McGraw Hill Financial Inc.’s Standard & Poor’s unit may be allowed to seek information from former U.S. Treasury Secretary Timothy Geithner related to what the company said was a “threatening” call he made to Harold W. McGraw III after S&P’s downgrade of U.S. debt in 2011.
U.S. District Judge David Carter, at a hearing today in Santa Ana, California, said he’s concerned why Geithner would have made the call to McGraw Hill’s chairman, three days after the downgrade, other than for it to have a “chilling effect.”
“Why is Geithner calling?” Carter asked. “What is he doing on the phone?” The hearing ended without a ruling by the judge.
S&P is seeking information from Geithner to argue it was singled out because of the downgrade in a Justice Department fraud lawsuit filed last year that accused the company of lying about its ratings being free of conflicts of interest. The firm has said it provided the same credit ratings as Moody’s Corp. and Fitch Ratings on residential mortgage-backed securities and collateralized debt obligations before the credit crisis and was the only ratings company to downgrade the U.S. debt.
The Justice Department has said it may seek as much as $5 billion in penalties for losses to federally insured financial institutions that relied on New York-based S&P’s ratings prior to the collapse of the U.S. housing market that wiped out the value of many of the securities.
McGraw said in a January court filing that Geithner called following the downgrade to inform him that “S&P’s conduct would be looked at very carefully” and would be met with a response by the government. Geithner made the “angry” call right after he met with President Barack Obama, according to S&P.
The U.S. has said the downgrade was based on a $2 trillion error by New York-based S&P and has denied any connection between the downgrade and its investigation of S&P, which it said started two years before the downgrade.
Floyd Abrams, a lawyer for S&P, told Carter today that the company seeks the evidence to argue that the lawsuit should be dismissed because of government misconduct.
The judge said that allowing S&P to seek the information from Geithner doesn’t mean he will allow it to be admitted as evidence in a trial. Carter told Abrams he’s not going to dismiss the case for government misconduct before the question of S&P’s liability has gone before a jury.
“Geithner, even if you depose him, may never come before an American jury,” Carter told Abrams.
Carter directed attorneys for both sides to plan a schedule leading to a trial in September 2015.
John Keker, another lawyer representing S&P, asked the judge to provide guidance on what damages theories the government is allowed to pursue under the Financial Institutions Reform, Recovery and Enforcement Act, the 1989 law passed in the wake of the savings-and-loan crisis.
“This case is all about the money,” Keker told the judge.
The amount of damages S&P faces would be an important factor in how the company prepares for the trial, according to the lawyer.
The government seeks billions of damages based on losses to federally insured banks, which Keker said is an “extortionist situation.” Any damages theory should be based on S&P gains from rating the securities in question, which would be in the tens of millions of dollars instead, according to the lawyer.
In a FIRREA case brought by federal prosecutors in Manhattan against Bank of America Corp.’s Countrywide Financial unit, the government won a jury verdict in October finding the company liable for selling defective mortgages to Fannie Mae and Freddie Mac and is seeking as much as $2.1 billion in civil penalties. The bank has claimed it should have to pay $1.1 million at most.
U.S. District Judge Jed Rakoff, who is presiding over the case, told company and government lawyers in December to submit written arguments over the mortgage lender’s “pecuniary gain” from a “scheme to defraud.”
Justice Department lawyers asked the judge to use “gross gain, rather than net gain” as the penalty benchmark, and to define “gain” as “all revenue or proceeds derived from the wrongdoing” rather than “net profit,” as the bank suggested.
The case is U.S. v. McGraw Hill Financial Inc., 13-cv-00779, U.S. District Court, Central District of California (Santa Ana).