WSJ Pushes Myth That DOJ Lawsuit Against S&P Is "Political Payback"

››› ››› ELLIE SANDMEYER & MICHELLE LEUNG

A Wall Street Journal editorial pushed the myth that a Department of Justice lawsuit against credit rating agency Standard & Poor's (S&P) is retaliation for the company downgrading the U.S.'s credit rating, failing to note experts' explanations that the suit is likely a test case that may be used to bolster future action against other credit rating agencies and that the suit predates S&P's downgrade.

S&P Cries Foul Over Alleged DOJ Targeting

DOJ Initiates Lawsuit Against S&P For Mortgage-Backed Securities Fraud. In a February 5 press conference, Attorney General Eric Holder announced the Department of Justice's (DOJ) investigation and case against S&P:

Yesterday, the Justice Department filed a civil lawsuit against Standard & Poor's Financial Services - as well as its parent company, McGraw-Hill - alleging that the credit rating agency S&P engaged in a scheme to defraud investors in financial products known as Residential Mortgage-Backed Securities, or RMBS, and Collateralized Debt Obligations, or CDOs.

[...]

To date, we have identified more than $5 billion in such losses, resulting from CDOs that were rated by S&P between March and October 2007.   During this period, nearly every single mortgage-backed CDO that was rated by S&P not only underperformed - but failed. [Department of Justice, 2/5/13]

S&P Labels Lawsuit Filed by Justice Department "Retaliation." Reuters reported that, in a court filing, S&P claimed the lawsuit had been brought "in retaliation" of its decision to downgrade the U.S.'s credit rating in 2011:

In a filing with the U.S. District Court in Santa Ana, Calif., S&P said the government's "impermissibly selective, punitive and meritless" lawsuit was brought "in retaliation for defendants' exercise of their free speech rights with respect to the creditworthiness of the United States of America." It also said the "excessive fines" violated the Eighth Amendment. [Reuters, 9/3/13, via The Washington Post]

Wall Street Journal Pushes S&P's Accusation Of Retaliation

The Wall Street Journal: Timeline of Lawsuit Has "The Aroma Of Political Payback." On September 8, a Wall Street Journal editorial bolstered S&P's claims that the U.S. government is seeking reprisal for its lowered credit rating. The editorial claimed that the DOJ investigation "has the aroma of political payback" because S&P is the only credit rating agency currently being sued, and alleged that the suit was issued in response to S&P's downgrade of the U.S.'s credit rating in 2011:

We've been skeptical of all of these investigations, since credit ratings are merely opinions. The simple solution is for the government to stop forcing people to pay attention to them. But the point of this chronology is that there is an unambiguous record from 2008 through 2010 of various government bodies investigating both S&P and Moody's.

Then along comes 2011. In April of that year, S&P shifted the U.S. credit outlook to "negative" from "stable." As is its custom, S&P made this change to warn markets that Uncle Sam could face a downgrade.

Team Obama was not happy. The Washington Post reported that Administration officials had urged S&P not to make this move. After it was announced, officials criticized S&P's analysis. Treasury Secretary Timothy Geithner dismissed the warning and said there was "no risk" of a downgrade.

Two months later, this newspaper reported that the SEC was investigating both Moody's and S&P, with particular attention to S&P. Two months after that, in August, S&P announced its downgrade, triggering a stock market selloff and embarrassing the President.

Fewer than two weeks later, the New York Times reported that Justice was conducting an investigation specifically of S&P. The Times said it was "unclear" whether Moody's, which did not downgrade the U.S., was also being investigated. And now we know that Moody's has not been charged in the Justice suit. Coincidentally, Moody's counts among its owners Berkshire Hathaway, run by Obama pal Warren Buffett.

Yet Moody's had a rating identical to S&P's on nearly every tranche of every security mentioned in the lawsuit. All of which raises the question posed by federal Judge David Carter of the Central District of California in a recent court hearing: "Where's Moody's?" [The Wall Street Journal, 9/8/13]

But Reports Say That The S&P Suit Is Likely A Precursor To Action Against Moody's

Reuters: Officials Say Suit Against Moody's Will Likely Progress After S&P Action Is "Tested In The Courts." Reuters reported that, although the DOJ had initially chosen to dedicate more resources to pursuing a lawsuit against S&P, officials familiar with the case said that the DOJ is also considering a lawsuit against S&P competitor Moody's, but "will likely wait" until the S&P suit is resolved. Reuters quoted a law enforcement official saying: "Don't think Moody's is off the hook." Reuters also explained that the DOJ chose to sue S&P first because the "paper trail" against it is stronger:

Despite similar evidence against both companies, people with knowledge of the rating agencies say authorities may have moved first against S&P because of a stronger paper trail against it.

