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Financial Crisis

The Government's S&P Lawsuit Could Sink McGraw-Hill


The Government's S&P Lawsuit Could Sink McGraw-Hill

Photograph by Fuse/Getty Images

Let’s cut through the esoteric legal theories and comically incriminating e-mails: By seeking $5 billion in penalties from Standard & Poor’s as punishment for inflating credit ratings, the Obama administration turned its fraud suit into a potential corporate death penalty case.

S&P’s parent, McGraw-Hill (MHP), may not survive in its current structure if Attorney General Eric Holder follows through on his draconian civil action. “This alleged conduct is egregious—and goes to the very heart of the recent financial crisis,” Holder said at a press conference on Feb. 5 in Washington. McGraw-Hill, which denies wrongdoing, had net income of $867 million in the past four quarters. It can’t afford to pay $5 billion. McGraw-Hill stock fell more than 20 percent on word of the suit.

The U.S. Department of Justice’s decision to go medieval on the country’s largest credit-ratings company became evident to McGraw-Hill months before the filing of the suit in federal court in Los Angeles. In settlement talks, Holder’s aides had been demanding the company pay $1 billion and admit to committing fraud, according to the New York Times. That could have ignited a fatal firestorm of additional litigation. The company decided to fight back instead.

None of which should trouble anyone except McGraw-Hill employees and shareholders, according to Barry Ritholtz, chief executive officer of the quantitative research firm Fusion IQ. “If Arthur Andersen received the ultimate penalty for their part in the Enron and other fraud,” Ritholtz blogged on Feb. 6, “I see no reason why Moody’s (MCO) and S&P don’t suffer the same fate.”

In 2002, Andersen, once a Big Five accounting firm, shut its auditing business after being found guilty in a criminal case related to the collapse of the Houston-based energy firm Enron. The Supreme Court overturned the verdict, but the damage had been done.

Moody’s, which owns the second-largest credit-ratings service, wasn’t named in the Justice Department suit. A central element of S&P’s defense is expected to be that its overly generous evaluations of complicated mortgage-backed securities were no different from those of Moody’s or the No. 3 service, Fitch Ratings. In other words, S&P would insist it was no dumber than its rivals—and certainly not a fraudster. “Claims that we deliberately kept ratings high when we knew they should be lower are simply not true,” Catherine Mathis, a McGraw-Hill spokeswoman, said in a statement. (Until December 2009, McGraw-Hill owned BusinessWeek.)

Criticized for not responding strongly enough to the 2008-09 crisis, the Justice Department would send an unmistakable message and deter dishonest dealings throughout the financial industry by crushing Standard & Poor’s. Why S&P? Well, one reason is the company’s antic culture of e-mail confession. The government’s suit offers a trove of jury-ready quips. “We rate every deal,” one analyst said. “It could be structured by cows, and we would rate it.” Cartoonist Gary Larson must have had a giggle over that one.

Holder has denied that his decision to single out S&P had anything to do with the company’s stripping the U.S. of its AAA credit rating in August 2011. Barry Adler, the Petrie Professor of Law and Business at New York University School of Law, says that even if S&P suffers the full wrath of the federal government, it could still have value: “The company could refinance, reorganize, and move forward with a reformed business, or could just be sold for the benefit of its creditors.”

The bottom line: The government’s demand for $5 billion in penalties from S&P may in effect be a death sentence for its parent, McGraw-Hill.

Barrett_190
Barrett is an assistant managing editor and senior writer at Bloomberg Businessweek. His new book, Law of the Jungle, tells the story of the Chevron oil pollution case in Ecuador.

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