Conn. Gains Allies In Suit Against Ratings Agency

MIKE SCARCELLA

The Connecticut Law Tribune

2013-02-11 11:07:10.0

Back in 2010, the Connecticut Attorney General's Office filed a lawsuit against Standard & Poor's Financial Services, accusing the investment rating agency of misleading the public about the value of new types of securities that evenutally helped cause the economic meltdown.

Last week, the state added an army of legal allies.

The U.S. Justice Department, 16 states and the District of Columbia announced fresh lawsuits against Standard & Poor's, which analyzes bonds, securities and other financial instruments and rates them on the basis of risk to investors. Attorney General Eric Holder Jr. accused Standard & Poor's of lying to investors prior to the economic collapse and manipulating its ratings to boost its profits.

Specifically, Holder and others pointed to residential mortgage-backed securities and collateralized debt obligations, and said S&P manipulated its ratings to make these new, debt-based sercurities seem less risky than they actually were. The officials said the actions, which allegedly took place between 2004 and 2007, cost investors more than $5 billion and helped to tank the nation's economy.

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 Justice Department.

Individual states have also filed lawsuits that seek court orders to stop S&P from making misrepresentations to the public; changes in the way the company does business; civil penalties and disgorgement of ill-gotten profits, which may total hundreds of millions of dollars. Connecticut's 2010 lawsuit, brought under the Connecticut Unfair Trade Practices Act, is pending in Hartford Superior Court.

"We believe that S&P's analytical models for rating structured finance securities were directly influenced by the demands of S&P's powerful investment banking clients," said Connecticut Attorney General George Jepsen. "Contrary to what S&P was publicly representing, S&P served its own financial interests and those of the investment banks. Countless investors and market participants, including state regulators, were misled by S&P's promise that its analysis was independent and objective. S&P violated the trust that it purposefully cultivated with the marketplace leading to disastrous results."

Jepsen said Connecticut assisted the initial stages of the Department of Justice's investigation because of its earlier investigation of S&P. In a prepared statement, Jepsen's office described Connecticut as one of the leaders of the multi-state challenge.

U.S. Senator Richard Blumenthal, D-Conn., the former state attorney general who initiated the Connecticut lawsuit, said in a statement that "the ratings agencies were preeminent culprits and enablers in financial abuse and fraud that crippled employment and nearly destroyed our economy."

The federal 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."

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."

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."

The Connecticut Law Tribune staff contributed to this article.