S&P, Ambac Must Face Negligence Claims by California Cities

McGraw-Hill Cos.’s Standard & Poor’s unit and Ambac Financial Group Inc. lost a bid to dismiss a negligence claim in a lawsuit alleging they conspired to force California local governments to buy bond insurance they didn’t need.

State court Judge Richard Kramer in San Francisco said yesterday that the California entities presented sufficient evidence to pursue claims of negligent misrepresentation and unfair business practices. He didn’t rule on the merits of the case.

Los Angeles, San Francisco and other municipal entities and local businesses allege ratings companies and bond insurers worked together to improperly maintain high credit ratings for the insurers when they knew such ratings weren’t warranted and to perpetuate a dual credit-rating system that punished cities with lower ratings than corporate entities.

The plaintiffs say they spent millions of dollars to buy insurance to enhance the credit ratings of their bonds, while S&P was giving its highest ratings to the risky subprime mortgage-backed securities the bond insurers were backing. When the mortgage crisis occurred in 2008, the bonds became unmarketable and cities racked up millions of dollars in fees to support them, according to the complaint.

“This is a huge victory for California cities,” Joseph Cotchett, who represents the municipalities, said after the hearing.

Scott Cooper, an attorney for Ambac, said at the hearing that he will appeal the ruling.

“We believe the case is without merit and we will defend ourselves vigorously,” Ed Sweeney, a spokesman for New York-based S&P, said in an email.

Kramer previously ruled that the California plaintiffs couldn’t pursue claims that the defendants violated state antitrust laws.

Moody’s Corp. and Fitch Ratings Ltd. were dropped as defendants in the case, Cotchett said Monday. Claims against them were “resolved,” he said, declining to provide details.

Daniel Noonan, a Fitch spokesman, said in an email, “We are pleased with the outcome.” Michael Adler, a Moody’s spokesman, didn’t immediately respond to an email message seeking comment on the ruling.

S&P also faces claims by the U.S. government in federal court in Santa Ana, Calif., that the company’s mortgage-backed securities ratings were fraudulent. S&P yesterday filed court papers asking a judge to dismiss the lawsuit.

The U.S. Justice Department accused S&P in a Feb. 4 complaint of inflating grades on mortgage-backed securities to win business, helping trigger the worst financial crisis since the Great Depression.

The U.S. is seeking as much as $5 billion in damages in its lawsuit. S&P rated more than $2.8 trillion of residential mortgage-backed securities and about $1.2 trillion of collateralized-debt obligations from September 2004 through October 2007, according to the U.S. complaint.