Tag Archives: Judge Carter

DoJ All FIRREA-ed Up With S&P Suit

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Law360 quoted me in a story, Prosecutors Unleashed As $5B S&P Action Rolls On (behind a paywall), about DoJ’s success in fending off S&P’s motion to dismiss its FIRREA case. It reads in part

While the latest ruling against S&P was lighter on substance, Brooklyn Law School professor David Reiss called it “a very big deal.”

“It adds to a body of law that gives the government another powerful tool to go after alleged misdeeds by financial institutions,” he said.

The suit, launched in February to much fanfare, targets S&P’s top-notch ratings for complex mortgage-backed securities that later failed. As part of a controversial, widespread practice known as the “issuer pays” model, banks created the securities, paid S&P to rate them and then sold them to investors. The DOJ claims S&P mismarked the securities on purpose to keep clients happy and boost profits.

In its motion to dismiss, the firm argued its public statements touting the ratings as objective, based on solid data and unaffected by potential conflicts of interest amounted to “puffery” and therefore could not form the basis of a fraud suit against S&P and parent company McGraw-Hill Cos. Inc.

But Judge Carter ruled Tuesday that the DOJ had sufficiently alleged S&P’s statements were not general, subjective claims, but were based on specific policies and procedures governing how the firm “shall” or “must not” rate securities. The judge called the firm’s puffery argument “deeply and unavoidably troubling when you take a moment to consider its implications.”

“Despite defendants’ protestations to the contrary, the court cannot find that all of these ‘shalls’ and ‘must nots’ are the mere aspirational musings of a corporation setting out vague goals for its future,” the judge wrote in an 18-page order. “Rather, they are specific assertions of current and ongoing policies that stand in stark contrast to the behavior alleged by the government’s complaint.”

Judge Carter also found the DOJ had sufficiently claimed S&P defrauded investors who had relied upon the ratings in determining the credit risk of certain investments. And the judge ruled the government did not have to plead “with a high degree of particularity” that S&P intentionally issued false ratings because the suit was filed under FIRREA. Tougher pleading requirements set out in the Private Securities Litigation Reform Act, which governs many securities suits, therefore do not apply, the judge ruled.

S&P spokesman Ed Sweeney noted Wednesday that the ruling did not address the merits of the case, as the judge was required to accept the government’s factual allegations as true during the early stages of litigation.

“We now welcome the opportunity to demonstrate the lack of merit to the Department of Justice’s complaint,” Sweeney said. “We firmly believe S&P’s ratings were and are independent, and expect to show just that in court.”

The decision followed a tentative July 8 ruling by Judge Carter. And indeed, given the sheer amount of resources the government has devoted to the case, the finding should have come as no surprise, according to Jacob Frenkel, an attorney at Shulman Rogers Gandal Pordy & Ecker PA who chairs the firm’s securities enforcement practice.

“When you have a deep-pocketed client that is willing to fight, a good lawyer will exhaust all options and remedies,” Frenkel said of S&P’s motion. “It would have been unreasonable to believe it stood any chance of success, but that does not mean you don’t try.”

Still, Judge Carter’s takedown should give the firm pause as it weighs whether to fight the claims or strike a settlement, according to Reiss, the Brooklyn professor.

“We now have a sense that the judge’s take on the guts of the case is pretty favorable to the government,” Reiss said. “And we’re now seeing the rating agencies start to crumble a little bit after their decades-long run of avoiding either settling or losing at trial.”

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.