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S&P, Moody's Shares Surge on Fraud Lawsuit Settlement

Many on Wall Street appear to feel renewed scrutiny on the bubbly pre-crisis ratings handed out by the likes of S&P and Moody's will fizzle out, just like toxic real estate and structured securities they gave high ratings to.

Currently, Moody's, Standard & Poor's and Fitch Ratings' best defense against fraud or misrepresentation allegations centers on the First Amendment. Bond ratings, they claim, are simply opinions and fall under free speech rights.

In September, a ruling by U.S. District Judge Shira Scheindlin on the lawsuit against Moody's and S&P cast doubt on whether ratings opinions can be protected by First Amendment free-speech rights if a fraud can be proven.

While multi-year lawsuits by Abu Dhabi and King County, Washington won't expose whether or not a fraud can be proven against Moody's or S&P, there is still the prospect federal and state proceedings do so.

The DoJ's civil fraud charges were brought under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, which allows the government to seek civil penalties equal to the losses suffered by federally insured financial institutions. To date, the DoJ has identified over $5 billion in federal losses resulting from CDOs that were rated by S&P between March and October 2007, according to U.S. Attorney General Eric Holder.

"We expect the legal risk focus to shift to the DOJ case and the state attorneys general cases which are all in the early stages... The next milestone for the DOJ case is a May 20th hearing in Los Angeles, but we expect years before the cases get to a potential trial (a settlement could come sooner)," Alex Kramm, a UBS analyst wrote in a Monday client note.

Kramm rates McGraw-Hill shares a 'buy' and has the equivalent of a hold rating on Moody's shares.

"A DOJ lawsuit would be entirely without factual or legal merit," S&P said in a February statement.

-- Written by Antoine Gara in New York

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