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N.J. Accuses Standard & Poor’s of Fraud

NEWARK, N.J. (CN) - New Jersey accuses Standard and Poor's of fraud in a lawsuit the claims the ratings agency "failed to disclose that it was allowing its desire for revenue and market share to influence and undermine the integrity of the analytical models that it used to evaluate the risk of and to issue ratings on structured finance securities."

Acting Attorney General John J. Hoffman sued Standard & Poor's Financial Services and McGraw Hill Financial in Essex County Chancery Court.

New Jersey's lawsuit follows a slew of legal complaints against the financial giant, including one filed in February by the federal government.

New Jersey is the 19th state to claim in court that the bond-rating company defrauded the public by not disclosing its own financial interest in the securities it ranked.

New Jersey says that its lawsuit "does not challenge S&P's judgment or opinion regarding which rating to apply to any specific structured finance security. Nor is this action brought for the purpose of demonstrating that any particular rating was incorrect." Instead, the state says, "S&P violated the CFA [Consumer Fraud Act] by misrepresenting that it was at all times independent and objective."

New Jersey claims that Standard & Poor's violated the Consumer Fraud Act "by failing to disclose that S&P's desire to maximize its revenues and market share caused it to utilize issuer-friendly analytical models, as well as to provide insufficient monitoring of the instruments that it had already rated."

In its 37-page complaint, the state cites S&P's ranking of collateralized debt obligation (CDOs) and residential mortgage-backed securities (RMBS). It claims that "as the volume of RMBS and CDO offerings increased, so did the opportunity for S&P to derive significant fees for issuing such favorable ratings on these securities."

"For S&P to capitalize on these revenue-driven opportunities, it channeled its efforts on pleasing this relatively small group of investment banks and financial institutions that issued structured finance securities and were repeat customers of S&P, thus allowing S&P to avoid the risk of losing the business of these issuers in the future. ...

"Rather than maintain its independence and objectivity when rating structured finance securities, S&P opted to cater to a small group of repeat issuers who pay S&P to rate their securities. As a result, when S&P rated structured finance securities, S&P allowed its credit analytics to be unduly influenced by the very market share and revenue considerations that its public statements consistently and explicitly disavowed."

The state claims that from 2001 to 2008 S&P used an outdated model to assign ratings to RMBS securities and that this decision, which "ignored the potential risk of default and delinquency in the loan pools underlying RMBSs, was motivated by S&P's desire to continue to assign its 'AAA' ratings with minimal credit enhancement, which issuers coveted, thus preserving S&P's market share and earning much more revenue for the company."

New Jersey adds: "Prior to 2008, S&P performed only a sporadic and cursory review of its RMBS ratings and did not use the best surveillance tools that were at its disposal."

It claims that "S&P knew that there was very little profit in diligently monitoring the performance of previously rated RMBS because S&P had already been paid its fee and issuers continued to want only AAA ratings."

Standard & Poor's spokesman Edward Sweeney said the company will fight the lawsuit. Sweeney said in a statement: "New Jersey and other states have filed meritless civil lawsuits against S&P challenging our ratings on structured finance securities. The claims are simply not true and we will vigorously defend S&P against them."

New Jersey seeks damages for fraud and misrepresentation.

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