Tag Archives: DoJ

What Was S&P Puffing?

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I have been closely following DoJ’s suit against S&P since the complaint was filed in February (and see here, here and here).  DoJ alleges that S&P “issued or confirmed ratings that did not accurately reflect true credit risks” and seeks to obtain civil penalties pursuant to FIRREA. (4) Yesterday, Judge Carter issued a doozy of an order, denying S&P’s motion to dismiss the case.

Let’s remember that for the purposes of a motion to dismiss, the judge takes as true all of the facts alleged in the plaintiff’s complaint.  So, if a complaint survives a motion to dismiss, it means that the legal theory of the case is sound and that the plaintiff can win if the facts are as it alleges.

This should be the scariest passage in the order, as far as S&P is concerned:

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 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. (7-8)

This is repudiation of S&P’s “puffery” defense: their statements about their objectivity and rigorous methodology were merely “non-actionable puffery” along the lines of Charmin’s claim that it is the softest of all toilet papers. (8)

The Court follows this line of thought through to its logical conclusion:

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? (12)

One wonders how S&P executives responded to their lawyers when they proposed this argument — were they thinking about anything else other than winning this motion?  Did they consider how regulators might react to this argument?

And, while this goes beyond the matter at hand, the Court’s reaction to S&P’s argument is an implicit indictment of the business model of the major rating agencies: they are really in the business of selling licenses to access the capital markets more than they are in the business of issuing mini-editorials about the creditworthiness of securities, as they have successfully argued in previous cases challenging their ratings.

S&P Myth #1: No One Could Have Known

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S&P filed its Memorandum in Support of Defendants’ Motion To Dismiss the DoJ lawsuit filed back in February. The memorandum states that S&P’s inability, along with other market participants, “to predict the extent of the most catastrophic meltdown since the Great Depression reveals” only “a lack of prescience” and “not fraud.” (1) This short phrase requires some serious unpacking.

First, it ignores the fact that many of the analysts who engaged in fact-based investigations of the rated securities were sounding warnings but were overruled by higher ups who demanded that market share be maintained.  So if S&P and “other market participants” is defined to exclude all of those analysts, risk officers, underwriters and due diligence providers that worked for all of those market participants, then S&P is certainly right.  But if plaintiffs can demonstrate that facts were ignored to the extent that short term profits would be hurt by them, then S&P’s characterization is less compelling.

A second related point is that S&P’s argument that “its views were consistent with those of virtually every other market participant” is not compelling if plaintiffs can demonstrate that it ignored the facts before it and the findings of its own models.

Finally, its characterization of the Subprime Bust as “the most catastrophic meltdown since the Great Depression” fails to acknowledge that an S&P AAA rating offers quite the stamp of approval:  “An issuer or obligation rated ‘AAA’ should be able to withstand an extreme level of stress and still meet its financial obligations. A historical example of such a scenario is the Great Depression in the U.S.”  (The quote is from S&P’s website and can be accessed here on page 58.) But mortgage-backed securities with that S&P triple A did not quite live up to their promise.

This is not to say that S&P has not raised serious legal issues with Justice’s complaint in its motion to dismiss, but just that its rationalizations of its own behavior (which echo those of Dick Fuld and many others at the helm of various “market participants”) don’t stand up against the record.