S&P’s Assurances to Investors Not Mere Puffery, U.S. Says

Standard & Poor’s assurances to investors that its credit ratings were free of conflicts of interest amounted to fraudulent representations rather than “mere puffery,” the Justice Department said.

The U.S. filed its response yesterday to a request by the McGraw Hill Financial Inc.-owned rating company to dismiss civil claims that it knowingly and intentionally defrauded investors in residential mortgage-backed securities, and in collateralized-debt obligations that included those securities.

“It would no doubt come as some surprise to many, RMBS and CDO investors, regulators, and legislators among them, that S&P’s repeated assurances that its ratings were objective, independent, and uninfluenced by any conflict of interest were mere puffery,” the Justice Department said in its filing in federal court in Santa Ana, California.

S&P, based in New York, had said in its April 22 request to dismiss the government’s lawsuit that its public statements about its ratings being free of conflicts of interest couldn’t form the basis of fraud allegations.

The company cited in its request a recent ruling by a federal appeals court in New York. That court found in a case brought by a Florida pension fund against S&P that “statements concerning the ‘integrity and credibility and the objectivity of S&P’s credit ratings’ were exactly ‘the type of mere puffery’ that we have previously held to be not actionable.’”

“We look forward to having our motion heard by the court,” Catherine Mathis, an S&P spokeswoman, said in an e-mail.

‘Outrageous’ Statements

In yesterday’s filing, the Justice Department said that S&P’s assurances to investors were not “outrageous generalized statements” that were so exaggerated that no one could be expected to rely on them. Rather, they were specific assertions about S&P’s policies and procedures concerning the separation of its analytical work and its business interests, the U.S. said.

The government alleged in its Feb. 4 lawsuit that S&P lied about its ratings being free of conflicts of interest because it downplayed or disregarded credit risks to win more business from investment banks and other issuers of the securities that paid the company to provide the ratings and that sought the highest possible ratings.

Banks create collateralized debt obligations by bundling bonds or loans into securities of varying risk and return. They pay ratings firms for the grades, which investors may use to meet regulatory requirements.

In its 119-page complaint, the Justice Department cited meetings, messages and memos that it said showed S&P analysts assigned investment-grade ratings to securities based more on a desire to win business than to be accurate.

Objectively False

S&P said in its request to dismiss the case that the government’s lawsuit didn’t provide the legally required detail to back up its claims that the company’s ratings were objectively false or subjectively disbelieved by S&P when they were issued. The company said it issued the same ratings as its competitors for the securities at issue in the lawsuit.

Justice Department officials said in February they may seek more than $5 billion in civil penalties from S&P.

McGraw Hill has rebounded 28.9 percent to trade at $54.99 since a low on Feb. 8 following the lawsuit. Demand for ratings has been boosted by the Federal Reserve’s pledge to hold interest rates near zero to spur economic growth. The world’s largest credit rater reported a 20.4 percent increase in revenue last quarter to $561 million.

March Sales

Chief Executive Officer Harold “Terry” McGraw III completed the sale of the company’s education unit in March for $2.4 billion in cash after pressure from Jana Partners LLC, a New York-based hedge fund, and the Ontario Teachers’ Pension Plan. That leaves S&P at the center of the company, making up 45 percent of sales.

McGraw Hill’s origins date back to 1888, when James H. McGraw acquired The American Journal of Railway Appliances, according to the company’s website. More than 20 years later, he merged his book-publishing department with John A. Hill’s, creating the McGraw-Hill Book Co. In 2009, McGraw-Hill agreed to sell Businessweek magazine to Bloomberg LP, the parent of Bloomberg News.

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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