Editor: David Reiss
Brooklyn Law School

July 17, 2013

What Was S&P Puffing?

By David Reiss

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.

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