CT Sues Credit Rating Agencies for Misleading Investors

Blumenthal said Moody’s and S&P’s alleged misconduct enabled the worst economic downturn in the nation since The Great Depression. In particular, an announcement from Blumenthal’s office said ratings on structured finance securities were tainted by the agencies’ desire to earn lucrative fees. 

Blumenthal alleges that Moody’s and S&P knowingly catered to the demands of investment banks and other large issuers of structured finance securities in order to increase their own revenues, and as a result, many structured finance securities that contained a great deal of credit risk undeservedly received Moody’s and S&P’s highest ratings.

According to the announcement, Blumenthal said Moody’s and S&P’s lack of independence and objectivity, violating the Connecticut Unfair Trade Practices Act, has manifested itself in several ways, including:

• In direct contrast to their public representations, and unbeknownst to investors and other market participants, Moody’s and S&P’s rating methodologies were directly influenced by a desire to please their clients and enhance their own revenue. Assessing actual credit risk was of secondary importance to revenue goals and winning new business.
• Issuers unhappy with a credit rating agency’s initial analysis can attempt to influence the process by informing the rating agency of a more desirable rating that one of its competitors is willing to assign. As a result, the rating agency knows that it must meet its competitor’s rating or forgo the revenue altogether. Both Moody’s and S&P knuckled under to this pressure and allowed it to influence the ratings they assigned to structured finance securities.
• Despite public representations of vigilant monitoring of conflicts of interest inherent to the Issuer Pays business model, Moody’s marginalized its own compliance departments and even punished employees who raised concerns about its lack of independence and objectivity. In some cases, compliance employees were given poor performance evaluations, less compensation and even demoted for interfering with Moody’s ability to please the large issuers of structured finance securities that paid the majority of Moody’s fees.

Blumenthal’s also has ongoing litigation against Moody’s, S&P, and Fitch that was filed in July 2008 and alleges that the agencies knowingly gave state, municipal and other public entities lower credit ratings as compared to other forms of debt with similar or even worse rates of default. Those cases remain pending.

Recently, a federal judge in New York threw out a lawsuit by two pension funds against Moody’s and S&P, agreeing with the agencies that they are not liable under the Securities Act of 1933 as either underwriters or sellers (see Judge Dismisses Ratings Agency Lawsuit). However, another federal judge in New York rebuffed efforts by the agencies to seek constitutional free speech protection for their evaluations of securities instruments (see Judge Rejects Free Speech Shield for Credit Raters).

The agencies face several lawsuits by public pension funds (see Ohio AG Sues Rating Agencies), including CalPERS, and are the subject of discussions about financial reform (see CO PERA Wants Increased Oversight of Rating Agencies).