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Court Refuses to Toss Gov't Suit Against S&P Over Allegedly False Ratings

Friday, July 12, 2013

The U.S. District Court for the Central District of California July 8 refused to dismiss the Justice Department's civil suit against McGraw-Hill Cos. Inc., (MHP) alleging that its subsidiary Standard and Poors Financial Services LLC misled and defrauded investors by inflating the credit ratings of certain structured debt securities (United States v. McGraw-Hill Cos. Inc., C.D. Cal., Case No. SACV 13-779 DOC(JCGx), 7/8/13).

In what the court described as a tentative ruling, Judge David O. Carter held that the government has sufficiently alleged with particularity that S&P's ratings were “both objectively and subjectively false” and that the credit rating agency acted with “'specific intent to obtain money or property'” from the allegedly deceived investors. The court said it would provide a fuller explanation of its decision later. 

Credit Rating

“This is a case about credit rating--how they are created, whose interests they serve, and how they may or may not have been manipulated during the period leading up to this country's financial meltdown,” the court said.

According to the complaint filed by the Justice Department and several states, from 2004 through 2007, S&P issued ratings for residential mortgage back securities and collateralized debt obligations that "downplay[ed] and disregard[ed]" the risks of the products it was rating in a bid to boost profits and to "favor the interests" of large banks and other issuers.

Despite S&P's assurances that it had “'established policies and procedures'” to avoid conflicts of interest and to ensure independent ratings, the government alleged that beginning in 2007, “S&P issued or confirmed ratings that did not accurately reflect true credit risks.” In particular, the government claimed that S&P knew that certain classes of RMBSs that backed CDOs were “rapidly deteriorating” even as it gave high ratings to these CDOs. Further, the government asserted that S&P executives prevented certain analysts from issuing credit ratings that “accurately represented the falling creditworthiness.”

The Justice Department sued under the 1989 Financial Institutions, Reform, Recovery, and Enforcement Act, seeking civil penalties. S&P moved to dismiss, arguing: the allegedly fraudulent statements constitute pufferey that is not actionable; the government failed to plead facts showing that S&P's ratings were objectively or subjectively false and misleading; and the government failed to plead that S&P had the “requisite culpable state of mind” to deceive investors. 

Dismissal Bid Denied

Denying S&P's dismissal bid, the court held that the allegedly fraudulent statements cannot be “mere aspirational musings of a corporation setting out vague goals for its future.” “Rather,” the court explained, “they are specific assertions of current and ongoing policies that stand in stark contrast to the behavior alleged by the government's complaint.”

Next, the court held that the government has sufficiently alleged with particularity that the credit rating agency's rating were “both objectively and subjectively false.” The evidence presented by the government is “voluminous” and the complaint comprehensively alleged “how and why S&P's ratings were both false and material,” the court explained.

Finally, the court held that the complaint sufficiently alleged that S&P intended to, and did, obtain money from issuers who were paid by the investors allegedly deceived by the false credit ratings. Although S&P may disagree with the government's version of the facts, the court said, “the opportunity to challenge such facts comes later in the litigation process.”


To see the opinion, go to http://www.bloomberglaw.com/public/document/United_States_of_America_v_McGrawHill_Companies_Inc_et_al_Docket_/2.

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