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S&P Faces Widening Ratings Litigation as States Pile On

Standard & Poor’s may face widening litigation over credit ratings during the housing boom as states investigate the company and consider bringing new cases that would add to more than a dozen across the country.

New York Attorney General Eric Schneiderman and Massachusetts Attorney General Martha Coakley are conducting probes of S&P, which has been accused by the U.S. of defrauding investors.

Their investigations threaten the McGraw-Hill Cos (MHP). unit with broader litigation after the Justice Department sued the company this week with 13 states and the District of Columbia. Connecticut, Illinois and Mississippi had earlier filed lawsuits.

“We’ll likely see other state attorneys general joining the fray and jumping in on these lawsuits,” said Robert Mintz, an attorney at McCarter & English LLP (1389L) and a former federal prosecutor. “Whenever you have company like S&P that does business around the country, it gives each individual state a bite at the apple.”

Connecticut Attorney General George Jepsen, who is leading the multistate coalition, said in an interview that additional states are “actively considering” filing lawsuits. He declined to comment on how many.

Banks Favored

The Justice Department sued S&P on Feb. 4, saying that the company downplayed and disregarded the risk posed by the mortgage-backed securities and collateralized debt obligations and issued inflated ratings on CDOs. S&P was driven by a desire to increase revenue and market share and was favoring the interests of investment banks that sold the securities at the expense of investors, the government said.

S&P rated more than $2.8 trillion worth of residential mortgage-backed securities and almost $1.2 trillion worth of collateralized debt obligations from September 2004 to October 2007, according to the complaint. Federally insured financial institutions suffered $5 billion in losses on CDOs rated by S&P, the Justice Department said in a statement.

S&P called the U.S. and state lawsuits “meritless” and said its ratings reflected the company’s best judgments, according to a statement.

California Attorney General Kamala Harris claimed in that state’s lawsuit that two public pension funds, the California Public Employees Retirement System and the California State Teachers Retirement System, relied on S&P’s ratings and lost hundreds of millions of dollars when the housing market collapsed, according to the complaint.

‘Corrupted’ Ratings

“S&P corrupted its ratings’ process to curry favor with large banks, which paid S&P billions of dollars in return,” Harris’ office said in the complaint. “In other words, S&P claimed to be a gatekeeper, but it acted like a toll collector.”

Other states that filed lawsuits with the Justice Department were: Arizona, Arkansas, Colorado, Delaware, Idaho, Iowa, North Carolina, Maine, Missouri, Pennsylvania, Tennessee and Washington, according to a statement from Connecticut.

The states are seeking disgorgement of what S&P earned from the scheme, Jepsen said.

“In theory, the collective disgorgement would be for hundreds of millions from ill-gotten gains, but there could be fines and penalties above that,” he said.

Moody’s, Fitch

Schneiderman is investigating whether S&P, Moody’s Investors Service and Fitch Ratings violated a 2008 settlement that was reached with his predecessor Andrew Cuomo that resolved a state investigation into ratings, according to a person familiar with the matter. The investigation includes a probe into potential misconduct by the three companies since the settlements expired in 2011, said the person, who wasn’t authorized to speak publicly and asked not to be identified.

In the settlement with Cuomo, now New York’s governor, the companies agreed to a series of reforms, including changes to their fee structures, disclosures about loan pools, reviews of mortgage originators and annual reviews of processes for practices that could compromise independent ratings.

Schneiderman, who is helping lead a group of state and federal officials investigating misconduct in the bundling of mortgage loans into securities, last year sued JPMorgan Chase & Co. (JPM) and Credit Suisse Group AG over mortgage bonds sold to investors.

Massachusetts Probe

Coakley, the Massachusetts attorney general, is also investigating S&P, said Brad Puffer, a spokesman for her office, in an e-mail.

“Our office is engaged in our own related investigation into this matter and we are closely monitoring this lawsuit filed by other attorneys general,” he said in a statement. “These are serious allegations.”

Mintz, the former prosecutor, said S&P may try to reach a global settlement to resolve all the lawsuits.

“It’s costly to fight the battle on multiple fronts,” he said. “And you run the risk of getting inconsistent rulings by judges around the country.”

The U.S. case is U.S. v. McGraw-Hill, 13-00779, U.S. District Court, Central District of California (Los Angeles).

To contact the reporter on this story: David McLaughlin in New York at dmclaughlin9@bloomberg.net

To contact the editor responsible for this story: John Pickering at Jpickering@bloomberg.net

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