[by Larry Goldfarb]

The Justice Department's attention is swinging to the rating agencies.  First the Justice Department initiated a law suit against Standard and Poor’s early last week.  The $5 billion lawsuit against S&P accused it of a scheme to defraud investors in the run-up to the financial crisis, fueled by a desire to gain more business.  Now, the Justice Department is discussing also suing Moody's Corp for defrauding investors.  Most analysts believe that any such move will likely wait until a similar lawsuit against rival Standard and Poor's is tested in the courts.

Like S&P which was sued by the state of Connecticut in 2010, Moody’s was sued by the state in January.  The S&P case is expected to go to court in 2014.  The case against S&P is based on a theory that the firm misled investors by stating that its ratings on mortgage products was  objective and not influenced by conflicts of interest.Instead, the lawsuits contend, the firms inflated ratings and understated risks as the housing bubble started to burst, driven by a desire to gain more business from the investment banks that issued mortgage securities.  Framing the cases in that manner steers clear of attacking individual ratings, which have largely been shielded under free speech protections. Instead, the focus is on proving false just one statement S&P made - that its ratings were objective.  The case against Moody’s is based on a similar theory.

A 2011 Congressional report on the causes of the financial crisis singled out both Moody's and S&P for blame, because their ratings made the risky mortgage-backed securities that were central to the crisis seem like safe investments.  The report from the Senate's permanent subcommittee on investigations detailed specific pressures at Moody's to keep investment bank clients happy.  For instance, managers were evaluated based on their ability to build market share, and former Moody's employees testified that employees were fired when they challenged senior management with a more conservative approach to rating the securities.

For more information, please read [Reuters, 2/7/13]