S&P Loses Bid to End California’s Mortgage Ratings Suit

Standard & Poor’s lost a second bid to dismiss a lawsuit by California’s attorney general seeking to hold the company responsible for $1 billion in losses by state pension funds that bought mortgage-backed securities awarded the company’s highest ratings.

State court Judge Curtis Karnow in San Francisco yesterday denied S&P’s request to dismiss the lawsuit on grounds that it’s a malicious lawsuit intended to intimidate the credit rater. S&P, a unit of New York-based McGraw Hill Financial Inc., argued to Karnow this week that its ratings are opinions, and like newspaper editorials, are protected by the First Amendment of the U.S. Constitution.

S&P asked Karnow to dismiss the case under a California law that blocks nuisance lawsuits filed by plaintiffs seeking to silence their critics. An order explaining the reason for denying the request wasn’t published electronically.

The California lawsuit is one of more than a dozen filed in February against S&P by the U.S. and a group of states over ratings on mortgage-backed securities during the housing boom.

The U.S. Justice Department has proposed a trial start date of Feb. 17, 2015, for its suit against S&P. The government accuses the company of inflating ratings on mortgage securities to win business, which helped trigger the financial crisis. S&P has called those claims “meritless.”

It was the second time Karnow refused to throw the case out. In August he rejected S&P’s arguments that Attorney General Kamala Harris filed the lawsuit too late and didn’t have grounds to file it because state money wasn’t involved in the pension funds’ securities purchases.

‘Magic Numbers’

Harris alleged in her complaint S&P used “guesses” and “magic numbers” to inflate ratings of mortgage-backed securities purchased by the California Public Employees’ Retirement System and the state’s teacher pension fund.

The entities bought the securities because they had received AAA ratings, signaling they were very low risk investments. After the mortgage crisis hit, the funds ultimately lost more than $1 billion on the investments, according to the lawsuit.

Harris alleged that instead of using independent and objective analysis to assign ratings to the securities, S&P from 2004 to 2007 lowered its standards and gave its highest credit ratings to risky securities to bolster its business with banks selling the investments.

By claiming the practice violated a law against using false statements to defraud the state, the attorney general is allowed to seek triple damages.

“We are pleased with the judge’s ruling and look forward to beginning the discovery process,” Special Assistant Attorney General Jeff Tsai said in an e-mail.

Ed Sweeney, a McGraw-Hill spokesman, didn’t immediately respond to an e-mail yesterday after regular business hours seeking comment on the ruling.

The case is California v. McGraw-Hill Cos., CGC 13-528491, California Superior Court (San Francisco).