on ratings S&P supplied for the collateralized debt obligations and residential mortgage-backed securities that were at the core of the financial meltdown in 2008.
But he does not rule out expanding that focus or filing similar suits against Moody’s and Fitch.
S&P has responded to the actions by attorneys general around the country by removing them to federal court.
Most of those were consolidated in the Southern District of New York on June 6, by the Judicial Panel on Multidistrict Litigation as In re: Standard & Poor’s Rating Agency Litigation.
S&P asserts federal question jurisdiction based on its defenses under the First Amendment and the Credit Rating Agency Reform Act of 2006, or CRARA.
It claims CRARA specifically authorizes its “issuer pays” business model, a practice assailed in the state suits, including New Jersey’s, as creating a conflict of interest.
The 15 states in the consolidated litigation are Arizona, Arkansas, Colorado, Delaware, Idaho, Indiana, Iowa, Maine, Mississippi, Missouri, North Carolina, Pennsylvania, South Carolina, Tennessee and Washington.
Their joint motion seeking remand was argued on Oct. 4 before U.S. District Judge Jesse Furman.
Led by Olha Rybakoff of the Tennessee Attorney General’s Office, they contend that their suits should be remanded to their respective state courts because in seeking relief, they “are pursuing their sovereign interests in an area of traditional state authority” and there exists no recognized basis for federal jurisdiction.
Other states that have sued S&P but managed to remain in or return to state court are California, Connecticut and Illinois.
Porrino says, “we believe the case is properly in state court, seeking to provide relief and restitution under the state Consumer Fraud Act.”
But if the judge decides the matter is to be litigated in federal court, the state is ready, willing and able to do so, he adds.
The Department of Justice suit over S&P’s ratings, U.S.A. v. McGraw-Hill Companies Inc., filed on Feb. 4 in federal court for the Central District of California, withstood a motion to dismiss on July 16.
The federal government sued under the Financial Institutions Reform, Recovery and Enforcement Act, seeking civil penalties for alleged violation of criminal statutes against mail, wire and financial institution fraud.
A call to S&P counsel Floyd Abrams of Cahill Gordon & Reindel in New York was referred to the company, which provided a statement through spokesman Edward Sweeney.
It said, “New Jersey and other states have filed meritless civil lawsuits against S&P challenging our ratings on structured finance securities. The claims are simply not true and we will vigorously defend S&P against them.”