The U.S. Department of Justice (DOJ) sued McGraw-Hill (NYSE:MHP) subsidiary Standard & Poor's (S&P) late Monday for alleged illegal behavior in conjunction with the 2008 financial crisis. According to Reuters, U.S. Attorney General Eric Holder said the civil suit seeks more than $5 billion in damages.
The DOJ Charges
The Wall Street Journal reported that the lawsuit alleges S&P ignored its own internal standards in rating mortgage bonds, or CDOs, which precipitated a financial crisis, costing investors billions of dollars.
The Department of Justice's action is the first by a federal agency against a major credit rating agency over alleged illegal behavior connected to the financial crisis.
S&P issued a statement in response to the government's action which said, "A DOJ lawsuit would be entirely without factual or legal merit. 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 - and that every CDO that DOJ has cited to us also independently received the same rating from another rating agency."
S&P's attorney, Floyd Abram, partner at the law firm Cahill Gordon & Reindel, in a CNBC interview on Tuesday said, "There was no fraud. The ratings that were issued were believed by the people that issued them."
Abram added, "The organization was trying its best to come out with answers at a time when answers were very difficult to come by."
"The government," Abram said, "doesn't have to show that people lost money, they have to show that S&P literally disbelieved its ratings. There is no proof of that, because it isn't so."
Abram pointed out that the ratings issued by S&P were identical to those issued by other ratings agencies and echoed the views on risk held by government agencies and officials at the time.
"I don't think we should be involved, and I don't think Moody's (NYSE:MCO) should be charged," Abram said, although he acknowledges he has no knowledge of Moody's actions prior to the financial crisis.
Not a Pretty Picture
The government's lawsuit against S&P paints a sordid picture of a company that knowingly misled investors and was more concerned about making money than about accurate ratings.
The suit says S&P delayed updating its ratings models, rushed through the ratings process and was fully aware that the subprime market was in trouble, even as it gave high ratings to investments built on shaky subprime mortgages.
The evidence includes a 2007 video of one analyst singing and dancing to a tune about the deterioration of the subprime market, with colleagues laughing.
The Moody's Question
When asked whether the fact that rival agency, Moody's, is not being sued indicates that the government is punishing S&P for its downgrade of the U.S. economy in 2011, Abram refused to speculate. He did say, however, that "the intensity of the investigation" into the agency's bond ratings "significantly increased" after S&P downgraded the U.S. government's credit rating in 2011.
Anthony Sabino, a professor at St. John's University's Peter J. Tobin College of Business, told Forbes that the DOJ lawsuit was "part of the federal government's continued effort to 'round up' anybody and everybody allegedly culpable in the financial crisis."
The Bottom Line
Does this mean Moody's is next? Forbes points out that S&P argues that it wasn't alone in giving insufficient ratings to toxic mortgage assets. BTIG Research expects more action from the government, saying that while agencies like Moody's and Fitch have been able to avoid a lot of litigation so far, that could change as the federal authorities feel more pressure to prosecute.