Connecticut Attorney General's Office
Attorney General Sues Credit Agencies For Tainted Ratings That Enabled Financial Meltdown
March 10, 2010
Attorney General Richard Blumenthal today sued two of the nation’s largest credit rating agencies -- Moody’s and Standard & Poor’s -- for knowingly assigning tainted credit ratings to risky investments backed by sub-prime loans.
Blumenthal said Moody’s and S&P’s alleged misconduct enabled the worst economic downturn in the nation since The Great Depression.
The lawsuits, unique and unlike others filed on behalf of specific investors or pension funds, are sovereign enforcement actions brought under the Connecticut Unfair Trade Practices Act.
Despite repeated statements emphasizing their independence and objectivity when rating structured finance securities, Moody’s and S&P knowingly failed to live up to their representations. In particular, their ratings on structured finance securities were tainted by their desire to earn lucrative fees.
Moody’s and S&P knowingly catered to the demands of investment banks and other large issuers of structured finance securities in order to increase their own revenues. As a result, many structured finance securities that contained a great deal of credit risk undeservedly received Moody’s and S&P’s highest ratings, Blumenthal alleges.
“These credit rating agencies gave the best ratings money could buy -- catering to their powerful investment bank clients, rather than objectively rating risky bonds,” Blumenthal said. “Countless investors and others -- including individuals, banks, mutual funds, insurance companies, hedge funds and pension funds -- were misled into believing that these credit ratings were independent and objective, and lost money on investments they might have avoided if told the truth.
“Moody’s and S&P violated public trust -- resulting in many investors purchasing securities that contained far more risk than anticipated and that have ultimately proven to be nearly worthless.
“The results have been catastrophic -- crippling the entire economy. Today’s lawsuit seeks an order stopping Moody’s and S&P from deceiving consumers, as well as civil penalties and disgorgement of ill-gotten profits.”
Structured finance securities have been the centerpiece of the national financial crisis. They are financial products whose value is derived from a stream of revenue flowing from a pool of underlying assets -- assets most commonly backed by residential mortgages, including subprime mortgages. They can also be backed by other assets such as student loans and credit card balances.
Moody’s and S&P dominate the ratings market for structured finance securities -- and are responsible for rating virtually all structured finance securities issued into the global capital markets.
Investors and other market participants rely on Moody’s and S&P to fulfill their stated promise of independence and objectivity.
In Moody’s own Best Practices Handbook, the company claims: “We serve investors by providing them with timely credit research and independent, thoughtful, and accurate rating opinions on which they can base their investment decisions.”
Both Moody’s and S&P have secretly defied their public promises and legal duty to provide independent and objective ratings, Blumenthal said.
This was not always the case. At one time, Moody’s and S&P refused payments from -- or even to meet with -- issuers of a security it rated. The companies’ business models have increasingly shifted, however, so that a vast majority of their fees are now paid by issuers.
As one of Moody’s former vice presidents publicly noted, “Starting in 2000 there was a systematic and aggressive strategy to replace a culture that was very conservative, an accuracy and quality oriented culture, a getting the rating right kind of culture, with a culture that was supposed to be business friendly but was consistently less likely to assign a rating that was tougher than our competitors.”
Blumenthal said Moody’s and S&P’s lack of independence and objectivity, violating the Connecticut Unfair Trade Practices Act, has manifested itself in several ways, including:
- Moody’s and S&P modified rating methodologies to make more money: In short, in direct contrast to their public representations, and unbeknownst to investors and other market participants, Moody’s and S&P’s rating methodologies were directly influenced by a desire to please their clients and enhance their own revenue. Assessing actual credit risk was of secondary importance to revenue goals and winning new business.
- Ratings shopping: Issuers unhappy with a credit rating agency’s initial analysis can attempt to influence the process by informing the rating agency of a more desirable rating that one of its competitors is willing to assign. As a result, the rating agency knows that it must meet its competitor’s rating or forgo the revenue altogether. Both Moody’s and S&P knuckled under to this pressure and allowed it to influence the ratings they assigned to structured finance securities.
- Despite public representations of vigilant monitoring of conflicts of interest inherent to the Issuer Pays business model, Moody’s marginalized its own compliance departments and even punished employees who raised concerns about its lack of independence and objectivity. In some cases, compliance employees were given poor performance evaluations, less compensation and even demoted for interfering with Moody’s ability to please the large issuers of structured finance securities that paid the majority of Moody’s fees.
Today’s action is distinct from Blumenthal’s ongoing litigation against all three credit rating agencies -- Moody’s, S&P and Fitch -- that was filed in July 2008.
The earlier lawsuits allege that the agencies knowingly gave state, municipal and other public entities lower credit ratings as compared to other forms of debt with similar or even worse rates of default. Those cases remain pending.
Blumenthal thanked members of his office who worked on the investigation – Assistant Attorneys General Matthew Budzik, George O’Connell and Laura Martella, and Paralegal Holly MacDonald, under the direction of Assistant Attorney General Michael Cole, Chief of the Attorney General’s Antitrust Department.
View Standard & Poor's Complaint - (PDF-8MB)
View Moody's Complaint - (PDF-3MB)