WASHINGTON (REUTERS) - The United States (US) government is seeking US$5 billion (S$6.2 billion) in its civil lawsuit against Standard & Poor's, accusing the ratings service of defrauding investors, in one of the most ambitious cases yet from the Justice Department over conduct tied to the financial crisis.

The US said S&P inflated ratings and understated risks associated with mortgage securities, driven by a desire to gain more business from the investment banks that issued those securities. S&P also falsely claimed its ratings were objective, the lawsuit said.

"Put simply, this alleged conduct is egregious - and it goes to the very heart of the recent financial crisis," said Attorney General Eric Holder at a news conference in Washington announcing the charges.

The 119-page lawsuit, filed late Monday in federal court in Los Angeles, is the first from the government against a ratings agency, a sector that has generally shielded itself from liability by citing First Amendment protection.

Sixteen states and the District of Columbia are also suing S&P, a unit of the McGraw-Hill Companies Inc.

McGraw-Hill shares were down 5.3 per cent at $47.61 on Tuesday, extending Monday's declines.

No individuals were charged in the DOJ's lawsuit, and it was not immediately clear why the government focused on S&P instead of rivals Moody's Corp or Fimalac SA's Fitch Ratings, which were also major raters of such securities.

S&P issued a statement on Tuesday saying the lawsuit is meritless and that it will vigorously defend itself. It said the government "cherry picked" emails to misconstrue analyst activity.

"Claims that we deliberately kept ratings high when we knew they should be lower are simply not true," the company said.

GOV'T HAS TOUGH CASE TO PROVE - S&P LAWYER

Mr Floyd Abrams, a lawyer for S&P, predicted the government may have a difficult time proving that S&P intentionally mismarked its own ratings.

He also noted that S&P's opinions on mortgage-related products were not that far from major US policymakers who did not foresee the depth of the financial crisis.

"There was no fraud," Mr Abrams said on CNBC Tuesday morning. "The ratings that were issued were believed by the people who issued them. And that's what the government has got to disprove."

Between September 2004 and October 2007, as stress in the housing market was starting to emerge, S&P delayed updates to its ratings criteria and analytical models, which weakened its criteria beyond what analysts believed was needed to make them more accurate, the Justice Department said.

During that period, according to the complaint, S&P issued credit ratings on US$2.8 trillion worth of mortgage securities and some US$1.2 trillion in related structured products.

It charged up to US$750,000 per deal it rated, which meant that S&P viewed the investment banks that issued the securities as its main customers, according to the complaint.

In August 2004, the head of S&P's commercial mortgage-backed securities sent an email to her colleagues and said they planned to meet to discuss adjusting criteria "because of the ongoing threat of losing deals".

Earlier in May, an analyst wrote, "We just lost a huge Mizuho RMBS deal to Moody's due to a huge difference in the required credit support level... our support level was at least 10 per cent higher than Moody's," the complaint said.

S&P had planned in 2004 to update its model for rating mortgage securities by including a broader data set of past loans, which would provide more accurate comparisons for the more risky loans that were being packaged.

In 2006, S&P loosened assumptions on its ratings of collateralized debt obligations, which one of the firm's analysts described as creating a loophole big enough to drive a Mack truck through.

Between March and October of 2007, S&P knew the credit risks of certain non-prime deals were increasing, but disregarded those risks in rating-related securities, the United States said.

OLD LAW, NEW TWIST

The lawsuit was brought under FIRREA, the Financial Institutions Reform, Recovery, and Enforcement Act, a federal civil fraud statute passed in the wake of the 1980s savings-and-loan scandals. It covers fraud affecting federally insured financial institutions.

While it has appeared in only a few dozen cases, its low burden of proof, broad investigative powers and long statute of limitations encouraged the Justice Department to dust it off for potential cases, especially after criminal inquiries failed to yield major prosecutions.

In its complaint against S&P, the Justice Department accused S&P of defrauding Western Federal Corporate Credit Union, and other institutions that purchased certain securities based on the high ratings by S&P.

Some credit unions are required by law to rely on credit ratings issued by firms that included S&P in making its investment decisions, the complaint said.