Standard & Poor’s manipulation of its financial ratings cost investors more than $5 billion and helped to tank the nation’s economy, Attorney General Eric Holder Jr. said in explaining why the government decided to sue the agency.
Flanked by a team of state attorneys general during a news conference on February 5, Holder said that Standard & Poor’s Financial Services LLC essentially defrauded investors between 2004 and 2007 concerning products that were at the heart of the financial crisis.
One by one, federal and state officials took turns chiding S&P’s alleged misconduct, saying the company lied to investors and manipulated ratings to boost profits. The officials alleged that as early as 2003, analysts within Standard & Poor’s were raising warnings about the accuracy of the company’s rating system.
"Put simply, this alleged conduct is egregious—and it goes to the very heart of the recent financial crisis," Holder said during a news conference at the U.S. Justice Department.
The civil suit was filed February 4 in U.S. District Court for the Central District of California. S&P parent company McGraw-Hill is also named as a defendant in the 119-page complaint.
Tony West, the acting associate attorney general at DOJ, said that Standard & Poor’s promised "objective and independent" ratings for residential mortgage-backed securities and collateralized debt obligations. "But the evidence we have uncovered tells a different story," West said.
West said the agency, for instance, knew it was going to downgrade the ratings on a certain class of mortgage bonds but did nothing to adjust the ratings to reflect that inevitability.
"It’s sort of like buying sausage from your favorite butcher, and he assures you the sausage was made fresh that morning and is safe," West said. "What he doesn’t tell you is that it was made with meat he knows is rotten and plans to throw out later that night."
The federal suit marked the first against a ratings agency since the financial crisis. Sixteen states, including Connecticut, Delaware and California, in addition to the District of Columbia, are pursuing actions against Standard& Poor’s for alleged violations of state law.
Holder said the government was "always open" to conversations with the lawyers representing the agency, a team that includes Floyd Abrams, a litigation partner in the New York office of Cahill Gordon & Reindel.
Standard & Poor’s said in a formal statement that DOJ claims "that we deliberately kept ratings high when we knew they should be lower are simply not true. We will vigorously defend S&P against these unwarranted claims." The company added that, "unfortunately, S&P, like everyone else did not predict the speed and severity of the coming crisis and how credit quality would ultimately be affected."
More than two dozen Main Justice attorneys and lawyers with the U.S. attorney’s office in Los Angeles participated in the investigation, DOJ officials said. The investigators said they served hundreds of civil subpoenas and interviewed more than 150 witnesses, including former analysts and executives.
The DOJ suit was filed in Los Angeles because that’s the home of the now-defunct Western Federal Corporate Credit Union (WesCorp), formerly the largest corporate credit union in the country. DOJ lawyers said WesCorp collapsed amid the financial crisis, suffering "massive losses" on residential mortgage-backed securities and CDOs that Standard & Poor’s had rated.
The federal suit was filed under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 to seek penalties that equal the losses suffered by federally insured financial institutions. Under this law, DOJ said it can seek penalties for the violation of criminal law, including mail, wire and bank fraud. The burden of proof, however, remains a preponderance of the evidence.
"Rating agencies have never faced enforcement on these grounds before," said Jeffrey Manns, an associate professor at The George Washington University Law School who specializes in banking and securities law. Still, the government, he said, "has a high burden to show that S&P knowingly committed fraud."
U.S. Senator Richard Blumenthal (D-Conn.), the former state attorney general who sued Standard & Poor’s nearly five years ago, said in a statement Tuesday that "the ratings agencies were preeminent culprits and enablers in financial abuse and fraud that crippled employment and nearly destroyed our economy." Blumenthal said he hopes the DOJ action against S&P "will help vindicate victims of rating agency abuses."
The federal government, Blumenthal said, "needs to be even more aggressive in holding S&P and others accountable." DOJ officials declined to comment during their news conference on whether the federal government intends to charge other ratings agencies.
Stuart Delery, a top DOJ Civil Division lawyer, called the financial institutions reform law, enacted in the aftermath of the savings and loan scandal on the 1980s, a "powerful weapon for combating financial fraud."
Mike Scarcella is a reporter for The National Law Journal, a Legal affiliate based in New York.