LOS ANGELES A federal judge today rejected claims by Standard & Poor’s that its boasts of its ratings impartiality were nothing more than public relations “puffery” aimed at but not to be relied on by investors like WesCorp FCU and Eastern Financial Florida CU to buy what turned out to be billions of dollars of faulty mortgage-backed securities that led to their failures.
S&P, which rated the fated investments bought by WesCorp, Eastern Financial and others, has said statements about the integrity of its ratings are "puffery" that cannot be a basis for the fraud lawsuit, filed on February 4 by the Department of Justice.
But the Judge emphatically disagrees.
“Defendants lead off with a proposition that is deeply and unavoidably troubling when you take a moment to consider its implications,” wrote Judge David Carter, in denying an S&P motion to dismiss the suit brought by the U.S. Justice Department.
“They claim that, out of all the public statements that S&P made to investors, issuers, regulators, and legislators regarding the company’s procedures for providing objective, data-based credit ratings that were unaffected by potential conflicts of interest, not one statement should have been relied upon by investors, issuers, regulators, or legislators who needed to be able to count on objective, data-based credit ratings,” he wrote.
“Defendants correctly note that a “general, subjective claim about a product is nonactionable puffery,” wrote the judge, in ruling the government may proceed with its $5 billion lawsuit accusing S&P of misleading investors.
In a written decision, the judge said the government could pursue claims that S&P manipulated ratings to boost profit, and in doing so, concealed credit risks and conflicts of interest.
Judge Carter said in his 18-page ruling the Justice Department has provided sufficient evidence to argue an intent to defraud investors like WesCorp, the one-time $34 billion corporate, and Eastern Financial, a $2.4 billion Miami credit union, both of which were taken over by NCUA in 2009.
“S&P might disagree with the government’s version of these facts, but the opportunity to challenge such factual allegations comes later in the litigation process,” wrote the judge, sitting in U.S. District Court for the Southern District of California, where WesCorp was based.
The Justice Department has sued S&P under the 1989 S&L bailout law known as the Financial Institutions Reform, Recovery and Enforcement Act, or FIRREA.
In its suit, the Justice Department claimed that S&P knew that an alleged scheme to defraud by issuers of the collateralized debt obligations, or CDOs, would result in the rating agency earning lucrative fees from investors who were fooled by their ratings. S&P, according to the Justice Department, knew, the costs of those fees “were passed through to the investors who purchased CDO tranches.” They allege the motive for doing so was “to maintain and increase its share of the market for credit ratings of RMBS and CDOs and the high fees and profits those ratings generated,”
CDOs are mortgage-backed securities constructed of other mortgage-backed securities.
WesCorp lost almost all of its $609 million investment in CDOs, making up the brunt of its $1.2 billion of losses in 2009. Projected losses on the corporate credit union failure are as much as $7 billion.
Eastern Financial was taken over by NCUA after it lost 99%l of its $150 million investments in CDOs, making it the biggest natural person credit union failure ever. Space Coast CU, which acquired the remnants of the failure, is suing several Wall Street banks over the sale of the CDOs. The Space Coast CU suits cite some of the same deals included in the Justice Department suit.
WesCorp and Eastern Financial were the only two credit unions authorized by regulators to purchase CDOs.