July 30 (Bloomberg) -- Connecticut Attorney General Richard Blumenthal sued Moody's Corp., Fitch Inc. and Standard & Poor's parent McGraw-Hill Cos. claiming they unfairly gave municipal bonds lower ratings than comparable corporate or structured debt.

``We are holding the credit-rating agencies accountable for a secret Wall Street tax on Main Street,'' Blumenthal said in a statement. The complaints, filed today in Connecticut Superior Court in Hartford, seek redress for what Blumenthal called the companies' ``deceptive and illegal'' business practices.

Blumenthal, the state's top law enforcement officer, has been conducting an antitrust probe of the three companies since last summer. In June, he said firms that rate U.S. municipal bonds ``knowingly and systematically'' gave the securities lower grades, raising costs for state and local governments. At a press conference today, he said the investigation is continuing.

Moody's, under pressure from regulators and state finance officials, said last month it would change the way it rates municipal bonds and rank them on the same scale it uses for corporate and sovereign debt. Blumenthal said the dual standard benefited bond insurers, investors and the agencies themselves.

``This rating charade created a Wall Street shell game constructed by the ratings agencies for the benefit of the bond insurers,'' he said, adding that bond insurers profited from unnecessary premiums and interest paid by taxpayers.

`Meritless' Suit

Blumenthal is seeking a ruling declaring the companies engaged in unfair and deceptive acts, an order to determine the amount of improper fees and revenue they gained, penalties for each violation of the state's unfair trade practices act, restitution and disgorgement.

Moody's Chief Executive Officer Raymond McDaniel called the lawsuit ``meritless.''

``The suit implies that the measuring system is wrong,'' McDaniel said today during a conference call with analysts. ``That's like saying it's wrong to measure distance in centimeters and right to measure it in inches.''

Blumenthal's allegations are ``an unfortunate development'' and without merit, Fitch Managing Director David Weinfurter said in an e-mailed statement, adding the firm would fight the suit.

``Fitch rates Connecticut and all states based on our forward-looking opinion as to their financial capacity to pay their debts as they come due -- not based solely on historical rates of default,'' Weinfurter said in the statement.

`Comprehensive Review'

He said Fitch performed ``a comprehensive review'' of its municipal finance ratings and will disclose the results tomorrow.

McGraw-Hill echoed Weinfurter's comments in a separate statement, saying it too would fight the litigation.

Connecticut is attempting to ``use litigation to dictate what bond rating it receives,'' McGraw-Hill said.

State officials and regulators have criticized New York- based firms Moody's and Standard and Poor's, as well as Fitch, a unit of Paris-based Fimalac, for using a scale that raised borrowing costs by holding municipal bonds, whose 10-year default rate was 0.1 percent between 1970 and 2006, to a higher standard than corporate and sovereign debt.

Many issuers bought bond insurance to improve their rating, a strategy that backfired this year when some guarantors lost their AAA ratings amid subprime mortgage-related losses.

The Connecticut probe has included whether the firms rank debt against issuers' wishes, then demand payment, or threaten to downgrade debt unless they're awarded business to rate all of an issuer's securities, Blumenthal has said.

Scrutinizing Links

He has also been scrutinizing links between Moody's and its largest shareholder, Warren Buffett's Berkshire Hathaway Inc.

McGraw-Hill fell 26 cents to $39.52 at 3:06 p.m. in New York Stock Exchange composite trading. Moody's dropped $1.15, or 3.2 percent, to $35.

California State Treasurer Bill Lockyer has led efforts to end the separate rating scales, saying they burden taxpayers with unnecessary, added interest expense.

Lockyer said that if California, the most-populous U.S. state, had top credit ratings, it might save more than $5 billion over the 30-year life of $61 billion in yet-to-be-sold, voter- approved debts. California has spent $102 million on municipal bond insurance in the last four years, he said.

Los Angeles City Attorney Rocky Delgadillo on July 24 sued MBIA Inc., Ambac Financial Group Inc. and four other bond insurers for allegedly conspiring to maintain a credit-rating system that led local governments to buy ``unnecessary'' policies on their bonds.

Municipal Market

Borrowers in the $2.66 trillion U.S. municipal market have for decades paid insurers to guarantee their bonds, seeking to lower borrowing costs by paying AAA rated companies to stand behind the securities. That practice has drawn fire this year from public officials who said it exaggerates the risk that municipal bonds will default, forcing states, cities and schools to buy backing they don't need.

Hundreds of state and local governments were stung by higher borrowing costs this year after bond insurers, including Armonk, New York-based MBIA and Ambac, were stripped of their top credit ratings because of losses on securities linked to U.S. home loans. Officials including Lockyer have said that insurance wouldn't be necessary if state and local bonds were assessed using the same criteria as corporate debt.

Press Conference

On June 20, U.S. House Financial Services Chairman Barney Frank introduced legislation in an effort to make the credit- rating agencies end the separate rating scales.

At his press conference today in Hartford, Blumenthal said ``the vast majority of towns and cities do not have a triple A rating and they should.'' If they did, he said, bond insurers ``would virtually be out of business.''

The cases are State of Connecticut v. The McGraw-Hill Companies, State of Connecticut v. Fitch Inc., and State of Connecticut v. Moody's Corp., Superior Court of the State of Connecticut (Hartford).

To contact the reporter on this story: Karen Freifeld in New York at kfreifeld@bloomberg.net.

Last Updated: July 30, 2008 15:07 EDT