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February 5, 2013

US Justice Department Sues Standard and Poor's Over Allegedly Fraudulent Ratings of Collateralized Debt Obligations

The US Department of Justice and has filed civil fraud charges against Standard & Poor’s Ratings Service, contending that credit rating agency’s fraudulent ratings of mortgage bonds played a role in causing the economic crisis. Settlement talks with Justice Department reportedly broke down after the latter indicated that it wanted at least $1 billion. S & P was hoping to pay around $100 million. Also, there was disagreement between both sides as to whether or not the credit rater could agree to settle without having to admit to any wrongdoing.

The securities case against S & P involves over 30 collateralized debt obligations, which were created in 2007 when the housing market was at its height. The government believes that between September 2004 and October 2007 the credit rater disregarded the risks that came along with the investments, giving them too high ratings in the interest of profit and gaining market share. The ratings agency allegedly wanted the large financial firms and others to select it to rate financial instruments. Meantime, S & P continued to tout its ratings as objective, misleading investors as a result. S & P would go on to make record profits, and the complex home loan bundles eventually failed.

Although there have been questions for some time now about the credit ratings agencies’ role in creating a housing bubble, this is the first securities lawsuit brought by the government against one of these firms over the financial crisis. It was in 2010 that a Senate probe revealed that from 2004 to 2007 S & P and Moody’s Investors Service (MC) both applied rating models that were inaccurate, which caused them to fail to predict exactly how well the risky mortgages would do. The lawmakers believed that the credit rating agencies let competition between each other affect how well they did their jobs.

S & P claims that a CDO lawsuit by the DOJ would be completely lacking in legal or factual merit. It pointed out that in the two years leading up to the economic collapse it had gone ahead and downgraded a lot of mortgage-backed investments. Also, S & P notes, it had access to the same subprime mortgage data as everyone else—and that every mortgage-backed bond cited by the government also got the same rating from another agency. S & P maintains that when it issued the ratings, it acted in good faith.

Over a dozen federal prosecutors are expected to join the federal securities case. The DOJ had considered also pursuing a criminal case against S & P but has since changed its mind.

U.S. Accuses S. & P. of Fraud in Suit on Loan Bundles, NY Times, February 4, 2013

Feds file suit over S&P mortgage bond ratings, USA Today, February 5, 2013

More Blog Posts:
McGraw Hills, Moody’s, & Standard & Poor’s Can’t Be Held Liable by Ohio Pension Funds for Allegedly Flawed MBS Ratings, Affirms Sixth Circuit, Stockbroker Fraud Blog, December 20, 2012

Standard & Poor’s Misled Investors By Giving Synthetic Derivatives Its Highest Ratings, Rules Australian Federal Court, Institutional Investor Securities Blog, November 8, 2012

Standard & Poors Receives SEC Wells Notice Over CDO Rating, Institutional Investor Securities Blog, September 30, 2011

Posted by Shepherd Smith Edwards & Kantas LTD LLP | Permalink | Email This Post

Posted In: Collateral Debt Obligation , Credit Ratings Agencies , Standard and Poor's

December 20, 2012

McGraw Hills, Moody’s, & Standard & Poor’s Can’t Be Held Liable by Ohio Pension Funds for Allegedly Flawed MBS Ratings, Affirms Sixth Circuit

This month, the U.S. Court of Appeals for the Sixth Circuit refused to revive statutory and common law MBS claims made by five Ohio pension funds: The Ohio Police & Fire Pension Fund, the State Teachers Retirement System of Ohio, the Ohio Public Employees Retirement System, the Ohio Public Employees Deferred Compensation Program, and the School Employees Retirement Systems of Ohio. All of them are run by the state for public employees.

Per the court’s opinion, between 2005 and 2008, the funds had invested hundreds of million of dollars in 308 mortgage-backed securities that all were given AAA or the equivalent from one of the three credit rating agencies. When MBS value dropped during this time, the Funds lost about $457 million.

The plaintiffs believe that the reason that they lost their money is because the ratings that were given to the MBS were false and misleading. They filed their Ohio securities lawsuit under the state’s “blue sky “ laws, as well as the common law theory of negligent misrepresentation.

