February 7, 2015

Feds and 19 States Obtain $1.375 Billion Settlement with S&P

Resolving allegations that S&P had engaged in a scheme to defraud investors in real-estate focused financial products, Eric Holder announced a $1.375 billion settlement between Standard & Poor and the DOJ and 19 states. This settlement is among other civil and criminal prosecutions the DOJ pursued against a variety of businesses and individuals whose collective actions arguably led to the financial crisis.  The S&P lawsuits alleged that investors incurred substantial losses on Residential Mortgage-Backed Securities and Collateralized Debt Obligations for which S&P issued inflated ratings that misrepresented credit risks.  The suits also alleged that S&P falsely represented that its ratings were objective, independent and uninfluenced by S&P’s business relationships with the investment banks that issued the securities.  As part of the settlement, S&P admitted its ratings were affected by business concerns.  As stated in the DOJ press release:

Half of the $1.375 billion payment – or $687.5 million – constitutes a penalty to be paid to the federal government and is 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.  The allocation among the states and the District of Columbia reflects an agreement between the states on the distribution of that money.

In its agreed statement of facts, S&P admits 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. 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.

S&P had alleged that the suits were retaliation for its lower credit rating given to the US in 2011, but, according to the release, will formally retract that claim.  More on the settlement can be found in the original press release.

Bills and a Piggy Bank