U.S. sues S&P over pre-credit-crisis ratings

The U.S. Justice Department sued Standard & Poor’s over claims the ratings firm knowingly understated the credit risks of bonds and derivatives that were central to the worst financial crisis since the Great Depression.

The suit was filed Monday in Los Angeles, accusing S&P and its parent, McGraw-Hill Cos., of three types of fraud, the first federal case against a ratings company for grades related to the credit crisis.

S&P issued credit ratings on more than $2.8 trillion of residential mortgage-backed securities and about $1.2 trillion of collateralized-debt obligations from September 2004 through October 2007, according to the complaint. S&P downplayed the risks on portions of the securities to gain more business from the investment banks that issued them, the U.S. said.

“It’s going to be a tricky time for rating agencies,” Fred Ponzo, a capital markets analyst at Greyspark Partners in London, said in a telephone interview. “S&P is probably just the first to face the music.”

Under the Financial Institutions Reform, Recovery and Enforcement Act of 1989, the U.S. seeks civil penalties of as much as $1.1 million for each violation.

According to the U.S. complaint, S&P falsely represented to investors that its credit ratings were objective, independent and uninfluenced by any conflicts of interests.

“A DOJ lawsuit would be entirely without factual or legal merit,” S&P said in a statement Monday before the case was filed. “It would disregard the central facts that S&P reviewed the same subprime mortgage data as the rest of the market, including U.S. government officials who in 2007 publicly stated that problems in the subprime market appeared to be contained.”

S&P, in its statement, cited court rulings that have dismissed challenges to the opinions of ratings firms. The company also said it planned to fight any lawsuits.

Catherine Mathis, a spokeswoman for S&P, had no immediate comment on the complaint after it was filed.

The Justice Department cites e-mails from S&P employees discussing the need to modify ratings criteria to win business after the company’s grades were more conservative than competitors.