S&P Loses the First Round Against the DOJ

By Cydney Posner

You might be interested in this article from The Wall Street Journal, reporting on the U.S. District Court's denial of S&P's motion to dismiss the Justice Dept's $5B fraud lawsuit. As you probably know, S&P (and other credit rating agencies) have been widely criticized for their roles in the financial crisis, most notably for the allegedly inflated ratings that they issued for certain structured debt securities. As the article reports, the "federal government claims that S&P was fraudulently misrepresenting its ratings process as independent and objective when behind the scenes the company was allegedly catering to bankers and other clients that wanted high ratings." The $5B in losses were allegedly suffered by federally insured banks and credit unions that bought structured debt securities in reliance on S&P's ratings.

In support of its motion, the article reports, S&P "claimed that the statements about independence and objectivity highlighted by the federal government as alleged fraudulent misrepresentations—such as employee codes of conduct and official policy statements about the company's process for rating deals—were generic, corporate ‘puffery' statements that weren't meant to be taken at face value by investors." [emphasis added]

The court was apparently flabbergasted by that argument: "Defendants lead off with a proposition that is deeply and unavoidably troubling when you take a moment to consider its implications. They claim that, out of all the public statements that S&P made to investors, issuers, regulators, and legislators regarding the company's procedures for providing objective, data-based credit ratings that were unaffected by potential conflicts of <br>interest, not one statement should have been relied upon by investors, issuers, regulators, or legislators who needed to be able to count on objective, data-based credit ratings."

Some of these statements (e.g., S&P's Code of Conduct) were submitted to the SEC in support of S&P's request for NRSRO status; other representations about objectivity were made to Congress "to avoid stricter regulation of the issuer-pays model." However, the court said, these statements were not "mere aspirational musings of a corporation setting out vague goals for its future." Rather, they were specific assertions that "appear designed to induce reliance on current policies and practices."

The court continued, at "the hearing on this matter, [S&P] repeatedly asserted that no reasonable investor would have relied on S&P's claims of independence and objectivity. Regarding the question of materiality, S&P argued that, since the issuer banks had access to the same information and models that S&P analysts did, they could not have been fooled by faulty credit ratings. This begs the question: if no investor believed in S&P's objectivity, and every bank had access to the same information and models as S&P, is S&P asserting that, as a matter of law, the company's credit ratings service added absolutely zero material value as a predictor of creditworthiness?"

The article reports that the U.S. has asked the judge to approve a February 2015 jury trial date, assuming no prior settlement.

Here is a copy of the court's order: sandpdismiss0717.pdf

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