Well, better late than never.
It took five years, but the U.S. government is finally going after Standard & Poor’s for its role in the financial crisis. The Justice Department, along with 16 states and the District of Columbia, is seeking $5 billion in a civil lawsuit against the ratings agency, claiming S&P defrauded investors by claiming their ratings were objective when in fact they were giving top grades to risky mortgage-backed securities.
The move will be the first federal action against a credit-rating firm in connection with the 2008 meltdown, though the high grades the firms gave to subprime mortgage bonds precipitated the crisis. The charges come after settlement talks between S&P and the Justice Department broke down and reportedly focus on the models S&P used to rate mortgage bonds.
It was unclear whether the Justice Department was looking at the other two major ratings agencies, Moody’s and Fitch. Tony West, the acting associate attorney general, said he would not discuss actions against other ratings agencies.
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NY TIMES
Justice Department Faces Uphill Battle in Proving S.& P. Fraud
PETER J. HENNING and STEVEN M. DAVIDOFF
...whether the company’s practices equate to fraud will be difficult to prove.
The government is bringing charges under a provision of the Financial Institutions Reform, Recovery and Enforcement Act, a statute adopted in 1989 during the savings and loan crisis to make it easier to pursue fraud cases in the banking business. The law allows for a penalty of up to $1 million for each violation of the mail, wire and bank fraud statutes for conduct “affecting” a federally insured financial institution.
The statute is designed to help the government recoup money it expended bailing out any failed bank. In this case, the government is suing over the failure of Western Federal Corporate Credit Union and other unnamed financial institutions.
The statute was rarely used until recently, when the Justice Department apparently found it useful for cases arising out of the financial crisis. The United States attorney’s office in Manhattan sued Wells Fargo and Bank of America in October for penalties related to their mortgage operations.
The benefit of using the Financial Institutions Reform, Recovery and Enforcement Act is that one only needs to meet the lower burden of proof in civil cases of a “preponderance of the evidence” while still being able to use the broad mail and wire fraud statutes. This is in contrast to criminal charges, which require that prosecutors prove guilt beyond a reasonable doubt.
The government probably thinks it has some smoking guns. The complaint claims that S.& P. continued to rate subprime mortgage securities highly as the financial crisis began to hit and the securities looked increasingly shaky.
The Justice Department also contends that S.& P. helped fuel the financial crisis. In the first half of 2007, the company rated a number of large mortgage-backed securities, bestowing top grades on the investments. It then quickly downgraded the securities, which defaulted in months.
Then there is the usual array of inappropriate e-mails and text messages.
Despite the colorful e-mails, the Justice Department will face an uphill battle, even with the lower burden of proof.
The first problem is that Justice Department will have to demonstrate that S.& P. acted inappropriately. The government will have to prove that ratings were in fact faulty, and published intentionally so as to deceive investors in the securities. In response, S.& P. could simply argue that the company was just as blinded by the financial crisis as anyone else, and that questionable e-mails are simply the work of lower-level employees who were not involved in the decision-making.
In other words, S.& P. lacked the intent necessary to prove fraud.
Even if the Justice Department can prove the agency acted to deceive investors, it still has to deal with something lawyers call reliance. In other words, did investors rely on these ratings to make their decisions?
S.& P. did not deal directly with any investors, working only with the issuers and receiving payment for its ratings. In fact, most offering documents for these securities specifically told investors not to rely on the ratings. While that does not preclude finding that the company engaged in a fraudulent scheme, it does make it more difficult to show the link between purportedly shoddy ratings and any direct effect on the investors.
Perhaps more important is that S.& P. was not the only company that rated the securities. Typically, a security was also rated by at least one of the other two major rating agencies, Fitch Ratings and Moody’s Investors Service. They have not been accused of any misconduct by the Justice Department, and S.& P. can point to its competitors’ ratings as proof that it did not intend to mislead investors.
In its complaint, the government asserts that S.& P.’s fraudulent scheme “caused” investors to buy the securities, but the ratings by other firms may well have contributed to that decision. By only suing S.& P., the Justice Department will have to show that the company’s ratings played a major role in the investment decision
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