S&P to Fight for Evidence U.S. Suit Was Political Payback

S&P Said to Face SEC Inquiry on 2011 Commercial-Mortgage Bonds
Standard & Poor's signage is displayed outside of the company's building in New York. Photographer: Michael Nagle/Bloomberg

Standard & Poor’s is trying to show it was unfairly singled out in a $5 billion fraud lawsuit 18 months after it downgraded U.S. sovereign debt. Getting the government to provide supporting evidence will prove difficult.

McGraw Hill Financial Inc. and its S&P unit are seeking information from the Justice Department about the decision to target the company in the first federal case against a ratings firm for grades related to the credit crisis. S&P also wants a look at the government’s investigative files on other raters as part of a defense strategy to show it was unfairly sued.

S&P in the coming months will seek to defeat government attempts to shield internal discussions and evidence as the case heads for a first round of procedural deadlines that will determine what evidence eventually goes before the jury.

Even with the judge in the case sounding sympathetic in court to S&P’s desire to know why the U.S. sued it and not other ratings firms, it’s highly unlikely the government will be forced to reveal its internal discussions on the matter, said Wayne Gross, a former federal prosecutor now with Greenberg Gross LLP in Costa Mesa, California.

“It is important that the government be able to conduct investigations confidentially to protect the subjects of investigations who may never be charged,” Gross said in a phone interview.

Having lost a pretrial bid to get the case dismissed in federal court in Santa Ana, California, S&P now must prepare a defense that will persuade a jury to reject allegations that it defrauded investors by falsely claiming its ratings were independent and free of conflicts of interest.

Retribution Theory

U.S. District Judge David Carter hinted at a retribution theory at a July 29 court hearing, saying that S&P may seek to interview government officials about whether they sued because of the company’s downgrade of U.S. debt two years ago. While the judge described himself as a believer in transparency with a “pretty wide open” philosophy about pretrial evidence sharing, he made no promises S&P will get what it wants.

“You’re going to have a very difficult time with some of the government agencies,” Carter told S&P’s lawyers.

U.S. Attorney General Eric Holder said Feb. 5, the day after the complaint was filed against S&P, that it was unrelated to the downgrade. Holder made the comment in Washington as some financial professionals said publicly the targeting of S&P looked suspicious because the company’s two primary competitors, Moody’s Corp. and Fitch Ratings, awarded the same top grades to troubled mortgage bonds and didn’t downgrade the U.S. debt.

“There’s no connection between the two,” Holder said. “They did what they did, assessing what the creditworthiness was of this nation. We looked at the facts, the law and the investigation” and determined the lawsuit was “appropriate.”

‘Slashing,’ ‘Smashing’

S&P lawyer John Keker, the founding partner of San Francisco-based Keker & Van Nest LLP, may not let Holder have the last word. Keker, whose self-described approach to white-collar crime trials and corporate litigation is “slashing and smashing,” said at the July 29 hearing the company’s legal team will eventually seek to question a number of high-level government officials at the Justice Department as well as at the U.S. Treasury and the Securities and Exchange Commission.

“We anticipate highly contentious motion practice,” Keker told the judge, adding that he would focus on getting documents first and interrogating officials later. “They’re going to fight like mad.”

The Justice Department is seeking as much as $5 billion in civil penalties for losses to federally insured financial institutions that relied on S&P’s investment-grade ratings for mortgage-backed securities and collateralized debt obligations.

Central Theme

It will be a central theme of S&P’s defense to convince jurors that the government isn’t acting as an advocate of the interest of the American people in this case, said John Hueston, a former federal prosecutor now with Irell & Manella LLP in Los Angeles.

Gathering evidence about the government’s motivation to bring the lawsuit might also put S&P in a better position to negotiate a settlement, Hueston said in a phone interview.

“It is a brilliant move to try to obtain documents that go as high as possible,” Hueston said. “If the government becomes uncomfortable and it becomes a trial of the Justice Department, it could be a highly effective leverage strategy.”

While the congressionally appointed Financial Crisis Inquiry Commission blamed all three of the leading U.S. credit raters for inflated ratings that helped cause the worst financial crisis since the Great Depression, Moody’s and Fitch said after the Justice Department filed its complaint against S&P that they had no reason to believe they would be sued too.

AAA Rating

S&P has said nothing in court filings drawing a link between the lawsuit against it and its August 2011 decision to downgrade the U.S.’s 60-year-running AAA credit rating to AA+ with a negative outlook.

S&P said at the time that the Obama administration and Congress failed to take sufficient steps to reduce the record budget deficit. Moody’s and Fitch the same month affirmed their AAA ratings. All three firms are based in New York.

The Treasury Department said S&P had made a $2 trillion error in its analysis. S&P said there was no mistake and the discussion hinged on which baseline assumption should be used from the nonpartisan Congressional Budget Office.

S&P’s move roiled the markets, contributing to a global stock-market rout that erased about $6 trillion in value from July 26 to Aug. 12, 2011. The firm changed its outlook for the U.S. to “stable” in June from “negative,” citing “tentative improvements” in the debt burden.

Credit Crisis

The government alleged in its Feb. 4 complaint against S&P that the firm knowingly downplayed the risk on securities before the credit crisis in a desire to win business from investment banks that sought the highest possible ratings to sell them.

In other probes of abuses that fueled the collapse of the U.S. housing market starting in 2007 and led global credit markets to freeze in 2008, the Justice Department and Securities and Exchange Commission this month sued Charlotte, North Carolina-based Bank of America Corp., the nation’s second-biggest lender, while New York-based JPMorgan Chase & Co., the biggest U.S. bank, disclosed that it’s under federal criminal investigation for practices tied to to sales of mortgage-backed bonds.

S&P’s first line of defense failed when it asked Carter to dismiss the lawsuit on the grounds that its statements about the objectivity of its ratings were so generic that reasonable investors wouldn’t have relied on them.

‘S&P’s Objectivity’

“If no investor believed in S&P’s objectivity,” the judge wrote in a July 16 ruling, “is S&P asserting that, as a matter of law, the company’s credit ratings service added absolutely zero material value as a predictor of creditworthiness?”

The company also has argued that its ratings were the same as those of its competitors and that the government’s complaint failed to specify what the correct ratings should have been.

S&P said in a July 24 filing that it would seek transcripts of all testimony the government took in its investigation, all materials about interactions the Justice Department had with other federal and state agencies about its investigation, and about “the government’s decision to authorize the filing of this litigation.”

The Justice Department’s initial discovery will focus on identifying those CDOs and mortgage-backed securities that it believes were affected by the alleged fraud and that will serve best as evidence to present to a jury when the case goes to trial, government lawyers said in a July 27 filing. The judge gave the government a Nov. 18 deadline to complete that task.

Carter set a Dec. 16 hearing to determine how much additional time both sides need for discovery. The government has proposed a trial start date of Feb. 17, 2015.

Keker was asked by the judge at the July 29 hearing about the prospects for a settlement.

“The impediment is that the government has a view of this case that makes it impossible to settle,” Keker said.

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


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