Standard & Poor's to Face US Government Lawsuit Over Pre-Crisis Debt Ratings
The US Government is planning to sue Standard & Poor's over decisions taken by the ratings agency during the global financial crisis.
The ratings firm, a unit of publishing group McGraw Hill Companies, said the Civil Division of the US Department of Justice will file a civil complaint against it focusing on ratings the agency assigned to collateralized debt obligations in 2007. S&P said the lawsuit was "entirely without factual or legal merit," in a statement published on its website.
"S&P deeply regrets that our CDO ratings failed to fully anticipate the rapidly deteriorating conditions in the U.S. mortgage market during that tumultuous time," the agency said. "However, we did take extensive rating actions in 2007 - ahead of other ratings agencies - on the residential mortgage-backed securities which were included in these CDOs ... with 20/20 hindsight, these strong actions proved insufficient - but they demonstrate that the DOJ would be wrong in contending that S&P ratings were motivated by commercial considerations and not issued in good faith."
A collateralised debt obligation, or CDO, in an investment which gathers bonds and other financial assets of varying quality and re-packages them for re-sale, usually with a higher collective debt rating than the securities have individually.
McGraw Hill stock fell more than 14 percent following news of the planned litigation to change hands at a six month low of $50.40 each.
In August of 2011, S&P became the first of the three major ratings agencies to downgrade the AAA debt grade of the US government, citing the protracted Congressional budget negotiations. US Treasuary officials said at the time the decision was "flawed" and said errors within its rating model "raise fundamental questions about the credibility and integrity of S&P's ratings action."
S&P said the DoJ is planning to sue under terms of the 1989 Financial Institutions Reform, Recovery and Enforcement Act, which is says would be a first for any legal action against a ratings agency.
S&P lost an appeal last November to have a case brought by Illinois Attorney General Lisa Madigan dismissed on the grounds that its ratings opinions are protected by First Amendment guarantees to freedom of speech.
Madigan is suing S&P for its alleged "fraudulent role" in assigning top credit ratings to mortgage backed bonds that subsequently plunged in value during the global credit crisis.
That same month, Australia's Federal Court ruled that S&P had misled investors by giving its top credit rating to two complicated bond issues that collapsed in value during the credit crisis
In the first ruling of its kind in any major jurisdiction, Justice Jayne Jagot said S&P was "misleading and deceptive" when it assigned the top triple-A credit grade to two structured debt issues sold in 2006 under the name "Rembrandt" on behalf of the former Dutch investment bank ABN Amro.
The case was brought by a group of councils in New South Wales, known as Local Government Financial Services (LGFS), who claimed to have lost around 90 percent- or A$16.6m - in the so-called constant proportion debt obligation, or CPDO, notes when the prices collapsed.
CPDOs are a type of credit derivative that links its value to a broader index of credit default swaps, which themselves are a form of default insurance that investors can use to mitigate risk in their portfolios. The most complicated aspect of a CPDO is the way in which it is "rebalanced" by its managing bankers. In effect, more leverage is added to the portfolio as the prices of its assets fall, creating riskier context for its investors as the underlying market deteriorates.
By some estimates, investors have been hit by more than $2tn worth of losses from the collapsed value of assets that once held a triple-A rating from either S&P or its two main rivals, Moody's Investors Service and Fitch Ratings.
All three have been named in a series of lawsuits filed in the United States by several investors, including Abu Dhabi Commercial Bank, alleging that a $100m structured deal sold by Morgan Stanley, known as Rhinebrigde and backed by so-called sub-prime mortgage debt, was fundamentally flawed and that those flaws were shielded by both the bank and the ratings agencies.
In October of last year, the DoJ filed its first suit against major Wall Street firms in connection with the collapse of residential mortgage backed securities (RMBS) market. In a so-called Martin Act lawsuit, the DoJ accused JPMorgan Chase, JPMorgan Securities (formerly Bear Stearns) and EMC Mortgage LLC of deceiving investors "as to the care with which they evaluated the quality of mortgage loans packaged into residential mortgage-backed securities prior to Bear Stearns & Co's collapse in early 2008, incurring losses that have totaled approximately $22.5 billion to date."
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