Litigation: S&P can’t dodge the DoJ
By accusing Standard & Poor’s of civil fraud the US Department of Justice has removed the rating agency’s First Amendment protection.
When the Department of Justice brought a $5 billion lawsuit against rating agency Standard & Poor’s in early February the market could be forgiven a certain degree of scepticism. The agencies have had considerable success in fending off sub-prime-mortgage-related litigation since the financial crisis by hiding behind the First Amendment defence of free speech.
This time, however, things could be different. The DoJ is bringing a civil case against the rating agency under the Financial Institutions Reform, Recovery and Enforcement Act of 1989, accusing it of mail fraud, wire fraud and financial institutions fraud in connection with roughly 40 CDO trades that it rated.
The DoJ has taken two unusual approaches in its case against S&P. First, the accusation of civil fraud is not open to protection under the First Amendment, which removes the rating agency’s first line of defence. Secondly, the case has been filed in California rather than New York and focuses on the failure of the Western Federal Corporate Credit Union (WesCorp) among others. S&P stands accused of defrauding a federally insured institution, thereby injuring the taxpayer. The case alleges that S&P deliberately limited adjustments and delayed changes to statistical models that would have resulted in the firm issuing lower ratings to the transactions.
The 40 CDO deals in question were rated between 2004 and 2007, reportedly earning S&P around $13 million, but on which investors lost more than $5 billion. The agency generally charged $500,000 to rate a cash CDO and $750,000 to rate a synthetic CDO.
The lawsuit was filed once protracted attempts to reach a settlement broke down. The DoJ had been prepared to settle for $1 billion but crucially wanted S&P to admit wrongdoing – something the agency will do everything to avoid because of the avalanche of civil suits that would inevitably follow. S&P rated more than $2.8 trillion of RMBS and $1.2 trillion of CDOs in the three years prior to October 2007.
Hence it is prepared to risk this lawsuit. The DoJ’s trawl through 20 million pages of email evidence has produced a slew of damaging and embarrassing disclosures but success for the department is far from assured. The case could, however, be seen as evidence of the US government being prepared to take a tougher line in seeking redress from the rating agencies for their role in the sub-prime mortgage crisis. Or simply to punish S&P for downgrading the country in mid-2011 – as the conspiracy theorists would have it.