Probe adds to rating firms' woes, Wall Street Journal reports

YEREVAN, February 8. /ARKA/. New York's top prosecutor has launched a probe into the conduct of the three major credit-ratings firms, according to a person familiar with the matter, opening another legal front for an industry that remains in the cross hairs of state and federal investigators.

New York Attorney General Eric Schneiderman this week subpoenaed Standard & Poor's Ratings Services and formally requested information from Moody's Investors Service MCO -1.05% and Fitch Ratings to examine ratings they issued in the run-up to the financial crisis, the person said. His office is investigating the ratings the three firms issued on mortgage-backed deals before the crisis, the person said.

However, it isn't clear if Mr. Schneiderman would be able to proceed with any legal action related to crisis-era ratings because of a 2008 agreement his predecessor made with the firms.

The state prosecutor's subpoena comes amid a spate of federal and state lawsuits that hit S&P this week.

The Justice Department late Monday sued S&P for the alleged $5 billion in losses suffered by the federally-backed banks and credit unions that relied on the firm's high ratings on mortgage-backed deals that later soured. S&P, a unit of McGraw-Hill Cos., MHP -1.79% has called the suits "meritless." 

Thirteen state attorneys general also filed lawsuits against S&P this week alleging the firm presented its ratings as based on objective and 

independent analysis but were actually inflated to cater to banking clients.

Unlike either the federal government or other state prosecutors, the New York attorney general would be able to sue under the state's Martin Act, which doesn't require prosecutors to prove a firm intended to defraud investors to win a case.

Moody's, like S&P, has been sued by several states and both are set to face a jury trial in May in a case filed by Abu Dhabi Commercial Bank and other institutional investors over financial losses based on ratings issued in advance of the crisis. The case will be heard in federal district court in New York. The firms have said they intend to fight the suits vigorously.

The SEC has a continuing investigation into S&P, according to people familiar with the matter. The SEC and Justice Department also have continuing probes into Moody's for its conduct in the financial crisis, the people said. Moody's is a unit of Moody's Corp.

Fitch, a unit of Fimalac SA FIM.FR +0.43% and Hearst Corp., has been largely overlooked by prosecutors. Spokesmen for Moody's and S&P declined 

to comment. Fitch didn't respond to requests for comment.

For Mr. Schneiderman to move forward, he has to prove that one or more of the credit-rating firms violated a 2008 agreement with his predecessor, Andrew Cuomo. Mr. Cuomo, a Democrat, is now governor of New York. 

In the June 2008 agreement, Mr. Cuomo agreed to "terminate" all current investigations of the firms and not "institute any action" against them, according to documents reviewed by The Wall Street Journal. That agreement lasted through 2011.

S&P, Moody's and Fitch didn't admit wrongdoing and agreed to work with the attorney general in his investigation of the mortgage industry, the documents show.

The "cooperation agreement" applied only to the firms' ratings on mortgage securities backed by subprime and other risky loans.

In return, the three ratings firms agreed to six "reforms" to the way they rated certain mortgage-backed deals.

For one, they had to conduct an annual review of the way they rate residential mortgage-backed securities to ensure the issuance of "independent ratings." The firms also agreed to step up disclosure and change the way they were paid to rate some deals, the documents show.

One possibility is that if Mr. Schneiderman finds that one of the ratings firms violated parts of that earlier agreement with Mr. Cuomo, his office could pursue a breach of contract action and then potentially sue the firms for their conduct in the lead up to the financial crisis.

The firms' action during that time is currently off limits because of the immunity agreement with Mr. Cuomo, the documents show. Mr. Cuomo's office didn't immediately respond to a request for comment.

The New York attorney general, based on what he receives through the subpoena and request for information, also could choose to look at the rating firms' conduct since the crisis. -0-