A judge for the US District Court Central District of California [official website] on Tuesday denied [opinion, PDF] a motion by McGraw-Hill Companies and Standard & Poor's Financial Services (S&P) [corporate websites], a unit of McGraw Hill Financial, to dismiss a lawsuit brought by the US government. The five billion dollar lawsuit accuses S&P of misrepresenting the credit risk of complex financial products including residential mortgage backed securities (RMBS) [SEC backgrounder] and collateralized debt obligations (CDO) [CNN backgrounder]. According to the court opinion, under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) [text], the government seeks to obtain civil penalties for S&P's violations of three criminal fraud statutes: 18 USC § 1341 (mail fraud); 18 USC § 1343 (wire fraud); and 18 USC § 1344(1), (2) (financial institution fraud) [texts].
The US Department of Justice (DOJ) [official website] filed the lawsuit [complaint, PDF; JURIST report] in February. S&P assessed the credit risk of structured financial instruments, such as RMBSs and CDOs, and assigned securities with ratings that described the associated risk. The complaint alleges that these ratings were inflated when they were relied upon by investors including many federally insured financial institutions. Further, the DOJ alleged that "S&P falsely represented that its ratings were objective, independent, and uninfluenced by S&P's relationships with investment banks when, in actuality, S&P's desire for increased revenue and market share led it to favor the interests of these banks over investors." A key claim in the complaint is that the ratings are purchased by the institutions holding the securities under review, creating an alleged conflict of interest.