Standard & Poor's, one of three firms that rates the bulk of public bonds and securities, is being charged with three counts of violating the New Jersey Consumer Fraud Act.
The state's suit is similar to a suit the federal government filed earlier this year against S&P. The ratings firm argued in a September filing that the federal government's suit was retaliatory because S&P downgraded its bonds in 2011.
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At issue, according to the suit, are "structured finance securities" that S&P rates. Those securities, the state claims, were rated without disclosing that the firm was "acting in its own business interests, and in the interests of favored clients whose fees provided the company with a significant revenue stream," said New Jersey Acting Attorney General John J. Hoffman.
The firm played favorites, the state claims, by catering to the very investment banking clients whose securities Standard & Poor's was rating. Those clients, the suit alleges, paid Standard & Poor's fees under an "issuer pays" model.
Those fees were a "significant and increasing source of revenue," and Standard & Poor's worried that it would lose market share to the two other major bond-rating firms, Moody's Investor Service and Fitch Ratings.
The administration of New Jersey Gov. Chris Christie has fought with Standard & Poor's over the company's rating of the state's bonds. The bond-rating company has been skeptical of the administration's revenue forecasts and even downgraded the state's outlook to "negative" in 2012, warning that it could lower New Jersey's bond rating in the future.
A lowering of the bond rating for a public entity such as t! he state of New Jersey can have a significant impact on taxpayers. A lower rating means that higher interest rates are charged for borrowing money for projects. Over the life of a large public bond sale, those increased interest rates can cost taxpayers millions of dollars.
The state's bond rating remains at AA-, the fourth highest rating given by Standard & Poor's and still considered high grade. The firm last lowered the state's bond rating in 2011, from AA to AA-.
The state, in its suit, did not argue over the 2012 outlook downgrade. The suit, the state said, was not "brought for the purpose of demonstrating that any particular rating was incorrect." Rather, the state alleges, Standard & Poor's violated the state Consumer Fraud Act "by misrepresenting that it was at all times independent and objective."
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The suit, filed in the Chancery Division of the Superior Court in Essex County, N.J., seeks to "redress years of unconscionable commercial practices, misrepresentations, and knowing omissions of fact by" Standard & Poor's and its parent company, McGraw Hill Financial.
The state claims the firm misrepresented itself on its website, in its annual reports and before Congress in testimony.
"The independence and objectivity of Standard & Poor's is of critical importance to New Jersey consumers, who placed their trust in the company's supposedly objective analysis," Hoffman said.
A call placed to Standard & Poor's for comment on the suit was not immediately returned.
In September 2012, Standard & Poor's said the state's continued issues with structural debt could cause another drop in New Jersey's bond rating.
"The negative outlook reflects that we could lower our ratings on New Jersey within the two year outlook horizon," the firm said in a September 2012 news release. "The negative outlook is based on our view of the state's inability to achieve structural balance, as well! as growi! ng fiscal pressures."
The state disagreed with the firm's assessment.
"We believe investors will find S&P's arguments to be out of step and its basis for revising New Jersey's outlook unconvincing, particularly in the face of the continued growth in New Jersey's economy and state revenues," said Andy Pratt, then a spokesman in the Department of Treasury.
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