Details Emerge on DOJ Lawsuit Against S&P Over RMBS Ratings

The Department of Justice (DOJ) hasrnreleased details of the suit it has filed against Standard and Poor’s (S&P)rnRatings Services and its parent company McGraw Hill.  The lawsuit alleges that investors, many ofrnthem federally insured financial institutions, lost billions of dollars onrnresidential mortgage-backed securities (RMBS) and collateralized debtrnobligations (CDO) for which S&P provided inflated ratings misrepresentingrnthe securities’ credit risks.  </p

DOJ maintains that S&P representedrnits rates as objective and independent when “S&Prnwas so concerned with the possibility of losing market share and profits thatrnit limited, adjusted and delayed updates to the ratings criteria and analyticalrnmodels it used to assess the credit risks posed by RMBS and CDOs.”   DOJ says that S&P weakened those criteriarnand models from what S&P’s own analysts believed was necessary to make themrnmore accurate and that, from at least March to October 2007 and because of thisrnsame desire to increase market share and profits, S&P issued inflatedrnratings on hundreds of billions of dollars’ worth of CDOs.   At the time, according to the allegations inrnthe complaint, S&P knew that the quality of non-prime RMBS was severelyrnimpaired, and that the ratings on those mortgage bonds would not hold.   Therngovernment alleges that S&P failed to account for this impairment in thernCDO ratings it was assigning on a daily basis.  rnAs a result, nearly every CDO rated by S&P during this time periodrnfailed, causing investors to lose billions of dollars.</p

The suit was filed in the CentralrnDistrict of California, home to the now defunct Western Federal CorporaternCredit Union (WesCorp), which was the largest corporate credit union in therncountry. Following the 2008 financial crisis, WesCorp collapsed after sufferingrnmassive losses on RMBS and CDOs rated by S&P.  Also joining the Department of Justice inrnmaking this announcement were the attorneys general from California,rnConnecticut, Delaware, the District of Columbia, Illinois, Iowa andrnMississippi, all of whom have filed or will file civil fraud lawsuits againstrnS&P alleging similar misconduct in the rating of structured financialrnproducts.   Additional state attorneysrngeneral are expected to make similar filings today.</p

The complaint seeks civil penaltiesrnunder the Financial Institutions Reform, Recovery, and Enforcement Act of 1989rn(FIRREA) based on three forms of alleged fraud by S&P: (1) mail fraudrnaffecting federally insured financial institutions; (2) wire fraud affectingrnfederally insured financial institutions; and (3) financial institution fraud.  FIRREA authorizes the Attorney General to seekrncivil penalties up to the amount of the losses suffered as a result of thernalleged violations. To date, the government has identified more than $5 billionrnin losses suffered by federally insured financial institutions in connectionrnwith the failure of CDOs rated by S&P from March to October 2007.    </p

S&Prnhad preemptively issued a press release in anticipation of the court filingrndenying the allegations.   Its statementrnwas abstracted in MND’srnearlier story on the suit.</p

“Put simply, this alleged conduct isrnegregious – and it goes to the very heart of the recent financial crisis,” saidrnAttorney General Holder.   “Today’srnaction is an important step forward in our ongoing efforts to investigate – andrn- punish the conduct that is believed to have contributed to the worst economicrncrisis in recent history.   It is justrnthe latest example of the critical work that the President’s Financial FraudrnEnforcement Task Force is making possible.”

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