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Investments

ItÕ official: S&P to pay record-breaking fine for misleading RMBS investors

Settlement with DOJ resolves claims of inflated pre-crisis ratings

[Update 1: Updated with statement from Standard & Poor's]

It's official, a credit ratings agency is finally facing the music.

As was first rumored in early January, Standard & Poor’s will indeed pay $1.375 billion as part of settlement with the U.S. Department of Justice and nearly 20 states over claims that S&P knowingly misled mortgage bond investors by issuing trumped up ratings for pre-crisis residential mortgage-backed securities.

Attorney General Eric Holder announced the massive settlement Tuesday morning, calling it a “major step forward in the Justice Department’s ongoing effort to safeguard the American people from financial fraud and misconduct; to protect the integrity of our financial system; and to hold accountable any individual or institution that violates the law and abuses the public trust.”

While, mortgage bond settlements are not unusual in the years since the subprime bust, credit ratings agencies were typically spared regulatory wrath. Until now. The settlement stems from claims that were first levied against S&P two years ago. The latest word is that Moody's Investors Service may be next.

In 2013, the DOJ and the group of states filed a civil suit against Standard & Poor's, and its parent company McGraw-Hill, for allegedly misleading investors who put money behind RMBS and collateralized debt obligations.

Each of the lawsuits alleged that investors incurred substantial losses on RMBS and collateralized debt obligations because S&P issued “inflated ratings that misrepresented the securities’ true credit risks,” the DOJ said. The DOJ also accused S&P of falsely representing that its ratings were objective, independent and uninfluenced by S&P’s business relationships with the investment banks that issued the securities.

S&P claimed at the time that the claims by the DOJ were “meritless” and said, “claims that we deliberately kept ratings high when we knew they should be lower are simply not true."

S&P later said that the U.S. government was retaliating against them because the ratings agency stripped the country of its AAA credit rating. 

But now, the ratings agency has settled the negligence claims brought by the DOJ and the states of Arizona, Arkansas, California, Connecticut, Colorado, Delaware, Idaho, Illinois, Indiana, Iowa, Maine, Mississippi, Missouri, New Jersey, North Carolina, Pennsylvania, South Carolina, Tennessee, Washington, as well as the District of Columbia.

“On more than one occasion, the company’s leadership ignored senior analysts who warned that the company had given top ratings to financial products that were failing to perform as advertised,” Holder said of the settlement with S&P.

“As S&P admits under this settlement, company executives complained that the company declined to downgrade underperforming assets because it was worried that doing so would hurt the company’s business,” Holder continued. “While this strategy may have helped S&P avoid disappointing its clients, it did major harm to the larger economy, contributing to the worst financial crisis since the Great Depression.”

As part of the settlement, S&P agreed to formally retract its allegation that the United States’ lawsuit was filed in retaliation for S&P’s decision to downgrade the U.S.’s credit rating.

Additionally, S&P agreed to comply with the consumer protection statutes of each of the settling states and the District of Columbia, and to respond, in good faith, to requests from any of the states and the District of Columbia for information or material concerning any possible violation of those laws.

According to the DOJ, half of the $1.375 billion penalty will be paid to the federal government, which makes it the largest penalty of its type ever paid by a ratings agency.

The remaining $687.5 million will be divided among the 19 states and the District of Columbia.

As part of the settlement, S&P admitted that its decisions on its rating models were affected by business concerns, and that, with an eye to business concerns, S&P maintained and continued to issue positive ratings on securities despite a growing awareness of quality problems with those securities, the DOJ said.

In addition, S&P acknowledges that:

  • S&P promised investors at all relevant times that its ratings must be independent and objective and must not be affected by any existing or potential business relationship
  • S&P executives have admitted, despite its representations, that decisions about the testing and rollout of updates to S&P’s model for rating CDOs were made, at least in part, based on the effect that any update would have on S&P’s business relationship with issuers
  • Relevant people within S&P knew in 2007 many loans in RMBS transactions S&P were rating were delinquent and that losses were probable
  • S&P representatives continued to issue and confirm positive ratings without adjustments to reflect the negative rating actions that it expected would come

The settlement marks the second time in a week that S&P has faced serious consequences from regulators over its ratings practices.

Last week, the Securities and Exchange Commission charged S&P with fraudulent misconduct related to the ratings of commercial-mortgage backed securities.

“The settlement we have reached today not only makes clear that this kind of conduct will never be tolerated by the Department of Justice – it also underscores our strong and ongoing commitment to pursue any company or entity that violated the law and contributed to the financial crisis of 2008,” Holder said. 

“We have been aggressive in working to address every part of the financial system that contributed to the crisis – from those who originated loans, to those who serviced them, securitized them, and rated them inappropriately,” Holder continued. “We have never hesitated to investigate and prosecute any individual, institution, or organization that attempted to exploit our markets and take advantage of the American people. And as I have made clear from the moment I took office as Attorney General – six years ago today – we will never rest in our determination to use every legal tool at our disposal to achieve justice for all Americans.”

Holder added that the DOJ “will never shrink from litigation” and is “extremely proud” of the task force that pursued the claims against S&P.

“As we have proven time and again – and as we made clear when we initiated legal action against S&P two years ago – we will not be deterred or outlasted,” Holder said.  “No unlawful conduct is too complicated to pursue. And no financial institution, at home or abroad, is too powerful to be held accountable for wrongdoing.”

In a statment, S&P noted that the settlement contains no findings of violations of law by the company, S&P Financial Services or S&P Ratings.  

"The settlement agreement states that all parties, including the Company, the DOJ and the States, settled this matter 'to avoid the delay, uncertainty, inconvenience, and expense of further litigation,'" S&P said in a statement. "After careful consideration, the company determined that entering into the settlement agreement is in the best interests of the company and its shareholders and is pleased to resolve these matters."

S&P added that the settlement amount will be reflected in the company's fourth-quarter and full-year financial statements for 2014, adding that additional details about the financial impact of the settlement will provided when the company releases its fourth-quarter earnings on Feb. 12. 

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