CHICAGO (CN) - The Illinois attorney general claims Standard & Poor's defrauded investors by systematically misrepresenting the credit analysis of structured finance securities.
"This lawsuit seeks redress for S&P's unfair, deceptive, and illegal business practice of systematically misrepresenting that its credit analysis of structured finance securities was objective, independent and not influenced by either S&P's or its clients' financial interests. These representations were untrue," Attorney General Lisa Madigan says in the 47-page complaint in Cook County Chancery Court.
The state sued Standard & Poor's Financial Services and its corporate parent, The McGraw-Hill Cos.
A structured security is an investment strategy based on derivatives, which packages stocks, commodities, options, debt issuance and/or foreign currency, among other financial products. Based on its research, Standard & Poor (S&P) rates the risk of such investments.
"S&P represents that its analysis of structured finance securities is independent and objective and the result of the highest quality credit analytics that are available to S&P," Madigan says. "Indeed, S&P's reputation for independence, objectivity and integrity is emphasized by S&P to the users of its ratings at nearly every turn."
Citing S&P's own Code of Professional Conduct, the complaint states: "'(I)t is a central tenet of [S&P] that its ratings decision not be influenced by the fact that S&P receives fees from issuers'. ... The S&P Code also assures consumers, shareholder, investors and regulators that S&P 'endeavors to conduct the rating and surveillance processes in a manner that is transparent and credible and that also maintains the integrity and independence of such processes in order to avoid any compromise by conflicts of interest, abuse of confidential information, or other undue influences.'" (Brackets in complaint.)
However, Madigan says: "(B)y at least 2001, S&P's desire to increase revenue and market share by rating as many structured finance deals as possible led S&P to ignore the increasing risks of structured finance securities to cater to the preferences of large investment banks and other repeat issuers of structured finance securities that dominated S&P's revenue base."
The complaint continues: "Although S&P's analysis was designed to satisfy the demands of repeat issuers, S&P represented that its analysis and rating of structured finance securities was independent, objective and, as stated in its Code of Conduct, 'not ... affected by the existence of, or potential for, a business relationship between [S&P] and the issuer ... or any other party, or the non-existence of any such relationship.' This representation by S&P was false.
"Since S&P allowed its compensation structure, desire for profits and fear of losing investment bank clients to taint the integrity of its supposedly independent credit analysis, S&P misrepresented the true nature of its services by advertising itself as objective and independent." (Brackets in complaint.)
Madigan specifically targets S&P's risk assessment of residential mortgage backed securities (RMBS) and collateralized debt obligations (CDOs), the sources of the subprime mortgage crisis of 2008.