|TRENTON – Acting Attorney General John J. Hoffman and the Division of Law announced today that the State has filed a lawsuit against Standard & Poor’s Financial Services, LLC charging that the company misled consumers about the independence and objectivity of its ratings services and, for self-serving reasons, used outdated analytic models to maximize market share and profits.
Filed today in New Jersey Superior Court in Essex County, the State’s lawsuit charges Standard & Poor’s, as well as its parent firm McGraw Hill Financial, Inc., with three counts of violating the New Jersey Consumer Fraud Act.
The suit alleges that Standard & Poor’s harmed New Jersey consumers by claiming to be an independent source of analysis on complex investments known as structured finance securities when, in fact, its ratings of those securities were driven by the company’s own revenue goals, as well as favoritism toward investment banking clients who issued the securities and who paid Standard & Poor’s related fees.
“The independence and objectivity of Standard and Poor’s is of critical importance to New Jersey consumers, who placed their trust in the company’s supposedly objective analysis,” said Acting Attorney General Hoffman. “Our lawsuit alleges that this trust was misplaced, because Standard & Poor’s was not providing independent investor information, but instead acting in its own business interests, and in the interests of favored clients whose fees provided the company with a significant revenue stream.”
The State’s lawsuit alleges that Standard & Poor’s “issuer-friendly” approach to securities analysis and rating was rooted in a fear of losing market share to competitors.
These competitive concerns not only undermined the integrity of the company’s ratings methodology, but caused it to be lax in monitoring the performance of structured finance securities it had already rated, the suit contends.
Structured finance securities are asset-backed securities, a financial product whose value is derived from the stream of revenue flowing from a pool of underlying assets. These securities are in turn sold to investors who rely on the revenue stream generated by the underlying asset pool for repayment of the investors’ principal, as well as collection of interest. One common type of structured finance security rated by Standard & Poor’s is a residential mortgage backed security, which is secured by a pool of residential mortgages -- often including subprime mortgages -- that are packaged together.
“Structured finance securities are extremely complex in nature, and there is limited information available to the investing public about the underlying asset pools from which their value is derived. Standard & Poor’s deceptively advertised its ratings of these investments as the product of independent and objective analysis when that was not the case,” said Division of Law Director Christopher S. Porrino. “The company made these claims on its Web site, in its annual reports, in Congressional testimony, and in numerous other statements. Our position is that these representations were false, and that there is ample evidence to demonstrate just how misleading the claims were.”
The State’s lawsuit points out that the market for analyzing and rating structured finance securities is lucrative. Standard & Poor’s charges three or four times as much to analyze a structured finance security as it does to rate a corporate bond, according to the Complaint. The lawsuit also notes that, in 2006, Standard & Poor’s revenues rose approximately 15 percent – to $12.7 billion – largely on the basis of increased fees it collected from structured finance security ratings.
The State is represented in the Standard & Poor’s matter by Assistant Attorney General Brian McDonough, Deputy Attorney General Edward Mullins, and Special Deputy Attorneys General Steven Scutti and Krima Shah, all assigned to the Division of Law’s Affirmative Civil Enforcement Practice Group.