Acting Attorney General John J. Hoffman announced today that Standard & Poor’s Financial Services LLP and its parent company, McGraw Hill Financial, Inc., will pay the State $21.5 million as part of a global settlement resolving allegations that it violated state and federal laws by misleading consumers about its structured finance securities rating practices.
Under the global settlement, Standard and Poor’s will pay New Jersey, 18 other states, the District of Columbia and the U.S. Department of Justice a total of $1.375 billion to resolve the lawsuits filed against it. The settlement resolves allegations that Standard & Poor’s harmed consumers by falsely claiming to be an independent source of analysis on complex investments known as structured finance securities, when in fact its ratings of the securities were driven by its own revenue goals, as well as favoritism toward investment banking clients who issued the securities and paid the company related fees.
The market for analyzing and rating structured finance securities is lucrative. According to the State’s original lawsuit against Standard & Poor’s, filed in 2013, the company charges three or four times as much to analyze a structured finance security as it does to rate a corporate bond. In 2006, Standard & Poor’s revenues rose approximately 15 percent – to $12.7 billion – largely on the basis of increased fees it collected from structured finance security ratings.
“This is an important settlement for New Jersey consumers. Standard & Poor’s sought – and won – investor trust by assuring consumers its investment ratings and analysis were objective and unbiased, but that was not the case. In reality, the company acted on behalf of its own business interests, and in the interests of favored clients whose fees provided a substantial revenue stream,” said Acting Attorney General Hoffman.
“Businesses have a duty under the law to treat consumers fairly and provide them with accurate and reliable information,” Hoffman said. “Our commitment is to hold accountable any business that fails to do so.”
Attorneys from the Division of Law filed New Jersey’s lawsuit against Standard & Poor’s in Superior Court in Essex County in October 2013. The lawsuit charged McGraw Hill and Standard & Poor’s with three counts of violating the New Jersey Consumer Fraud Act. In December 2014, Division of Law attorneys successfully opposed a motion by the Standard & Poor’s to dismiss the complaint.
The State’s lawsuit alleged that Standard & Poor’s had an “issuer-friendly” approach to securities analysis and rating that was rooted in a fear of losing market share to competitors. Such competitive concerns undermined the integrity of the company’s ratings methodology, the complaint alleged, and also caused Standard & Poor’s to be lax in monitoring the performance of structured finance securities it had already rated.
A complex investment option with limited public information available about the underlying asset pools from which their value is derived, structured finance securities are asset-backed securities. The securities are sold to investors who rely on the revenue stream generated by the underlying asset pool for repayment of the investors’ principal, as well as collection of interest. Two types of structured finance securities rated by Standard & Poor’s are:
- Residential mortgage backed securities (RMBS), which are secured by a pool of residential mortgages — often including subprime mortgages — that are packaged together.
- Collateralized debt obligations (CDOs) comprised of multiple debt securities, such as RMBS and other CDOs.
Structures finance securities backed by subprime mortgages were at the center of the 2008 financial crisis. As part of the settlement announced today, Standard & Poor’s is admitting to certain improper conduct in an accompanying Statement of Facts. Standard & Poor’s also has agreed under the settlement not to violate the State’s consumer protection laws, and to be subject to enforcement action by the State if it does so. This latter aspect of the settlement is significant, because Standard & Poor’s has previously taken the position that its ratings activities are beyond the reach of individual state laws.
In addition to New Jersey, the U.S. Department of Justice, Arkansas, Arizona, California, Colorado, Connecticut, Delaware, the District of Columbia, Idaho, Illinois, Indiana, Iowa, Maine, Mississippi, Missouri, North Carolina, Pennsylvania, South Carolina, Tennessee and Washington are parties to the settlement.
New Jersey was represented in the Standard & Poor’s matter by Assistant Attorney General Brian F. McDonough of the Affirmative Civil Enforcement Practice Group, Deputy Attorney General Edward J. Mullins III of the Government & Healthcare Fraud Section, , Deputy Attorneys General Erin M. Greene and Lorraine K. Rak, Section Chief, of the Consumer Fraud Prosecution Section, and Special Deputy Attorneys General Nicholas Dolinsky, Roman Guzik, Joseph J. Maccarone and Jesse J. Sierant, all assigned to the Division of Law’s Affirmative Civil Enforcemt Practice Group. Division of Consumer Affairs Investigator Aziza Salikhov assisted in the matter.