Landmark S&P Lawsuits Mark Improved State-Fed Relations

The lawsuits, which are the first against a credit ratings agency in connection with the economic meltdown, were a coordinated effort between states and feds who have historically clashed over who fights financial fraud.
by | February 11, 2013
 

State attorneys general got a gift a few weeks back: a landmark case against the country’s largest credit ratings agency, wrapped in a pretty bow and all but literally dropped at their doorstep.

That is, in essence, how the collaboration began between state AGs and the U.S. Department of Justice (DOJ) in their pursuit of Standard & Poor’s. The lawsuits filed last week are the first -- and some think they will be the only -- to be filed against a ratings agency in connection with the 2008 financial crisis.

The suits allege that S&P misrepresented its investment analysis services as being “objective, independent and not influenced by its own or its clients’ financial interests.” Citing internal memos and emails to build its case, the DOJ alleges that the New York-based ratings agency was motivated by profit to give mortgage-backed bonds favorable ratings. Federal investigators say those misrepresentations contributed to more than $5 billion in losses to institutional investors from bonds rated between March and October 2007 -- the period just before the financial crisis.

S&P denies the claims, calling the lawsuits without “factual or legal merit.”

Bennett Rushkoff, head of the D.C. Attorney General's Public Advocacy Section, said in nearly 20 years in government, it was the first time he’d seen such a level of information sharing from his federal counterparts.

“The DOJ conducted an incredibly extensive, resource-intensive, thorough investigation and presented the results of that investigation to the states and [Washington], D.C. on a silver platter,” he told Governing. “All we had to do was see if the facts were sustained under D.C. law, which they were.”

Thanks to the U.S. Department of Justice's information sharing, the District of Columbia and 14 states joined the federal government in filing lawsuits against S&P. Although three other states (Connecticut, Mississippi and Illinois) had previously filed suit in prior years, the coordinated effort in recent weeks signals an improved partnership between states and feds.

As detailed in a recent Governing feature, state AGs and some federal agencies have historically clashed over who will fight financial fraud. One battle that left some states particularly sore occurred during the mid-2000s when several state attorneys general initiated actions against predatory and misleading loans and mortgages. The federal Office of the Comptroller of the Currency (OCC), however, put up a brick wall, claiming the states didn't have the authority to proceed. The issue stalled and the practices in question ended up having a major hand in the massive number of foreclosures that marked the start of the financial crisis.

But there are signs -- the S&P lawsuit being the latest -- that the relationship is improving. For example, 49 states and the federal government struck a historic, $25 billion agreement with the nation’s five largest mortgage servicers last year to help struggling homeowners. (Oklahoma settled its case separately.) The joint agreement was partly a result of enforcement efforts by the Financial Fraud Enforcement Task Force established by President Barack Obama in 2012. The task force’s aim is to wage an aggressive and coordinated effort to investigate and prosecute financial crimes.

Still, the seemingly more united relationship between states and federal prosecutors has its limits. For one, Connecticut, Mississippi and Illinois acted against S&P before the U.S. government did, filing their own lawsuits years before federal investigators were ready with theirs. Mississippi's lawsuit, filed in 2011, is still in the discovery stage of litigation. Meanwhile, in Connecticut and Illinois, S&P unsuccesfully attempted to have both cases thrown out.

Justin Marlowe, a Governing contributor and public affairs professor at the University of Washington, said the coordination this month with the S&P suits is likely unique to the financial crisis.

“I think there’s a concerted effort on the part of the government to make sure there’s some accountability,” he said. “There haven’t really been any high-profile prosecutions … of people directly involved in facilitating the financial crisis. I think this is an opportunity to do something very clear, very visible.” Marlowe also noted that when it comes to finance law, a stronger case can be made at the federal level versus the state level.

“Every state has a small window and limited resources to pursue something like this, whereas if you’re S&P, you can pour resources to fight off a lawsuit in New Jersey or Nevada or wherever it may be,” he said. “Part of it is punch and whose laws have more teeth and part is as the government, you’re going to leverage a lot of sources to take on ratings agencies.”

Although some expect a settlement -- one that would break the previous record set by the national mortgage settlement -- others aren’t so sure. John Alan James, executive director of the Center for Global Governance, Reporting and Regulation at Pace University, says he wouldn’t be surprised to see S&P fight back based on its right to free speech. After all, he puts it, “the whole concept of the ratings agencies is on the line.”

“They have the right to give their opinion on anything they want, and therefore they can’t see anything in the law that’s felonious about stating your opinion,” James said. “In other words, let the buyer beware.”

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