S&P girds for U.S. to sue over ratings on doomed bonds

Firm to fight crisis-role accusations

— The Justice Department intends to sue Standard & Poor’s, the largest credit ratings firm, over ratings it gave certain collateralized debt obligations in 2007, the company said Monday.

Two people familiar with the matter said the Justice Department and state prosecutors are preparing lawsuits against the company alleging wrongdoing in its ratings of the mortgage bonds in the lead-up to the 2008 financial crisis.

The lawsuits from federal and state authorities come in the wake of criticism from U.S. lawmakers over the role of bond rating firms in the onset of the financial crisis.

Inflated grades on the mortgage bonds, backed by subprime mortgages, helped ignite the worst financial crisis since the Great Depression when their values plummeted.

The rating agencies are important arbiters of the creditworthiness of securities traded around the world. The grades they assign can affect the ability of a company to raise or borrow money and how much investors will pay for securities it issues.

Analysts at Standard & Poor’s, owned by New York based McGraw-Hill Cos., at Moody’s Investors Service and at Fitch Ratings were pressured to give their stamp of approval to complex investments in a “race to the bottom” to win lucrative business from Wall Street banks, the U.S. Senate Permanent Subcommittee on Investigations said in an April 2011 report.

“A DOJ lawsuit would be entirely without factual or legal merit,” Standard & Poor’s said Monday in a statement.

A federal lawsuit would “disregard” the fact that Standard & Poor’s reviewed the same data on risky mortgages as U.S. government officials, who said publicly in 2007 that the problems in the subprime mortgage market appeared to be limited, the company said in the statement.

In the statement, Standard & Poor’s said it “deeply regrets” that its ratings on some securities “failed to fully anticipate the rapidly deteriorating conditions in the U.S.mortgage market during that tumultuous time.”

Adora Andy, a spokesman for the Justice Department, declined to comment. The potential lawsuits were first reported by The Wall Street Journal.

Judges have previously thrown out claims brought by investors against the rating agencies, on the grounds that their ratings amount to free speech protected by the First Amendment.

But that argument hasn’t always succeeded in cases involving investments such as those in the expected Standard & Poor’s suit, according to research by The Brattle Group, a consulting firm. That’s because those ratings weren’t published widely, as most bond ratings are. As a result, several courts have ruled that those ratings do not enjoy free-speech protection.

“If [the Justice Department] does bring suit, we will vigorously defend our Company against such meritless litigation,” the company said in the statement.

Moody’s, the No. 2 ratings provider, also has its headquarters in New York, followed by Fitch Ratings, majority-owned by Paris-based Fimalac SA.

The credit-grading business was targeted by U.S. lawmakers in the 2010 Dodd-Frank Act after ratings companies issued top rankings to risky mortgage-backed securities. Reports from the Senate Permanent Subcommittee on Investigations , along with the Financial Crisis Inquiry Commission, cited failures of the companies as a reason for the financial crisis.

“Credit rating agencies erroneously rated mortgage backed securities and their derivatives as safe investments,” the Financial Crisis Inquiry Commission said in its 2011 report.

In November, an Australian judge ruled Standard & Poor’s misled investors by giving its highest credit grade to securities whose value plunged during the global financial crisis.

The ratings firm was “misleading and deceptive” in its rating of two structured-debt issues in 2006, Federal Court Justice Jayne Jagot said in her ruling released Nov. 5 in Sydney.

McGraw-Hill shares fell $8.04, or 13.8 percent, to close Monday at $50.74.

Collateralized debt obligations are investment vehicles that contain many underlying mortgage loans. They generally gain in value if borrowers repay. But a wave of defaults can cause them to tumble in value.

Information for this article was contributed by Phil Mattingly and Matt Robinson of Bloomberg News and Marcy Gordon and Daniel Wagner of The Associated Press.

Front Section, Pages 1 on 02/05/2013

Upcoming Events