S&P Ratings Debate Doesn’t Show Fraud, Peterson Says

Analysts at Standard & Poor’s, the ratings firm accused by the U.S. of misleading investors about the risks of mortgage bonds that helped ignite the financial crisis, were arguing the merits of their views on debt opinions, not committing fraud, President Doug Peterson said.

“Our culture has always been characterized by vigorous debate and robust analysis,” Peterson said yesterday in a video message that the world’s largest ratings firm sent to clients. “There may have been differing opinions within S&P and some were strongly held but that is not evidence of fraud.”

The Justice Department sued S&P and its parent, New York- based McGraw-Hill Cos. (MHP), in federal court in Los Angeles on Feb. 4, alleging analysts inflated ratings on mortgage securities and collateralized debt obligations leading up to the seizure in credit markets to win business from Wall Street banks. The civil lawsuit seeks about $5 billion in penalties, equivalent to more than five years of McGraw-Hill profit. S&P said on Feb. 5 the lawsuit is without merit.

S&P rated more than $2.8 trillion of residential mortgage- backed securities and about $1.2 trillion of CDOs from September 2004 through October 2007, according to the Justice Department complaint. When the U.S. housing boom collapsed, the world’s largest banks reported $2.1 trillion in losses and writedowns, triggering the worst financial crisis since the Great Depression and costing 8.8 million people their jobs.

‘Deeply Regret’

The Justice Department accuses S&P in its complaint of falsely representing to investors that its ratings were objective, independent and uninfluenced by any conflicts of interest. The company shaped its ratings to suit its business needs by weakening adjustments to its analytical models and by issuing inflated rankings on CDOs collectively worth hundreds of billions of dollars, according to the complaint.

In the 128-page civil complaint, the U.S. cites internal e-mail exchanges to bolster its case, including one in which an S&P analyst allegedly told a colleague in April 2007 that deals “could be structured by cows and we would rate it.”

“In hindsight, our rating opinions turned out to be insufficient in anticipating the speed, depth and duration of the housing crisis,” Peterson said in the video. “This is something we deeply regret. But we do not believe the government can prove that this was the product of intentional misconduct by anyone at S&P.”

‘Key Enablers’

S&P, Moody’s Investors Service (MCO) and Fitch Ratings were “key enablers of the financial meltdown,” the Financial Crisis Inquiry Commission, created by Congress with a 10-member bipartisan board, said in its January 2011 report. “This crisis could not have happened without the rating agencies.”

The government didn’t sue Moody’s or Fitch. Peterson said in the video that S&P’s ratings on CDOs cited in the complaint were “identical” to those from rival firms, and that its underlying assumptions about the U.S. real estate market were “consistent” with the opinions expressed at the time by the Treasury Department and the Federal Reserve.

“Our ratings were independent and issued by us in good faith, based upon the views of our rating committees at the time,” Peterson said.

The FCIC’s report also blamed the crisis on lenders’ irresponsible and sometimes fraudulent practices; regulators’ inattention and overconfidence; and the recklessness of borrowers and investors.

State Lawsuits

McGraw-Hill faces lawsuits from 16 states and the District of Columbia in addition to the federal case, which may not go to trial for “two to three years,” Kenneth Vittor, the company’s chief counsel, said on a conference call Feb. 12.

The company is asking for those lawsuits to be moved to federal court, where it may claim S&P is protected by the U.S. Constitution’s guarantee of free speech. McGraw-Hill filed so- called notices of removal in several courts to put the cases under federal jurisdiction and combine them for pretrial matters, such as the exchange of evidence and questioning of witnesses.

In federal court, the cases will be “adjudicated in a manner that takes into account the significant federal regulatory and constitutional issues that are necessarily and directly implicated,” the company said in papers filed this week in U.S. District Court in Wilmington, Delaware.

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

To contact the reporter on this story: Alan Goldstein at agoldstein5@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net

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