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State’s Consumer Protection Act key to forcing S&P settlement on bogus bond ratings

As he turns over $46 million in legal settlement money, Mississippi Attorney General Jim Hood says some state leaders want to limit his litigation options in order “to serve the special interest of big business.”

As he turns over $46 million in legal settlement money, Mississippi Attorney General Jim Hood says some state leaders want to limit his litigation options in order “to serve the special interest of big business.”

By TED CARTER

Mississippi’s Consumer Protection Act’s provision against making deceptive claims is credited as a key tool in extracting a $33 million settlement from Standard & Poor’s Ratings Service and parent McGraw-Hill Companies.

The settlement announced Feb. 3 is part of agreement by which S&P’s Rating Services turns over $1.375 billion to put the litigation behind it. The Justice Department gets half and the states split the rest.

Mississippi landed an $11.5 million bonus as a “Lead State” and the first to join Connecticut in contesting the objectivity of S&P ratings of mortgage held securities.

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The settlement represents more than a third of McGraw Hill’s yearly profits and more than a year’s profits for S&P, according to the Los Angeles Times.

A core claim is that a desire for lucrative fees from its investment bank clients influenced the credit rating agency’s independence and objectivity. “The same investment banks that issued these securities also paid S&P three or four times more to rate” mortgage-backed securities and collateral debt obligations “than traditional bonds,” Mississippi Attorney General Jim Hood said in an email reply to questions from the Mississippi Business Journal.

S&P admitted in a statement attached to the settlement that its ratings decisions were affected by business concerns, a fact it disputed two years ago when the lawsuit was filed, the LA Times reported.

The assigning of inflated credit ratings to toxic assets began in early 2001 and became particularly acute between 2004 and 2007, Hood said.

So-called “structured finance securities” backed by subprime mortgages are acknowledged to have been at the center of the financial crisis that began in 2008.

The litigation initiated by Hood and then-Connecticut AG Richard Blumenthal (now a U.S. senator) challenged the neutrality and truthfulness of ratings awarded to mortgage-backed securities by both S&P and Moody’s. The Moody’s litigation is continuing separately.

Mississippi and Connecticut initially fell short after a federal court upheld claims of the rating agencies that the First Amendment protected their negligent action. “They claimed they were just ‘puffing’ in the ratings and that ‘puffing’ was free speech,” Hood said in the email.

By 2010, it seemed the credit rating agencies were getting off scot free, Hood said. “This was something we wanted to change.”

In the meantime, Connecticut’s Blumenthal proposed that Hood team with him for a new challenge. The partnership led to the filing of a new suit in May 2011.

A year later, Illinois joined the suit. In 2013, the Justice Department and 17 other states joined. This, Hood said, “caused the case to settle much quicker.”

The legal claims of the case were under the Consumer Protection Act (CPA) for disgorgement and penalties, Hood said.

Disgorgement is a legal term for forcing a person or entity to return money wrongfully gained. In this instance, the suit sought to “disgorge S&P of its ill-gotten gains from the rating of mortgage-backed securities (MBS) and collateral debt obligations (CDO) derived from these MBS,” Hood said.

The suit argued that S&P violated Mississippi’s Consumer Protection Act by making deceptive statements that its business model with respect to mortgage-backed securities and certain collateral debt obligations was objective and independent.

“S&P knew this was not true,” Hood said.

If credit rating agencies such as S&P are lying when they say their business model is independent and objective, then “their services are worthless,” he added.

The agencies could puff up their claims about mortgage- backed securities, but they “had no right to mislead investors under the state CPAs,” Hood said.

At a Washington, DC, press conference announcing the settlement, Hood said the ratings agencies portrayed themselves as “pure as the driven snow…. You expected the banks to do some things slippery, but the credit rating agencies were supposed to be the ones we looked to.”

Likewise, U.S. Attorney General Eric Holder said that while awarding top ratings to undeserving investments “may have helped S&P avoid disappointing its clients, it did major harm to the larger economy, contributing to the worst financial crisis since the Great Depression.”

The action taken by Hood and the others did not seek to recover investment losses for institutional investors such as the Mississippi Employees Retirement System, or PERS, or individual investors, according to Hood. He emphasized the suit did not attack the ratings themselves, but instead focused “on the lie that S&P told to the public.”

Private securities’ fraud lawsuits against S&P for the same conduct have been largely unsuccessful, Hood said in his email reply.

Consequently, victims who “lost their homes, investors and our PERS are still suffering from the greed of the investment houses and the ratings agencies,” he said.

About Ted Carter

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