In the fallout of the financial crisis, many argued that the credit ratings agencies’ competition for business led to ratings shopping among bond issuers and relaxed ratings standards for the ratings agencies themselves.
Last year, Standard & Poor’s reached a settlement with the Department of Justice and nearly 20 states, which required S&P to pay $1.375 billion over claims that S&P knowingly misled mortgage bond investors by issuing trumped-up ratings for pre-crisis residential mortgage-backed securities.
That same day reports emerged that the DOJ was planning to look into the mortgage bond ratings activities of Moody’s Investor Service during the run-up to the financial crisis as well.
Now those chickens appear to be coming home to roost for Moody’s, as the company disclosed Friday that it is expecting a lawsuit from the DOJ over the ratings it issued for residential mortgage-backed securities and collateralized debt obligations before the crisis.
Moody’s revealed the pending lawsuit in its third-quarter earnings release in a section entitled “Litigation Update.”
In the Litigation Update section, Moody’s said that it has periodically received subpoenas and inquiries from various governmental authorities, including the DOJ and attorneys general of several states, over its ratings activities in the mid-to-late 2000s.
Moody’s said it received another of those communications from the DOJ recently, although this one is different.
“In a letter dated September 29, 2016, the DOJ stated that it is preparing a civil complaint to be filed against Moody’s and MIS in the US District Court for the District of New Jersey alleging certain violations of the Financial Institutions Reform, Recovery, and Enforcement Act in connection with the ratings MIS assigned to residential mortgage-backed securities and collateralized debt obligations in the period leading up to the 2008 financial crisis,” Moody’s said in its earnings release.
According to Moody’s, the DOJ also stated that its investigation is continuing and may expand beyond its current parameters to include “additional theories.”
Moody’s said that some number of state attorneys general have also indicated that they also expect to pursue similar claims under state law, including “additional periods, theories, asset classes or activities.”
Moody’s said that the company is “continuing to respond” to the DOJ’s and states’ subpoenas and inquiries.
The lawsuit against S&P took two years to move through the legal process, so it’s unlikely that there will be a resolution to the Moody’s situation any time soon, but a lawsuit is apparently coming.
In S&P’s case, the DOJ and the group of states filed a civil suit against Standard & Poor's, and its parent company McGraw-Hill, in 2013 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 eventually, S&P agreed in 2015 to pay $1.375 billion to settle those charges.
Time will tell whether Moody's will be the next company to settle.