S&P tried to defraud investors says US Justice Department

Eric Holder
Image caption Attorney General Eric Holder said that S&P's actions had been "egregious"

The US Justice Department has confirmed it will sue Standard and Poor's over a "scheme to defraud investors" before the financial crisis.

Attorney General Eric Holder announced that the Department had filed a civil lawsuit against the firm over the way it rated mortgage bonds.

"This alleged conduct is egregious and it goes to the very heart of the recent financial crisis," he said.

S&P said the case is entirely without factual or legal merit.

The lawsuit is the first to be brought against a ratings agency for alleged wrongdoing connected to the financial crisis.

On Monday, S&P announced that it expected to be accused by the Justice Department.

Shares in S&P's owner, the US publishing and media group McGraw Hill, fell 13.8% on Wall Street on Monday following the announcement, and a further 10.7% on Tuesday after the Justice Department unveiled details of its action.

Shares in fellow ratings agency Moody's fell 10.7% on Monday and more than 8% on Tuesday.

'Concealment of material facts'

S&P and other ratings agencies have faced criticism from investors, politicians and regulators for assigning their top AAA ratings to thousands of sub-prime and other mortgage securities that later collapsed in value.

In the run-up to the financial crisis, S&P and other ratings agencies were routinely hired by investment banks to assess the creditworthiness of investment products called Collateralised Debt Obligations, or CDOs.

These were complex financial transactions that packaged together thousands of loans to individual homebuyers.

The ratings agencies' job was to assess the likelihood that the home loans - and therefore the CDOs - would ultimately be repaid. Their ratings enabled the investment banks which put the CDOs together to then sell them to investors around the world.

The Justice Department claimed that S&P turned a blind eye to the risk inherent in these products, and assigned them ratings that were too high, because the ratings agency wanted to encourage investors to buy more CDOs so that they could earn more fees.

From September 2004 until October 2007, S&P had knowingly sought "to obtain money from [large US] investors by means of material false and fraudulent pretences, representations, and promises, and the concealment of material facts", according to the charges against it.

'Deep regret'

The Department also said that S&P knew to be false its claims to investors that it did not have any conflict of interest. This is because the fees it earned incentivised it to downplay the true risk of the CDOs never being repaid, the Department said.

The charges went on to accuse S&P of delaying updates to its financial models that might otherwise have made clear how risky these investments were.

Following the crisis, the models used by ratings agencies to assess CDOs were widely criticised for failing to consider the possibility that a downturn could afflict the entire US housing market simultaneously, simply because no such downturn had happened in recent history.

Furthermore, the Justice Department claimed that in 2007 - in the early stages of the financial crisis, when the US housing market had taken a decisive turn for the worse - S&P knowingly continued to assign overly optimistic ratings to high-risk subprime mortgage debts.

S&P said on Monday that it "deeply regrets" how its CDO ratings failed to anticipate mortgage market conditions as the financial crisis hit, and that it has since spent $400m to help bolster the quality of its ratings.

"Every CDO that [the department] has cited to us also independently received the same rating from another rating agency.

"The Department of Justice would be wrong in contending that S&P ratings were motivated by commercial considerations and not issued in good faith."

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