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Editor: Eric C. Chaffee
Univ. of Toledo College of Law

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Wednesday, March 10, 2010

Connecticut AG Sues Moody's and S&P, Alleging Tainted Credit Ratings for Risky Investments

Connecticut Attorney General Richard Blumenthal today sued Moody’s and Standard & Poor’s, alleging that they knowingly assigned tainted credit ratings to risky investments backed by sub-prime loans.  The lawsuits are sovereign enforcement actions brought under the Connecticut Unfair Trade Practices Act.  

According to the press release, Moody’s and S&P’s lack of independence and objectivity, violating the Connecticut Unfair Trade Practices Act, 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.

The Attorney General previously brought 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.

http://lawprofessors.typepad.com/securities/2010/03/connecticut-ag-sues-moodys-and-sp-alleging-tainted-credit-ratings-for-risky-investments.html

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