As we reported in a previous posting, on February 4, the Civil Division of the United States Department of Justice filed a civil lawsuit against The McGraw-Hill Companies and Standard & Poor’s Financial Services LLC in federal court in California. No other companies are named as defendants in the case nor are there any individuals who have been named as defendants. The case was brought under the Financial Institutions Reform Recovery and Enforcement Act of 1989, known as the FIRREA statute. This is a federal statute that permits the Department of Justice to seek civil penalties if it can establish that violations occurred of a number of other statutes and that the violations affected a federally insured financial institution.

Following the announcement of the DOJ lawsuit, 13 additional states and the District of Columbia filed lawsuits against McGraw-Hill and S&P. These losses generally follow the pattern of the lawsuits that were already pending in Connecticut, Illinois and Mississippi, although there are some differences among them.  One state, California, is suing for losses incurred by 2 state pension funds under a statute, the California False Claims Act, which potentially allows for treble damages. The lawsuits in Connecticut and Mississippi were brought against both S&P and Moody’s. It is possible that additional states will file similar lawsuits.  Generally speaking, these cases are being brought under each state’s consumer protection law and focus on S&P’s statements regarding the independence and objectivity of its ratings practices.

Standard & Poor’s says civil lawsuit threatened by the Department of Justice (DOJ) is without legal merit and unjustified and it will vigorously defend against erroneous claims regarding U.S. CDO ratings from 2007.  The civil suit seeks damages of US$15 billion, essentially the same amount McGraw-Hill alleged to have earned on the rated debt instruments.  S&P’s stated that the income from these debt instruments did not exceed US$15 million.

One wonders why the DOJ waited more than five years to contemplate legal action at a point when most legal cases against the ratings agencies have been dismissed.  In essence the DOJ is now blaming the rating agencies for the subprime credit crunch and not other institutions who were involved in the value chain of creating CDOs.

While Moody’s is not part of the civil suit it is widely expected that if the DOJ wins its case Moody’s and Fitch will be next.   It will be difficult for the DOJ to prove intent to defraud investors.  An audit by the SEC stated that the ratings agencies may have been sloppy in executing ratings of CDOs but accusing them of deliberate fraud is tantamount of overshooting the mark.  Perhaps the downgrading of the sovereign debt US may have been the main reason for attempting to punish S&P.

The news made headlines in major media across the globe.  Investors were rattled by the news and the shares of McGraw-Hill and Moody’s lost billions in shareholder values.

To read the comments of Kenneth M. Vittor – Executive Vice President and General Counsel at the McGraw-Hill Companies’ 2012 Earnings Conference Call (February 12, 2013) please click on this link:  004 MGraw-Hill DOJ legal action