US sues S&P's, alleges it inflated credit ratings

Washington: The United States today sued Standard and Poor’s alleging that the credit rating agency lied about its objectivity and independence and issued inflated ratings for certain structured debt securities, causing investors to lose billions of dollars.

“Put simply, this alleged conduct is egregious - and it goes to the very heart of the recent financial crisis,” the US Attorney General, Eric Holder, said.

The Department of Justice alleged that S&P engaged in a scheme to defraud investors in structured financial products known as Residential Mortgage-Backed Securities (RMBS) and Collateralized Debt Obligations (CDOs).

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The lawsuit alleges that investors, many of them federally insured financial institutions, lost billions of dollars on CDOs for which S&P issued inflated ratings that misrepresented the securities’ true credit risks.

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The complaint also alleges that S&P falsely represented that its ratings were objective, independent, and uninfluenced by S&P’s relationships with investment banks when, in actuality, S&P’s desire for increased revenue and market share led it to favour the interests of these banks over investors.

“Today’s action is an important step forward in our ongoing efforts to investigate - and - punish the conduct that is believed to have contributed to the worst economic crisis in recent history.

“It is just the latest example of the critical work that the President’s Financial Fraud Enforcement Task Force is making possible,” Holder said. “Our investigation revealed that, despite their representations to the contrary, S&P’s concerns about market share, revenues and profits drove them to issue inflated

ratings, thereby misleading the public and defrauding investors.

“In so doing, we believe that S&P played an important role in helping to bring our economy to the brink of collapse,” said the Acting Associate Attorney General Tony West.According to the complaint, S&P publicly represented that its ratings of RMBS and CDOs were objective, independent and uninfluenced by the potential conflict of interest posed by S&P being selected to rate securities by the investment banks that sold those securities.

Contrary to these representations, from 2004 to 2007, the government alleges, S&P was so concerned with the possibility of losing market share and profits that it limited, adjusted and delayed updates to the ratings criteria and analytical models it used to assess the credit risks posed by RMBS and CDOs.

According to the complaint, S&P weakened those criteria and models from what S&P’s own analysts believed was necessary to make them more accurate.

The complaint also alleges that, from at least March to October 2007, and because of this same desire to increase market share and profits, S&P issued inflated ratings on hundreds of billions of dollars’ worth of CDOs.

At the time, according to the allegations in the complaint, S&P knew that the quality of non-prime RMBS was severely impaired, and that the ratings on those mortgage bonds would not hold.

The government alleges that S&P failed to account for this impairment in the CDO ratings it was assigning on a daily basis.

As a result, nearly every CDO rated by S&P during this time period failed, causing investors to lose billions of dollars.

PTI