WASHINGTON -Connecticut Attorney General Richard Blumenthal yesterday sued Moody's Corp., Fitch Inc., and McGraw-Hill Cos., the parent company of Standard & Poor's, in a state court, charging they allegedly gave municipalities and their bonds lower credit ratings than were merited, costing taxpayers millions of dollars in unnecessary bond insurance and higher interest rates.

The suits come as the House Financial Services Committee yesterday approved a bill that would require the rating agencies to rate municipal general obligation bonds and other debt solely on the basis of repayment.

"All three credit rating agencies systematically and intentionally gave lower credit ratings to bonds issued by states, municipalities, and other public entities as compared to corporate and other forms of debt with similar or even worse rates of default," Blumenthal said in a statement released along with the three separate complaints he filed against each of the rating agencies in the state Superior Court in Hartford.

Blumenthal, who has been investigating the rating agencies since the fall of 2007, said this is the "first court action" in an investigation that could also result in litigation over possible antitrust, consumer protection, and other violations by the credit rating agencies, muni bond insurers, and related entities.

"Studies done by all three agencies themselves since 1999 show that public bonds default far less often than corporate bonds with similar, higher credit ratings," Blumenthal said. "In fact, public bonds with low ratings have lower default rates than the highest rated corporate bonds. [The rating agencies] have maintained the dual standard to financially benefit bond insurers, investors, and ultimately themselves."

"This rating charade created a Wall Street shell game constructed by the ratings agencies for the benefit of the bond insurers - which enabled the bond insurers to profit from unnecessary premiums and interest paid by taxpayers," he said.

The lawsuits, which are similar, charge the rating agencies engaged in unfair and deceptive practices in the course of trade or commerce with Connecticut and its municipalities under the Connecticut Unfair Trade Practices Act.

The suits urge the court to order the rating agencies to determine the amount of improper fees they received as well as the amount of unnecessary higher borrowing costs they forced on bond issuers. The suits ask the court to force the rating agencies to disgorge ill-gotten profits, pay bond issuers restitution, and pay civil penalties of $5,000 for each state law violation.

The three rating agencies issued statements yesterday claiming the suits are "without merit," and warning that they will "vigorously defend" themselves against the charges and seek to have the suits dismissed.

McGraw-Hill issued a statement contending the lawsuit against it "is simply a case of a state attempting to use litigation to dictate what bond rating it receives."

The company said, "The claims .... violate First Amendment rights - which courts around the country have repeatedly ruled apply to rating agencies and their opinions - and would result in an erosion of analytical independence and undermine investor confidence in the market by allowing ratings to be determined by governmental mandate or the threat of litigation."

Fitch called the lawsuit against it "an unfortunate development" and claimed it rates Connecticut and other states "based on our forward-looking opinion as to their financial capacity to pay their debts as they come due - not based solely on historical rates of default." Fitch said it plans today to report its findings from a comprehensive study of the credit risk of municipal issuers that it has been conducting for several months.

Moody's said its muni rating scale "has been in place for more than 90 years and has always been fully public and transparent. We have regularly solicited feedback from issuers, investors and other interested parties to ensure our municipal rating scale reflects the unique needs of the municipal market."

Blumenthal's suits come after the Justice Department's antitrust division, in 1999, ended a probe of Moody's without filing any charges against the rating agency. The probe, which began in 1996, was spurred in part by a lawsuit Jefferson County, Colo., School District had filed against Moody's in a federal court in Colorado, claiming the rating agency had interfered with a 1993 bond sale by publishing damaging statements about the district.

The suit revolved around allegations that Moody's used the threat of unsolicited rates to pressure issuers into soliciting ratings from it. The court dismissed the charges, as well as antitrust charges the district later filed against the rating agency.

But Blumenthal's complaint against Moody's suggests the rating agency colluded with the bond insurers to make sure tax-exempt bonds were not rated like corporate debt. Blumenthal claims that, in early 2006, Moody's began internal deliberations over whether it should offer corporate scale ratings for all public bonds and then drafted a request for comments which it sent to "prominent bond insurers," but not other market participants.

One insurer responded: "This is cutting at the heart of our industry given that investors buy on rating. While we in the industry might agree with the default/loss conclusion (this is in part the basis of our success and ability to leverage as high as we are), to lay it out there like this could be very detrimental."

Several bond insurers organized a coordinated industry response to Moody's draft request for comments.

In May 2006, after two leading bond insurers met with Moody's top public finance analysts to express concerns, one of the insurers wrote, "We were preaching to the choir." In June, Moody's sought public comments only on assigning corporate equivalent ratings to taxable muni bonds, Blumenthal said.

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