A U.S. district judge in California has put out a tentative decision in the $5B fraud lawsuit against Standard & Poor’s indicating that he will likely reject a motion to dismiss the civil case against the credit rating agency. Judge David Carter said he needs more time to come up with his final ruling, which is expected on July 15, but for now, he is turning down S & P’s request to toss out the case outright.
Federal prosecutors sued S & P contending that the credit rater chose not to alert investors that the housing market was failing in ‘06 and inflated high-risk mortgage investments’ ratings. The Obama Administration said the ratings agency did not act fast enough to put downgrade a large number of subprime-backed securities despite realizing that home prices were dropping and borrowers were finding it hard to pay back loans. Instead, collateralized debt obligations and mortgage-backed securities continued to receive elevated ratings from the top credit rating agencies, allowing banks to sell trillions of these investments.
Contending that the credit rater committed fraud by making false claims that its ratings were objective, the US Department of Justice wants S & P to pay $5 billion in penalties, The government believes that between 9/04 and 10/07, S & P delayed updating both its ratings criteria and analytical models, which means the requirements were weaker than what analysts say should have been necessary to ensure their accuracy. During this time, S & P credit rated about $1.2 trillion in structured products related to $2.8 trillion worth of mortgage securities and charged up to $750 per rated deal. The government says that this means that S & P saw the investment banks that put out the securities as its primary customers.
Now, S & P wants the MBS case thrown out, contending that the lawsuit is too broad and doesn’t offer enough specific examples of the alleged fraud. The credit rating agency maintains that the statements federal prosecutors say are the allegedly fraudulent misrepresentations are ones that investors were not supposed to take at face value and, therefore, they cannot be grounds for the securities fraud case.
Also, S & P’s legal defense says that just like other market participants, including the US Treasury, the credit rating agency did not have the ability to predict how severe the ensuing “catastrophic meltdown” would be and, if anything, this showed a “lack of prescience” rather than fraud.
However, Judge Carter in his tentative ruling, did say that S & P’s statements in employee conduct codes and official policy statements about its standards and processes for ratings deals aren’t just “mere aspirational musings,” but instead are “specific assertions of policies… in stark contrast” to conduct that the government is alleging occurred.
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