Standard & Poor’s Financial Services and its parent company McGraw Hill Financial reached a $1.375 billion settlement today with the Department of Justice, along with 19 states and the District of Columbia, for engaging in a scheme to defraud investors in structured financial products.

S&P will pay $687.5 million to the federal government—the largest penalty ever recovered by a ratings agency. The remaining $687.5 million will be divided among the 19 states and the District of Columbia.

The settlement resolves an investigation launched by the Justice Department in 2009, resulting in a lawsuit that the government filed nearly two years ago. The lawsuit alleged that, from at least 2004 until 2007, S&P engaged in a scheme to defraud investors by knowingly issuing inflated credit ratings for collateralized debt obligations (CDOs) that misrepresented their creditworthiness and understated their risks. 

“At the time, S&P claimed that its ratings were independent, objective, and not influenced by the company’s relationship with the issuers who hired S&P to rate the securities in question,” said Attorney General Eric Holder in a statement. “In reality, the ratings were affected by significant conflicts of interest, and S&P was driven by its desire for increased profits and market share to favor the interests of issuers over investors."

Several elements make up the settlement agreement. “As part of the resolution, S&P admitted facts demonstrating that it misrepresented itself to investors and the public, allowing the pursuit of profits to bias its ratings,” said Acting Associate Attorney General Stuart Delery.

S&P maintained and continued to issue positive ratings on securities, despite a growing awareness of quality problems with those securities. “On more than one occasion, the company’s leadership ignored senior analysts who warned that the company had given top ratings to financial products that were failing to perform as advertised,” said Holder. “As S&P admits under this settlement, company executives complained that the company declined to downgrade underperforming assets because it was worried that doing so would hurt the company’s business."

Statement of Facts

In its agreed statement of facts, S&P admitted that:

S&P promised investors at all relevant times that its ratings must be independent and objective and must not be affected by any existing or potential business relationship;

 

S&P executives have admitted, despite its representations, that decisions about the testing and rollout of updates to S&P’s model for rating CDOs were made, at least in part, based on the effect that any update would have on S&P’s business relationship with issuers;

 

Relevant people within S&P knew in 2007 many loans in RMBS transactions S&P were rating were delinquent and that losses were probable;

 

S&P representatives continued to issue and confirm positive ratings without adjustments to reflect the negative rating actions that it expected would come.

S&P further agreed to formally retract its unsubstantiated claim that the United States initiated the lawsuit in retaliation for S&P’s 2011 decisions on the credit rating of the U.S. government.

Thirdly, S&P has agreed to comply with the consumer protection statutes of each of the settling states and the District of Columbia. It further agrees to respond, in good faith, to requests from any of the states and the District of Columbia for information or material concerning any possible violation of those laws.

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