S&P Says Government’s Fraud Case Over Ratings Is Unwieldy

McGraw Hill Financial Inc.’s Standard & Poor’s unit said the U.S. government has broadened the securities covered in its fraud lawsuit against the ratings company so that the case would be unmanageable at trial.

The Justice Department has selected 56 residential mortgage-backed securities and 107 collateralized-debt obligations rated by S&P that will form the basis for its claims at trial that S&P defrauded investors, according to a joint filing yesterday in federal court in Santa Ana, California.

“Instead of narrowing its case, the government now proposes that discovery and trial in this action will concern more than five times as many securities as it identified in the complaint,” S&P said in the filing.

U.S. District Judge David Carter has set a Dec. 16 scheduling conference to help determine how big a case the government can bring before a jury and how long both sides will have to get ready for trial.

The Justice Department said this year’s trial against Bank of America Corp.’s Countrywide unit in New York, which involved similar allegations under the Financial Institutions Reform, Recovery, and Enforcement Act regarding more than 11,000 loans, showed that a trial on S&P’s liability based on the securities it proposed isn’t unmanageable.

S&P said pre-trial information exchange for the more than 150 securities would take at least two years. The judge should limit the case to securities bought by Citigroup Inc., which bought more of the securities and suffered more of the alleged losses than any other entity, according to S&P.

U.S. Allegations

The government alleged in its Feb. 4 complaint against S&P that the firm knowingly downplayed the risk on securities before the credit crisis in an effort to win business from investment banks that sought the highest possible ratings to sell them. The company has denied the allegations and said it has been singled out because it was only credit rater that downgraded U.S. debt.

The Justice Department said in yesterday’s filing that S&P’s contention that the government has expanded the case is “flawed” because it’s neither improper nor unusual for the allegations to involve more securities than the 26 CDOs it referred to by name in the complaint.

The government also said S&P was wrong to argue that each of the mortgage-backed securities or CDOs would “raise a host of deal-specific issues” that would need to be investigated before trial. The issue before the jury would be S&P’s conduct, according to the government.

‘Misleading Representations’

“This is not a securities fraud case in which reliance and loss causation would be elements of liability,” the Justice Department said. “To the contrary, the underlying FIRREA predicates are ordinary mail, wire, and bank fraud, which require that the United States establish only that S&P made false or misleading representations, that were material, with the intent to defraud.”

The government said that it will seek penalties based on the losses of 22 “victims” and that it wants the judge to determine the amount of the penalties rather than a jury, as is being done in the Bank of America FIRREA case in New York.

One of the alleged victims of S&P’s ratings is Western Corporate Federal Credit Union, according to yesterday’s filing. The National Credit Union Administration found that the credit union’s management rather than credit raters were to blame for its collapse, according to S&P.

The government proposed a May 19, 2015, trial date for the case. S&P said that even if the case were narrowed to focus only on securities that resulted in losses to Citigroup, it shouldn’t go to trial until Nov. 9, 2015.

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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