Almost two years after the Justice Department sued the ratings agency Standard and Poor's, accusing it of defrauding investors by giving optimistically high ratings to securities based on residential mortgages before the housing crash, the company has resolved the suit to the tune of $1.375 billion. In addition, S&P settled a similar suit with the California public employees pension system Calpers for $125 million.
In the court skirmishes since the suit was filed, Standard and Poor's claimed in court filings that the suit was retaliation for S&P downgrading United States government debt from AAA in 2011 following the showdown over the debt ceiling.
Today's resolution included no claims of retaliation nor an admission that S&P violated the law. The payout, however, is unprecedented for a suit against a ratings agency. S&P, alongside Moody's and Fitch, is one of three large ratings agencies that provides grades to most bonds.
Attorney General Eric Holder said some of the company's ratings were not "independent" as advertised, but instead were given to increase the company's business from the issuers of financial products based on mortgages, a booming industry before the financial crisis ground it to a halt.
Holder said the ratings agency "knowingly issued inflated credit ratings for CDOs [complex products based on contracts that pay out when a bond defaults] that misrepresented their credit worthiness and understated their risks."
Holder also said that the Justice Department's investigation had uncovered S&P's employees saying that the company declined to downgrade some financial products because the company was "worried that it would damage S&P's business."
McGraw Hill Financial, S&P's parent company, said in a statement that it had settled the suit "to avoid the delay, uncertainty, inconvenience, and expense of further litigation." Half of the $1.375 billion will go to the federal government, while the other half will go to 19 states and the District of Columbia, which also filed suits against the ratings agency.
While S&P did not plead guilty, it did agree to a "statement of facts" where S&P admitted to many of the claims that the Justice Department made in its suit filed in February, 2013.
In the run-up to the financial crisis, hundreds of billions worth of bonds and securities based on home mortgages received ratings indicating they were safe investments unlikely to default. When the housing market collapsed, the bonds went into default and ended up causing hundreds of billions of losses for banks, credit unions, insurance companies, and other investors.
The Justice Department claimed in its suit that banks that were insured by the federal government relied on ratings for the securities in deciding to buy them and that S&P had not followed its own ratings criteria in order to win business from the banks issuing the bonds.
Ratings agencies are typically paid by the issuers of bonds even though the ratings are relied upon by purchasers. The Justice Department claimed that S&P had ignored its own data about the housing market and the riskiness of the bonds and other securities in order to win more ratings business.
The Wall Street Journal reported that the Justice Department lowered its settlement figure and dropped its demand that S&P admit to violating the law, while S&P agreed to take back its claim that it had been retaliated against for the downgrade.
So far, S&P is the only ratings agency to face a major Justice Department suit over its behavior in the financial crisis, despite the fact that all three agencies turned out to be grievously wrong about the quality of many of the mortgage-based products they were rating. Associate Attorney General Stuart Delery wouldn't comment on whether the Justice Department was investigating the other two major ratings agencies, when asked in a press conference, but did say the Justice Department was still looking into cases connected with the financial crisis.
In a court filing, the chairman of McGraw Hill, Harold W. McGraw III, claimed that then-Treasury Secretary Tim Geithner told him after the August 2011 downgrade that S&P's behavior would be "looked at very carefully." Justice Department lawyers argued in court that the investigation had started almost two years before the downgrade and that there was no connection between the two. Geithner denied he had ever threatened S&P with retaliation. Delery said S&P's claim that it was the victim of retaliation was part of a "fishing expedition" and that S&P would withdraw that claim in a legal filing.
This piece has been updated with comments from Justice Department officials.