Standard & Poor’s unit McGraw-Hill is currently defending itself against allegations from the United States Justice Department that the company fraudulently misrepresented the quality of mortgage-backed securities to investors. S&P asked a federal judge yesterday to dismiss the charges citing that the plaintiff’s case is based on vague statements that cannot prove fraudulent activity.
The Justice Department claims that S&P intentionally defrauded investors by inflating the ratings on mortgage-backed securities in order to win more business from investment banks and other security issuers that were paying S&P to provide the ratings. The Justice Department further indicates that S&P could face more than $5 billion in civil penalties based on the ensuing losses by federally insured institutions that counted these ratings. The Justice Department’s lawsuit is filed under the 1989 Financial Institutions Reform, Recovery, and Enforcement which allows the government to seek penalties for fraud that affects federally insured financial institutions.
In their filing requesting a dismissal, S&P states that the government cannot prove the company fraudulently rated these securities and accuses the Justice Department of cherry-picking emails and data to misconstrue how their analysts came to their rating conclusions. The filing further reflects the following, “It is more than ironic that two of the supposed ‘victims’, Citibank and Bank of America – investors allegedly misled into buying securities by S&P’s fraudulent ratings – were the same huge financial institutions that were creating and selling the very CDOs (collateralized debt obligations) at issue.” It will be interesting to see how the court handles these allegations and how significant the discovery process is in coming to a conclusion.