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Study Brings Standard and Poors Credibility in Question

For decades, S&P and its chief competitor, Moody’s Investors Service (MCO), benefited from the government’s blessing as arbiters of creditworthiness. Two attempts by Congress to rein in the raters and probes by a Senate committee and the Financial Crisis Inquiry Commission didn’t change that. Now, the world’s largest ratings firm stands accused of violating its own standards at a moment when judgments free of bias might have reduced economic pain.

The Justice Department lawsuit, congressional records and interviews with former S&P employees provide a road map showing how the firm allegedly lost its way by stifling internal dissent, misleading regulators and accommodating issuers at the expense of investors. The first government fraud case involving a ratings company might set the stage for rule changes that S&P helped block in the past.

A finding against S&P “could be an explosive wake-up call that propels financial reform back to the top of the nation’s agenda, where it belongs,” said Dennis M. Kelleher, chief executive officer of Better Markets Inc., a Washington-based watchdog group, and a former partner at law firm Skadden Arps Slate Meagher & Flom LLP. “Regulators may finally stop listening to Wall Street lobbyists and pass rules to protect taxpayers from reckless and risky.

The 119-page government complaint alleges that S&P repeatedly “adjusted and delayed” improvements to its analytical models and “knowingly disregarded the true extent of the credit risks” associated with the CDO investments it rated.

John M. Griffin, a University of Texas finance professor, independently analyzed S&P’s main quantitative model, the CDO Evaluator, which the lawsuit says determined “whether the pool of assets could support the deal’s proposed structure.”

Griffin found that on 916 deals issued for $612.8 billion between January 1997 and March 2007, S&P expanded the AAA rated slices by an average of 12.2 percent beyond what the model specified, according to an article he wrote with University of Hong Kong professor Dragon Yongjun Tang and published in August in the Journal of Finance.
S&P spokesman Ryan Sweeney said Griffin’s research was “fundamentally flawed” because it’s based on only one model used by S&P and excludes other components of the ratings process, including a proprietary cash-flow analysis.

“It presents an incomplete and inaccurate description of S&P’s process for rating” the investments, Sweeney said.

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