Attorney General Eric Holder accused credit rater Standard & Poor's on Tuesday of "egregious" and fraudulent conduct as the federal government and several states brought civil charges against the firm.
Holder said S&P’s actions were at the “very heart” of the financial crisis and accused the firm of placing its own profits ahead of investors’ interests by “knowingly issuing inflated credit ratings” for risky mortgage securities.
"S&P misled investors, including many federally insured financial institutions, causing them to lose billions of dollars," Holder said.
Credit raters typically are paid by the issuer seeking the rating, leading some to argue there is implicit pressure to provide high ratings to paying customers. Holder said S&P tossed aside its role as an honest broker in pursuit of higher earnings.
"We allege that S&P falsely claimed that its ratings were independent, objective, and not influenced by the company’s relationship with the issuers who hired S&P to rate the securities in question – when, in reality, the ratings were affected by significant conflicts of interest, and S&P was driven by its desire to increase its profits and market share to favor the interests of issuers over investors," Holder said.
Justice is seeking civil penalties against S&P equal to the losses suffered by federally insured financial institutions. So far, $5 billion in losses have been identified from collateralized debt obligations (CDO) S&P rated between March and October 2007 — a stretch when "nearly every" mortgage-backed CDO rated by S&P ended up failing.
The charges are the first that the government has brought against a credit rating agency, which have been harshly criticized for their role in the financial crisis. Policymakers argue inflated ratings on complex financial products gave investors a false sense of security and failed to reflect the risk they really posed.
Holder contended that S&P's internal data showed "severe deterioration" in these types of financial products as early as 2007, but the firm continued to rate "hundreds of billions of dollars' worth" even as analysts project they would not perform as advertised.
In a statement Monday, S&P acknowledged that it missed the mark in many of its ratings before the crisis, but said a suit would be "entirely without factual or legal merit."
The rating agency contended that, while many of its ratings at the time were too high, it acted quickly to lower those ratings to a more appropriate level, and was the first among raters to take steps to require tougher standards on mortgage products receiving an "AAA" rating.
"S&P deeply regrets that our CDO ratings failed to fully anticipate the rapidly deteriorating conditions in the U.S. mortgage market during that tumultuous time," the agency said. "However, we did take extensive rating actions in 2007.”
Charges have not been filed against fellow raters Moody's Investors Service and Fitch Ratings. S&P became the first rater to downgrade the U.S. credit rating following the debt limit fight during the summer of 2011.
On Tuesday, Floyd Abrams, the lead attorney for S&P, told CNBC that the intensity of the government's investigation against the rater "significantly increased" following that downgrade.
State attorneys general from 13 other states and the District of Columbia have signed on to the lawsuit, which is being filed against S&P as well as its parent company, McGraw-Hill.