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S&P Raises Puffery Defense Against U.S. Ratings Case

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S&P to Argue Puffery Defense in U.S. Case’s First Courtroom Test
The Standard & Poor's logo is displayed at the company's headquarters in New York. Photographer: Scott Eells/Bloomberg

July 8 (Bloomberg) -- Standard & Poor’s, at the first court hearing over the U.S. government’s claims that the rating service defrauded investors, argued reasonable investors wouldn’t have relied on its “puffery” about credit ratings.

John Keker, a lawyer for the McGraw Hill Financial Inc. unit, today told U.S. District Judge David Carter in Santa Ana, California, that S&P’s generic statements about its business aspirations weren’t material to the banks buying securities and didn’t meaningfully change the mix of information available to investors.

“They’re seeking to blame the entire financial crisis on Standard & Poor’s,” Keker said in court. “Those generic statements don’t make a scheme to defraud. For a scheme to defraud, there has to be a specific intent to harm the victim, in this case the investor.”

Keker asked Carter to dismiss the government’s case, which seeks as much as $5 billion in civil penalties, on the grounds that the Justice Department didn’t adequately support its allegations that the company defrauded federally insured financial institutions by knowingly understating the credit risks of securities linked to residential mortgages.

Carter heard arguments from both sides and adjourned the hearing until 3 p.m. local time. He said he will give the parties a tentative ruling they can discuss in the afternoon.

Reasonable Investor

S&P said in its request to dismiss the case that the government can’t base its fraud claims on S&P’s assertions that its ratings were independent, objective and free of conflicts of interest because U.S. courts have found that such vague and generalized statements are the kind of “puffery” that a reasonable investor wouldn’t rely on.

The company also urged the judge to take into account that the U.S. is pressing fraud claims “despite the fact that other rating agencies issued ratings identical to those of S&P on the same securities at issue, and despite the fact that its views were consistent with those of virtually every other market participant,” according to an April 22 filing.

“Where’s Moody’s?” Carter asked Assistant U.S. Attorney George Cardona, who represented the Justice Department at the hearing.

Cardona said the government had developed evidence against S&P in this case without indicating whether the U.S. had investigated Moody’s Investors Service as well. Keker said the only difference between S&P and Moody’s was that S&P had downgraded the U.S. credit rating.

Reassuring Investors

Cardona told the judge that S&P’s “puffing” about its ratings being independent and objective was material because the ratings were important in reassuring investors about the credit quality of the securities they bought from investment banks.

The ratings weren’t independent and objective because S&P let issuers influence its models and criteria, Cardona.

The U.S. sued New York-based S&P on Feb. 4, alleging its credit ratings for residential mortgage-backed securities and collateralized-debt obligations that included those securities, contrary to what the company told investors, were based on a desire to win business from issuers of the securities more than on the credit risk of the investments.

Longest Recession

A surge in defaults of high-risk mortgages packaged in securities that had helped fuel the U.S. housing boom until 2007 led to the country’s longest recession since 1933. S&P rated $2.8 trillion in residential mortgage-backed securities from September 2004 through October 2007 and $1.2 trillion worth of CDOs, according the government’s complaint.

In evaluating S&P’s request to dismiss the case, the judge will assume that everything the government said in its complaint is true. If the judge finds the government’s allegations lack the legally required specificity, he may give the Justice Department an opportunity to address the deficiencies in a revised complaint.

The lawsuit was brought by U.S. Attorney Andre Birotte Jr. in Los Angeles under the 1989 Financial Institutions Reform, Recovery and Enforcement Act, a law passed after the savings and loan crisis to allow the government to seek civil penalties for losses of federally insured financial institutions caused by fraud.

In its 119-page complaint, the Justice Department cited meetings, messages and memos to support its claims.

‘Ironic’ Goal

S&P argued in its April 22 filing that it’s “ironic” that the government seeks penalties for losses by the same banks, Bank of America Corp. and Citigroup Inc., that were creating and selling the CDOs.

“The complaint charges S&P with intending to defraud these financial institutions about the likely performance of their own products,” the company said.

Banks create collateralized debt obligations by bundling bonds or loans into securities of varying risk and return. They pay ratings firms for the grades, which investors may use to meet regulatory requirements.

The case is U.S. v. McGraw-Hill Cos., 13-cv-00779, U.S. District Court, Central District of California (Santa Ana).

To contact the reporter on this story: Edvard Pettersson in the Los Angeles federal court house at +1-

To contact the editor responsible for this story: Michael Hytha at

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