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Huge Settlements Between Standard and Poor’s (S&P), Government re: Pre-crisis Ratings of MBS and CDOs

2015 is leaving Standard and Poor’s (S&P) quite a bit poorer. Yesterday, the major credit rating agency agreed to pay $1.375 billion to resolve lawsuits brought against it by the U.S. Department of Justice and attorney generals from 19 states and the District of Columbia regarding S&P’s pre-crisis ratings of mortgage-backed securitizations (MBS) and collateralized debt obligations (CDO). Those lawsuits, the first of which were initiated in 2013, allege that between 2004 and 2007, S&P misrepresented the stringency and objectivity of its ratings—that those ratings were plagued by conflicts of interest that incentivized S&P to artificially inflate the ratings in order to appease the issuers that paid millions of dollars for its services. Consequently, a large number of the MBS and nearly every CDO rated by S&P at that time failed, creating billions of dollars-worth of investor losses.

The “Big Three” ratings agencies (S&P, Moody’s, and Fitch) who have taken considerable public fire for their perceived role in the 2008 mortgage crisis week’s settlements, had previously remained largely unscathed in connection with their activities from that period. The settlement announced this morning constitutes the biggest settlement ever paid by a credit ratings agency. It comes on the heels of the $125 million settlement S&P reached yesterday with the California Public Employees’ Retirement System over the allegedly inflated grades S&P assigned three structured investment vehicles comprised of CDOs, RMBS, and securitized home equity loans. The collapse of those vehicles in 2007 and 2008 cost their retiree investors approximately $1 billion.

And two weeks ago, S & P reached a $58 million settlement with the SEC, a $12 million settlement with the New York Attorney General’s office and a $7 million settlement with the Massachusetts Attorney General’s office, all to resolve what the SEC has referred to as “race to the bottom behavior” in S&P’s ratings activities. S&P also agreed to a one-year suspension from the lucrative U.S. conduit/fusion ratings sector, which involves securities backed by pools of at least 40 loans secured by commercial real estate.

The January settlements were prompted by three separate allegations of misconduct. The first, common to the investigations of the SEC, New York and Massachusetts, focused upon S&P’s 2011 ratings in connection with six U.S. conduit/fusion CMBS transactions, and preliminary ratings in connection with two additional transactions of the same kind. S&P allegedly misled investors about the ratings systems being applied to those transactions, secretly applying a much looser methodology than it purported to apply, inflating the ratings of the CMBS pools in question.

S&P pulled its ratings of these transactions several months later, prompting suspicion and official investigations into the matter. In 2012, in the wake of the incident, S&P attempted to redeem its credibility and gain market strength by replacing its ratings criteria with a more conservative system. S&P subsequently published a study, one that became the second prong of the SEC investigation, touting the virtues and steadfastness of its new criteria. The study theorized that a AAA-rated debt under the new system could withstand Great Depression Era-level economic stress. The SEC has chastised the study as “false and misleading,” saying that the study “relied on flawed and inappropriate assumptions and was based on data that was decades removed from the severe losses of the Great Depression.”

Finally, the third prong of the SEC investigation focused on breakdowns in S&P’s ratings surveillance of previously-rated RMBS between October of 2012 and June of 2014.

The SEC’s S&P investigations represented its first offensive against one of the “Big Three,” but according to a Wall Street Journal article published this Sunday, it looks like Moody’s is about to take a turn in the hot seat. Unlike the SEC’s investigation into S&P, the Moody’s investigation, which is still in its early stages, purportedly focuses upon the agency’s pre-crisis ratings activities.

© 2019 Bilzin Sumberg Baena Price & Axelrod LLP

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About this Author

Philip R. Stein, Complex Commercial Litigation Attorney Bilzin Sumberg, Law Firm
Partner

Philip R. Stein, a Partner in Bilzin Sumberg's Litigation Group, focuses his practice on complex commercial litigation. He regularly acts as lead counsel to mortgage companies, financial services companies, and large national homebuilders on a broad range of issues of importance to companies in those industries. Phil is currently devoting a substantial part of his practice to representing originators and sellers of mortgage loans throughout the country as they defend against loan repurchase claims made by banks and other investors. He also regularly assists companies...

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Shalia Sakona, LItigation Attorney, Bilzin Sumberg Law Firm
Associate

Shalia Sakona is an associate in the Litigation Group. Her practice is focused on complex commercial litigation, including the representation of sellers and originators of mortgage loans against major financial institutions in mortgage repurchase and indemnification suits throughout the U.S. 

While attending law school, Shalia interned with the general counsel of a commercial real estate investment and development company. She also served as a notes and comments editor for the Boston College International and Comparative Law Review

305-350-7216