Reportedly seeking $1 billion in penalties, the Obama administration has selected Los Angeles as the venue for an ambitious legal effort to ascribe blame for the housing market collapse and the financial calamity that it triggered.
The Justice Department sued Standard & Poor’s Ratings Services in Los Angeles federal court late Monday, alleging the New York firm ignored its own standards when it rated mortgage bonds that subsequently imploded, costing investors billions.
Los Angeles was picked as the venue for the action in part because it is one of the regions hardest hit by the housing market collapse.
The civil suit, the first federal crackdown against a major credit rating service, relies on an untested legal approach.
S&P says the opinions it issues about financial products are protected under the 1st Amendment, but the argument could fail to sway if federal authorities can prove that analysts’ evaluations were motivated by financial considerations and not issued in good faith — something the company denies.
Prior to Monday’s filing, S&P and the Justice Department discussed a possible settlement for about four months, people close to the negotiations told The Wall Street Journal, but S&P balked over concerns that a deal could sink the company.
The government was seeking penalties of more than $1 billion, another person close to the talks told the Journal.
That would be the biggest sanction imposed on a firm related for its actions in the crisis.
S&P executives also were rattled that the government was pushing the company to admit wrongdoing, which could leave it vulnerable to other lawsuits, according to the Journal.
The government has been investigating for around three years whether S&P managers pushed to weaken company standards for rating mortgage-linked deals or ignored the standards entirely, people familiar with the probe told the Journal.
S&P said the government’s allegations stem from S&P’s rating of collateralized debt obligations issued in 2007 that included bundles of subprime mortgages.
The suit alleges that, from September 2004 through October 2007, S&P “knowingly and with the intent to defraud, devised, participated in, and executed a scheme to defraud investors in” collateralized debt obligations and securities backed by residential mortgages.
It says S&P “falsely represented that its credit ratings … were objective, independent, uninfluenced by any conflicts of interest … and represented S&P’s true current opinion regarding the credit risks” of the securities. In fact, S&P’s “desire for increased revenue and market share” prompted it to “downplay and disregard the true extent of the credit risks,” according to the suit.