U.S. District Judge David Carter in Santa Ana, California, affirmed his tentative decision of July 8, denying S&P’s request to throw out the allegation the ratings company misled investors in residential mortgage-backed securities and collateralized-debt obligations.
In his decision, the judge didn’t rule on the merits of the government’s claims that S&P lied to investors about its ratings being objective and free of conflicts of interest. He disagreed with S&P that, assuming everything the Justice Department said in the complaint were true, the government’s allegations failed to reach the legal threshold to make a viable fraud claim.
“The government has sufficiently pleaded the intent required to support its fraud claims,” Carter wrote in his ruling issued yesterday. “Any disputes over the veracity of these claims, or contested facts, are properly challenged at a later stage of litigation.”
The Justice Department seeks as much as $5 billion in civil penalties for losses to federally insured financial institutions that relied on S&P’s investment-grade ratings for mortgage-backed securities and CDOs. The value of many of the securities linked to risky, subprime mortgages was wiped out by a surge in defaults and the collapse of the U.S. housing market starting in 2007.
The U.S. said in its February 4 complaint that S&P, contrary to what it told investors, based its credit ratings for the securities on a desire to win business from investment banks that sought the highest possible ratings to sell them and not on the securities underlying credit risk.
New York-based S&P had argued that its statements about the objectivity of its ratings were so generic that reasonable investors would not have relied on them. The company also said that its ratings were the same as those of its rivals and that the government’s complaint failed to specify what the correct ratings should have been.
Carter rejected S&P’s arguments that its assurances were mere ‘puffery.’
“If no investor believed in S&P’s objectivity,’ the judge wrote, ‘‘is S&P asserting that, as a matter of law, the company’s credit ratings service added absolutely zero material value as a predictor of creditworthiness?”
The case is U.S. v. McGraw-Hill Cos., 13-cv-00779, U.S. District Court, Central District of California (Santa Ana).
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