Richard Greenfield of Greenfield & Goodman, who was part of a suit against Moody's with a settlement last year that included governance reforms and $4.95 million, said looking at the respective evidence, it does appear that there was more material against S&P.

"Here you've got a very, very good paper trail with S&P," he said. "If they are not totally smoking gun documents, they are collectively smoking gun documents."

The paper trail is important because the kinds of documents involved can help keep a judge from dismissing a case before it gets to trial, said Hillary Sale, a securities law and corporate governance expert and professor of law at Washington University in St. Louis.

The government's complaint against S&P includes numerous embarrassing emails, such as one in which an analyst parodies a Talking Heads song "Burning Down the House" to reflect the "boiling over" subprime market.

"When you have that kind of evidence that looks bad, you don't want to dismiss the case until you have more discovery," Sale said. That kind of a paper trail "helps you survive a motion to dismiss."

Legal experts say the type of activity described in the S&P lawsuit does not appear isolated to that firm, and the S&P case might simply be a prelude to more action.

"It may very well be that the government's testing their waters and they don't want to bite off more than they can chew," said Philip Hilder of Hilder & Associates in Houston, a former federal prosecutor. "Nobody should take these cases lightly." [Reuters, 2/7/13]

Industry Lawyer: S&P Lawsuit May Spur Similar Charges Against Moody's. In a Bloomberg News article, finance lawyer Robert Piliero explained that while the DOJ is currently only targeting S&P, that lawsuit may be used as a way to bring litigation against other credit rating agencies. From Bloomberg News:

The U.S. is seeking as much as $5 billion in penalties from New York-based McGraw-Hill as punishment for inflated credit ratings that Attorney General Eric Holder said were central to the financial crisis. While Moody's wasn't sued, a victory by the government would spur other lawsuits, according to Robert Piliero, a lawyer at Butzel Long in New York who's worked on structured-finance litigation. [Bloomberg News, 2/6/13]

AP: S&P Lawsuit Could "Serve As A Template" For Future Action Against Other Credit Rating Agencies. In an article explaining the DOJ's actions, The Associated Press reported that "[e]xperts said the lawsuit could serve as a template for future action against Fitch and Moody's, the other two major credit rating agencies." [The Associated Press, 2/5/13]

And The DOJ Investigation Predates S&P's Downgrade Decision

CBS News: Investigation Started Years Ago. While discussing the DOJ's lawsuit against S&P, CBS correspondent Anthony Mason noted that investigations take years to conduct, and that this particular one began in 2009:

MASON: Investigators tell me typically these complicated cases take years to build. I mean, this investigation began in 2009, and in this case, the government has had to go through 20 million pages of internal Standard and Poor`s documents. [CBS News, CBS Evening News, 2/5/13, via Nexis]

The Wall Street Journal: Government Has Been Investigating S&P For Years. In an article on the announcement of the DOJ's lawsuit, The Wall Street Journal reported:

For about three years, the government has been investigating whether S&P managers pushed to weaken company standards for rating mortgage-linked deals or ignored the standards entirely, people familiar with the probe said.

[...]

The lawsuit, filed in Los Angeles federal court, is the culmination of a government investigation that dates back to at least 2010, former S&P analysts have told the Journal. [The Wall Street Journal, 2/5/13]

Attorney General Eric Holder: S&P Investigation "Began In November 2009." In his press conference announcing the lawsuit on February 5, Attorney General Eric Holder explained the origin of the investigation and what had been found:

Put simply, this alleged conduct is egregious - and it goes to the very heart of the recent financial crisis.   Our investigation into this matter began in November 2009, in connection with the President's Financial Fraud Enforcement Task Force.   And it showed that - as early as 2003 - analysts within S&P raised concerns about the accuracy of the company's rating system, as well as the underlying methodology.   S&P executives allegedly ignored these warnings, and - between 2004 and 2007 - concealed facts, made false representations to investors and financial institutions, and took other steps to manipulate ratings criteria and credit models to increase revenue and market share.

Even in 2007 - when S&P's internal data showed a severe deterioration in the creditworthiness of the RMBS it had rated - S&P allegedly continued to rate hundreds of billions of dollars' worth of CDOs backed by RMBS collateral - ignoring their own analysts' performance projections showing that the ratings on that collateral would not hold. [Department of Justice, 2/5/13]

To learn more about the evidence of S&P's alleged wrongdoing, click here.

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