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U.S. sues rating agency for misleading investors in risky bonds

by Rhyan Kronzer
Feb 5, 2013


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Rhyan Kronzer/ MEDILL

Illinois Attorney General Lisa Madigan discusses reasons for suing Standard & Poor's at the Department of Justice Tuesday. 

Illinois Attorney General Lisa Madigan joined her counterpart in Washington D.C. Tuesday after the U.S. Justice Department brought suit against Standard & Poor’s Financial Services LLC. The suit alleges the rating agency violated its own standards in giving the highest rating to risky mortgage bonds.

Madigan filed a similar suit January 2012 alleging that the company compromised its independence as a rating agency to increase profits. By doing so, it contributed to the massive scope of the financial crisis.

“Standard & Poor’s was a trigger for the destruction of our economy. While the big banks and lenders built mortgage-backed bombs, it was S&P’s faulty ratings that detonated them,” Madigan said in a statement released Tuesday.

Madigan’s original complaint cites internal S&P emails among employees leading up to the market crash. In one such email, an employee wrote that an investment “could be structured by cows and we would rate it.”

Madigan is continuing to pursue her case in Cook County Circuit Court where S&P’s most recent motion to dismiss the case citing First Amendment protection was, in turn, dismissed by a judge.

S&P is a subsidiary of McGraw-Hill Cos. Inc. whose stock plunged 10.7 percent Tuesday.

Moody’s Corp., another top rating agency, also saw its stock price fall 8.8 percent Tuesday.

In a statement Tuesday, S&P asserted, “20/20 hindsight is no basis to take legal action against the good-faith opinions of professionals. The fact is that S&P’s ratings were based on the same subprime mortgage data available to the rest of the market.”

John C. Coates, a professor of law and economics at Harvard Law School, described potential for a conflict of interest in the bond rating process.

In a 2011 paper, Coates noted that credit rating agencies are allowed to talk with underwriters while determining a secure target rating on a bond issue. If the underwriter and agency cannot agree, “then the underwriter can pay a small contract-breaking fee and potentially use ratings from another rating agency,” he wrote. Critics call this “ratings shopping.”

“S&P misled investors, including many federally insured financial institutions causing them to lose billions of dollars,” said U.S. Attorney General Eric Holder.

The suit stems from an investigation that has been ongoing since November 2009, Holder said.

“I am not surprised by the federal lawsuit,” John Marshall Law School professor Ann Lousin said Tuesday. “The ratings companies have enormous power in the market. We all know what can happen to private companies and public entities like governments when their bond ratings plummet.”

According to Holder, the suit identifies more than $5 billion in losses that are being sought as damages from S&P and its parent company, McGraw-Hill.

McGraw-Hill spokeswoman Catherine Mathis maintains that the suit will not affect the company’s business. “This lawsuit is unjustified and baseless,” she said.