LOS ANGELES (7/18/13)--A federal judge in Los Angeles has refused to dismiss the federal government's lawsuit against Standard & Poor's over S&P's ratings of residential mortgage backed securities (RMBS) and collateralized debt obligations (CDOs) prior to the nation's financial crisis.
U.S. District Judge David O. Carter Wednesday denied the motion to dismiss by S&P and its parent company, McGraw-Hill Cos. Inc., rejecting S&P's argument that investors should not have relied on any of its statements about the credit ratings because the statements were "non-actionable puffery" and were "couched in aspirational terms" not subject to fraud claims.
In the suit, the Department of Justice alleged that S&P committed fraud under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 by inflating the ratings it gave the RMBS and CDOs. Financial institutions--including Western Corporate FCU and a credit union--invested in those instruments and suffered losses. The losses resulted in liquidation.
In his 18-page opinion, Carter noted that "defendants lead off with a proposition that is deeply and unavoidably troubling when you take a moment to consider its implications. They claim that, out of all the public statements that S&P made to investors, issuers, regulators, and legislators regarding the company's procedures for providing objective, data-based credit ratings that were unaffected by potential conflicts of interest, not one statement should have been relied upon by investors, issuers, regulators, or legislators who needed to be able to count on objective, data-based credit ratings."
The opinion noted that the government argued that "S&P's statements were not a 'general, subjective claim' about the avoidance of conflicts of interest, but rather a promise that it had 'established policies and procedures to address the conflicts of interest through a combination of internal controls and disclosure.'"
"It is clear that the government's complaint identifies and describes in detail examples of the CDOs for which S&P is alleged to have issued or confirmed ratings that did not accurately reflect their true credit risks," Carter wrote. "More importantly, the government's complaint alleges, in detail, the ways in which none of S&P's credit ratings represented the thing that they were supposed to represent, which was an objective assessment of creditworthiness, because business considerations infected the entire ratings process."
The government also argued that S&P had clear knowledge that CDOs were backed by deteriorating RMBS.
"The government has satisfied the heightened pleading standard ...and sufficiently pleaded both objective falsity and subjective knowledge and intent..." the court said, adding it agreed with the Ninth Circuit Court ruling that money need not flow "directly to the defendant from the party deceived by the defendant."
"The court finds that the government has sufficiently pleaded the intent required to support its fraud claims. Any disputes over the veracity of these claims, or contested facts, are properly challenged at a later stage of litigation."
The Justice Department's complaint listed 76 CDOs as examples of investments that went bad, including 11 sold to WesCorp and 26 sold to Eastern Financial Florida CU. Other losses listed including Citibank, Bank of America, M&T Bank and First Midwest (News Now Feb. 6).