Jessica M. Karmasek Feb. 6, 2013, 3:59pm

CHICAGO (Legal Newsline) -- A Chicago-based attorney contends a lawsuit brought by the U.S. Department of Justice against the nation's largest credit-ratings agency has "very little hope" of succeeding.

Hugh Totten of Valorem Law Group said Tuesday the lawsuit is merely being brought to the forefront as a means of justifying more than three years of investigation without "any tangible result."

In a suit filed in the U.S. District Court for the Central District of California late Monday, the Justice Department is accusing Standard & Poor's Rating Services, a subsidiary of The McGraw-Hill Companies Inc., of fraud.

The government's suit against S&P focuses on its ratings in 2007 of certain U.S. collateralized debt obligations, or CDOs, the ratings agency said in its own statement.

The DOJ contends in its suit that S&P inflated mortgage investment ratings and set them up for a crash.

In particular, the government claims that the agency -- from September 2004 through October 2007 -- "knowingly and with the intent to defraud, devised, participated in and executed a scheme to defraud investors" in certain mortgage-related securities.

It also claims S&P falsely represented that its ratings were "objective, independent, uninfluenced by any conflicts of interest."

The suit is the first significant federal action against the industry.

"Knowing that the ratings agencies have an airtight First Amendment defense to a typical claim, the Department of Justice has developed a workaround by attempting to claim 'fraud,' which gets around that defense, and violation of FIRREA which has been on the books for several decades and never used like this before," Totten said.

The Financial Institutions Reform, Recovery and Enforcement Act of 1989, or FIRREA, was enacted in the wake of the savings and loan crisis of the 1980s. It dramatically changed the savings and loan industry and its federal regulation, including deposit insurance.

Totten said proving fraud will require a showing that the corporation intended to lie about its ratings, and put the entire company at risk, in order to receive a small amount of additional revenue.

"Fraud requires certain proof, which is difficult to establish unless there is a whistleblower who is prepared to say he/she was part of a scheme with higher ups who also intended to defraud. The whole thing makes no sense," he explained.

Totten said the federal government is essentially claiming that S&P, and only S&P, failed to predict what would happen in the economy when, in fact, the ratings agency's opinion was shared by everyone else -- and everyone was wrong.

"If successful, the DOJ will likely bring down S&P in much the same way it brought down Arthur Anderson -- by blaming a tangential player for the entire country's woes and putting tens of thousands of people out of work," he said.

"Instead, the DOJ should be going after the people who sold the bad investments. It, however, appears this suit is purely political."

In a statement late Monday, S&P called the DOJ suit "entirely without factual or legal merit," saying it disregards the "central facts" that it reviewed the same subprime mortgage data as the rest of the market -- including, it says, U.S. government officials who in 2007 publicly stated that problems in the subprime market appeared to be contained -- and that every CDO that the DOJ has cited to the agency also independently received the same rating from another rating agency.

"S&P deeply regrets that our CDO ratings failed to fully anticipate the rapidly deteriorating conditions in the U.S. mortgage market during that tumultuous time," the agency said. "However, we did take extensive rating actions in 2007 -- ahead of other ratings agencies -- on the residential mortgage-backed securities (RMBS), which were included in these CDOs.

"As a result of these actions, more collateral or other protection was required to support AAA ratings on CDOs."

The agency added, "With 20/20 hindsight, these strong actions proved insufficient -- but they demonstrate that the DOJ would be wrong in contending that S&P ratings were motivated by commercial considerations and not issued in good faith."

Also joining the DOJ in suing the ratings agency are the attorneys general from California, Connecticut, Delaware, the District of Columbia, Illinois, Iowa and Mississippi, all of which have filed or plan to file civil fraud lawsuits against S&P alleging similar misconduct in the rating of structured financial products.

Additional state attorneys general were expected to make similar filings this week.

From Legal Newsline: Reach Jessica Karmasek by email at

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