The Funds claim that the defendants had a conflict of interest with the “issuer pays” model, which tainted the MBS ratings that they issued, and that they neglected to disclose this weakness even while knowing that investors depended on accuracy to make their investment choices.

Finding that the credit rating agencies were not the ones that sold the securities, nor did they assist the sellers in making fraudulent transactions, the district court dismissed the MBS securities lawsuit. Also, that court found the plaintiffs’ statements of opinion to be not actionable because the complaint did not allege that the defendants believed their ratings to be inaccurate when they made them.

The Sixth Circuit affirmed the district’s court ruling. It noted that Ohio Revised Code Section 1707.41(A) establishes a private remedy against securities sellers based on false sales material and persons that get the profits of these types of sales. With this mortgage-backed securities case, however, it found that the Funds did not allege that the defendants sold or offered the securities that they rated and this particular cold section would have been contingent upon if the CRAs profited from the MBS sales. The appeals court noted that the fees the defendants received for issuing the ratings were fixed costs of an MBS issue and don't have the “contingent quality” associated with profits.

Also, even though the Funds wanted relief too from Section 1707.43(A), which allows securities fraud victims a rescission remedy, the Sixth Court said that the plaintiffs mainly relied on the credit raters’ alleged violation of 1707.41(A), as support for their claim to Section 1707.43(A) rescission, which, the court determined is meritless. The court did not go with the Funds efforts to save their rescission remedy by claiming that the defendants violated Section 1707.44(B)(4), which only blocks affirmative misrepresentations.

As for common-law misrepresentations, the court affirmed that the plaintiffs couldn’t hold the agencies liable for this either under Ohio law or New York law. The Sixth Court said that the Funds failed to properly allege that the defendants owed them a duty or that the ratings that were issued were misrepresentations that weren’t actionable.

“Considering the widespread reliance upon their opinions, it is incredible that securities credit rating agencies are exempt from responsibility for their reporting,” said Shepherd Smith Edwards and Kantas, LTD, LLP Founder and Mortgage-Backed Securities Lawyer William Shepherd. Their only purpose is to give investors some sense of the risks involved in an investment. They serve absolutely no purpose to the issuers of the securities except to help them convince investors to invest. Thus, only the investor is the target of such information. CRA’s should be legally responsible for sloppy or misleading reports which cause investors to lose their money.”

Ohio Police & Fire Pension Fund v. Standard & Poor's Financial Services LLC (PDF)

More Blog Posts:
Standard & Poor’s Misled Investors By Giving Synthetic Derivatives Its Highest Ratings, Rules Australian Federal Court, Institutional Investor Securities Blog, November 8, 2012
Securities Law Roundup: Ex-Sentinel Management Group Execs Indicted Over Alleged $500M Fraud, Egan-Jones Rating Wants Court to Hear Bias Claim Against SEC, and Oppenheimer Funds Pays $35M Over Alleged Mutual Fund Misstatements, Stockbroker Fraud Blog, June 13, 2012

Moody’s, Fitch, and Standard and Poor’s Were Exercising Their 1st Amendment Rights When They Gave Inaccurate Subprime Ratings to SIVs, Says Court, Institutional Investor Securities Blog, December 30, 2010

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Posted In: Credit Ratings , Moody's , Mortgage Backed Securities , Standard and Poor's

October 7, 2009

Make Credit Rating Agencies Collectively Liable for Inaccuracies, Proposes Lawmaker

House Financial Services subcommittee chair Paul Kanjorski introduced a new draft bill that proposes making credit ratings agencies collectively liable for inaccuracies. The agencies received a lot of heat when they failed to properly warn investors about the risks associated with subprime mortgage securities before the market fell.

One problem with the current system is that the firms issuing the securities are the ones paying the credit ratings agencies for rating the securities. Kanjorski’s draft bill lets investors pursue lawsuits against credit rating agencies that recklessly or intentionally did not examine key data to determine the ratings. He says that collective liability could compel the ratings agencies to provide reliable, quality ratings while providing the proper incentive for them to monitor each other.

Critics of the plan, including Republicans and industry executives, warned that collective liability could result in a slew of expensive complaints while decreasing competition even more in an industry that Fitch Ratings, Moody’s Investors Services, and Standard and Poor’s already dominate.

