The Department of Justice (“DOJ”) announced that it had reached a landmark $1.375 billion settlement with the rating agency Standard & Poor Financial Services LLC (“S&P”).  The settlement resolves claims brought by the DOJ in 2013 and 19 states that S&P defrauded investors in residential mortgage-backed securities (“MBS”) and collateralized debt obligations (“CDO”).  The lawsuits alleged that investors suffered financial losses because S&P issued inflated ratings on MBS and CDO and that S&P falsely represented that its ratings were uninfluenced by S&P’s business relationships with the investment banks that issued the securities.

According to a press release from the DOJ:

Half of the $1.375 billion payment – or $687.5 million – constitutes a penalty to be paid to the federal government and is the largest penalty of its type ever paid by a ratings agency.  The remaining $687.5 million will be divided among the 19 states and the District of Columbia.  The allocation among the states and the District of Columbia reflects an agreement between the states on the distribution of that money.

In its agreed statement of facts, S&P admits that its decisions on its rating models were affected by business concerns, and that, with an eye to business concerns, S&P maintained and continued to issue positive ratings on securities despite a growing awareness of quality problems with those securities. S&P acknowledges that:

  • S&P promised investors at all relevant times that its ratings must be independent and objective and must not be affected by any existing or potential business relationship;
  • S&P executives have admitted, despite its representations, that decisions about the testing and rollout of updates to S&P’s model for rating CDOs were made, at least in part, based on the effect that any update would have on S&P’s business relationship with issuers;
  • Relevant people within S&P knew in 2007 many loans in RMBS transactions S&P were rating were delinquent and that losses were probable;
  • S&P representatives continued to issue and confirm positive ratings without adjustments to reflect the negative rating actions that it expected would come.

Under the settlement agreement, S&P did not admit any wrongdoing or that it violated any laws.