* Federal, state actions contemplated against Moody's
* Connecticut case against Moody's proceeding to trial
* Lawyers say stronger paper trail exists against S&P
By Aruna Viswanatha and Luciana Lopez
Feb 7 The U.S. Justice Department and multiple
states are discussing also suing Moody's Corp for
defrauding investors, according to people familiar with the
matter, but any such move will likely wait until a similar
lawsuit against rival Standard and Poor's is tested in the
Inquiries into Moody's are in the early stages, largely
because state and federal authorities have dedicated more
resources to the S&P lawsuit, said the sources, who were not
authorized to speak publicly about enforcement discussions.
Moody's spokesman Michael Adler and Justice Department
spokeswoman Adora Andy declined to comment for this story.
Moody's in the past has defended itself against similar
allegations, including a 2011 congressional report that
concluded the major ratings agencies manipulated ratings to
The firm previously said Moody's takes the quality of its
ratings and the integrity of the ratings process very seriously.
It also said the firm has protections in place to separate the
commercial and analytical aspects of its business.
The U.S. Justice Department filed a $5 billion lawsuit
against S&P late on Monday and accused it of an egregious scheme
to defraud investors in the run-up to the financial crisis,
fueled by a desire to gain more business.
Shares of McGraw Hill Cos Inc, which owns S&P, have
fallen more than 25 percent since news of the lawsuits. Moody's
shares have fallen about 15 percent, even though it was not
named in any of this week's actions.
"Don't think Moody's is off the hook," said one law
Another rival, Fimalac SA's Fitch Ratings, is
unlikely to face similar action, the sources said, since it is a
much smaller player in the U.S. ratings industry. The firm also
escaped the brunt of scrutiny from congressional investigators.
In a sign of just how high-stakes the battle is, S&P hired
prominent defense attorney John Keker, who has represented
everyone from cyclist Lance Armstrong to Enron's Andrew Fastow.
S&P said in a statement on Tuesday that the lawsuit is
meritless and said it will vigorously defend itself.
A similar coordinated federal-state action against Moody's
would follow lawsuits two states have already filed against the
ratings firm. Connecticut, which led the states in this week's
actions, sued Moody's and S&P in March 2010.
In January a state court in Hartford denied the last of the
preliminary motions Moody's had filed to have the case thrown
out. That case and the one against S&P are proceeding to trial
in the second half of 2014.
Those earlier cases and the more recent ones against S&P are
based on a theory that the firms misled investors by stating
that their ratings on mortgage products were 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 two state cases against Moody's present evidence that is
similar to material in the complaints against S&P.
According to the Connecticut lawsuit, Moody's pledged in its
code of conduct that its ratings are "not ... affected by the
existence of, or potential for, a business relationship between
(Moody's) ... and the Issuer ..."
"This representation by Moody's was false and Moody's knew
it," the Connecticut complaint said.
In rating a collateralized debt obligation in 2006, for
example, the issuer of the deal resisted a rating a Moody's
analyst had determined by arguing that S&P had provided a more
favorable rating. Following an exchange with managers, the
analyst provided a recommendation that Moody's "reconsider the
previously committed loss coverage levels," the lawsuit said.
The lawsuit does not say whether the levels were changed.
Moody's has said the Connecticut lawsuit is "without merit".
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, led by Democratic Senator Carl Levin from
Michigan, detailed specific pressures at Moody's to keep
investment bank clients happy.
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.
"The fear was real, not rare and not at all healthy. You
began to hear of analysts, even whole groups of analysts, at
Moody's who had lost their jobs because they were doing their
jobs, identifying risks and describing them accurately," former
Moody's senior vice president Mark Froeba testified to the
Despite similar evidence against both companies, people with
knowledge of the rating agencies say authorities may have moved
first against S&P because of a stronger paper trail against it.
Richard Greenfield of Greenfield & Goodman, who was part of
a suit against Moody's with a settlement last year that included
governance reforms and $4.95 million, said looking at the
respective evidence, it does appear that there was more material
"Here you've got a very, very good paper trail with S&P," he
said. "If they are not totally smoking gun documents, they are
collectively smoking gun documents."
The paper trail is important because the kinds of documents
involved can help keep a judge from dismissing a case before it
gets to trial, said Hillary Sale, a securities law and corporate
governance expert and professor of law at Washington University
in St. Louis.
The government's complaint against S&P includes numerous
embarrassing emails, such as one in which an analyst parodies a
Talking Heads song "Burning Down the House" to reflect the
"boiling over" subprime market.
"When you have that kind of evidence that looks bad, you
don't want to dismiss the case until you have more discovery,"
Sale said. That kind of a paper trail "helps you survive a
motion to dismiss."
Legal experts say the type of activity described in the S&P
lawsuit does not appear isolated to that firm, and the S&P case
might simply be a prelude to more action.
"It may very well be that the government's testing their
waters and they don't want to bite off more than they can chew,"
said Philip Hilder of Hilder & Associates in Houston, a former
federal prosecutor. "Nobody should take these cases lightly."