The Department of Justice has filed a civil lawsuit against Standard and Poors alleging that S&P engaged in a scheme to defraud investors in structured financial products known as Residential Mortgage-Backed Securities (RMBS) and Collateralized Debt Obligations (CDOs).

The lawsuit alleges that investors, many of them federally insured financial institutions, lost billions of dollars on CDOs for which S&P issued inflated ratings that misrepresented the securities’ true credit risks.

The complaint also alleges 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.

S&P along with other rating agencies Moodys and Fitch were an integral part of the 2008 financial crisis. The rating agencies were supposed to provide sound analysis of the mortgage securities they were reviewing but instead, as alleged in the DOJ complaint, cut corners and ignored due diligence in order to secure fees from the Wall Street banks. Due to the complicity of the rating agencies, the toxic composition of the assets was never properly evaluated or disclosed sowing the financial markets with financial time bombs that upon detonation brought the global economy to its knees.

Critics of the suit are focusing on the timing and who is included or rather excluded from the suit. Some are claiming the S&P suit is vengeance for the firm downgrading US debt with others highlight that the vengeance has a dash of intimidation mixed in as other rating firms evaluate American credit during the sequestration debate.

The U.S. is heading into another round of brutal budget debate that created a meaningful threat of yet another credit downgrade. In an ideal world of due process, the DOJ suit wouldn’t have an impact on the chances of a reduction in the US rating. In the real world, the suit may reduce the likelihood of an agency taking a stance against the U.S.

Regardless of the motivation, the suit clearly has merit. S&P’s ratings were proven incorrect and there seems to be an email trail establishing they knew they were incorrect but wanted the money. S&P’s lawyers are claiming their poor ratings are protected under free speech, unfortunately for them committing fraud is not.

 Photo by Brendel under Creative Commons License