Kanjorski said that his proposal was a “start,” which comes as Congress intensifies its watch over the credit ratings agency industry and the Obama administration calls for stricter government oversight.

Credit ratings agencies are charged with issuing the creditworthiness ratings of securities and public companies. The ratings can impact a company’s ability to borrow or raise funds and determine how much mutual funds, banks, local governments, and state pension funds will pay for securities.

When home-loan delinquencies went up last year, the investments’ value dropped and the credit ratings agencies were forced to downgrade the ratings they gave to thousands of securities. Large banks and investment firms sustained hundreds of billions of dollars in losses because of the downgrades.

Meantime, two former Moody’s employees, former analyst Eric Kolchinsky and former senior vice president for compliance Scott McCleskey, are accusing Moody’s of misconduct, including engaging in conflicts of interest, knowingly inflating ratings, and failing to implement “meaningful surveillance of municipal securities” despite the credit ratings agency's statements to the contrary. Moody’s acknowledges misjudging the magnitude of the subprime mortgage collapse but says the allegations are “unsupported.”

Recently, the SEC proposed rules that would put a stop to conflicts of interest and allow for greater transparency for credit ratings agencies.

When the subprime mortgage market collapsed, many investor sustained massive financial losses. Our securities fraud law firm is dedicated to helping our clients recover those losses. Contact Shepherd Smith Edwards & Kantas LTD LLP today.

Related Web Resources:
Lawmaker seeks group liability for rating agencies, Business Week, September 30, 2009

The Role and Impact of Credit Rating Agencies on the Subprime Credit Markets, SEC.gov, September 26, 2009

House Committee on Financial Services

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Posted In: Credit Ratings Agencies , Fitch , Moody's , Standard and Poor's

November 6, 2008

Moody’s, Standard & Poor's, and Fitch’s Assignment of High Credit Ratings to Mortgage-Backed Securities Contributed to the Financial Meltdown

At a hearing presided over by the House Oversight and Government Reform Committee in Washington DC, the executives of Moody’s, Standard & Poor's, and Fitch Ratings, the three top credit rating agencies in the country, were grilled about how their assignment of high ratings to mortgage-backed securities, while drastically underestimating their risks, contributed to the current financial crisis.

While the heads of the country’s three leading credit agencies—Standard and Poor’s Deven Sherman, Fitch Ratings’s Stephen W. Joynt, and Moody’s Raymond W. McDaniel—have called the mortgage-backed securities collapse “unprecedented” and “unanticipated and said that any errors the agencies' made were unintentional, internal documents reveal that the credit rating agencies knew that the ratings they were giving the securities were overvalued. It wasn’t until this past year, when homeowners began defaulting on subprime mortgages, that the credit ratings agencies began downgrading thousands of the securities.

Lawmakers are trying to determine whether the firms’ business model contributed to the conflicts of interests. Issuers pay the credit ratings agencies for evaluating securities. While the credit ratings agencies were giving mortgage-backed securities high ratings, the heads of the three leading credit agencies were earning $80 million in compensation.

At the hearing, former Moody’s credit policy managing director Jerome S. Fons testified that the agencies’ business model prevents analysts from placing investor interests before the firms’ interests. In one confidential document obtained by investigators, Moody’s CEO McDaniels is quoted as saying that bankers, investors and creditors regularly “pitched” the credit ratings agency. According to Frank L. Raiter, the former head of residential mortgage-backed securities ratings at Standard and Poor's, "Profits were running the show."

Investors depend on the credit rating agencies for independent evaluations. According to Congressman Waxman, the ratings agencies “broke this bond of trust,” while federal regulators failed to heed the red flags and protect investors.

Related Web Resources:

Credit Rating Agency Heads Grilled by Lawmakers, New York Times, October 22, 2008

Oversight Committee Hearing on Credit Rating Agencies and the Financial Crisis, Polfeeds.com, October 22, 2008

Committee on Oversight and Government Reform

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Posted by Shepherd Smith Edwards & Kantas LTD LLP | Permalink | Email This Post

Posted In: Credit Ratings Agencies , Fitch , Moody's , Standard and Poor's