S&P Ratings Suit, CBOE-SEC Talks, Bonuses: Compliance

The Justice Department decision to sue Standard & Poor’s has investors asking why Moody’s Investors Service and Fitch Ratings weren’t targeted for awarding the same top grades to troubled mortgage bonds and other debt securities.

The Financial Crisis Inquiry Commission and a Senate panel laid the blame on S&P, Moody’s and Fitch for inflated ratings on mortgage-backed securities and collateralized debt obligations that helped cause the worst financial crisis since the Great Depression. Together, they provided 96 percent of all ratings for governments and companies in the $42 trillion debt market in


The U.S., in a lawsuit filed Feb. 4 in federal court in Los Angeles, is alleging that the unit of New York-based McGraw-Hill Cos. defrauded investors by failing to adjust its analytical models or taking necessary steps to accurately reflect the risks of the securities because it was afraid of losing business.

The federal case was assigned to U.S. District Judge David O. Carter in Santa Ana, California.

S&P lowered the U.S. government’s credit rating one step to AA+ from the top AAA rank on Aug. 5, 2011, after months of wrangling between President Barack Obama and Congressional Republicans over whether to raise the federal debt limit. Bond investors repudiated the downgrade and U.S. borrowing costs fell to record lows as Treasuries gained the most since 2008.

S&P has used this as a defense. Floyd Abrams, the Cahill Gordon & Reindel LLP lawyer representing the company, said in a Feb. 5 appearance on Bloomberg Television that investors required two ratings on CDOs before they would buy, yet only S&P has been accused of acting in bad faith.

Ed Sweeney, an S&P spokesman, declined to elaborate on Abrams’s comments.

S&P Case To Turn on Question of Fraud, Not First Amendment

Standard & Poor’s lawyers will have no shortage of legal arguments as the ratings service defends a novel U.S. claim that it defrauded investors by deliberately understating the risk of mortgage-backed bonds.

U.S. success in the lawsuit in federal court in Los Angeles is “far from clear,” said Jeffrey Manns, an associate professor at George Washington University Law School. S&P’s defense may include evidence that the agency believed in its ratings and proof that U.S. fraud allegations are unfounded. Company lawyers are also weighing whether to argue that the 1989 statute underpinning the case doesn’t apply to S&P.

“We start with proposition that we deny there was any fraud,” Floyd Abrams, one of the lawyers for the ratings service, said Feb. 7 in a phone interview. Fraud claims have “a high burden of proof.”

In a Feb. 5 interview with Bloomberg Television, Abrams said this is not a First Amendment case because “the government is alleging that S&P didn’t believe what it said. The First Amendment doesn’t protect against that.”

S&P rated more than $2.8 trillion of residential mortgage-backed securities and about $1.2 trillion of collateralized-debt obligations from September 2004 to October 2007, the government said.

The Justice Department accuses S&P in its complaint of falsely representing to investors that its ratings were objective, independent and uninfluenced by any conflicts of interest. The company shaped its ratings to suit its business needs by weakening adjustments to its analytical models and by issuing inflated rankings on CDOs collectively worth hundreds of billions of dollars, according to the complaint.

In the 128-page civil complaint, the U.S. cites internal e-mail exchanges to bolster its case, including one in which an S&P analyst allegedly telling a colleague in April 2007 that deals “could be structured by cows and we would rate it.”

The U.S. may seek more than $5 billion in damages, acting U.S. Associate Attorney General Tony West said on Feb. 5. McGraw-Hill, which had net income of $867 million in the past four quarters, denies wrongdoing.

“The fact is that S&P’s ratings were based on the same subprime mortgage data available to the rest of the market -- including U.S. government officials who in 2007 publicly stated that problems in the subprime market appeared to be contained,” Catherine Mathis, a company spokeswoman, said in an e-mailed statement after the lawsuit was filed.

The case is U.S. v. McGraw-Hill, 13-00779, U.S. District Court, Central District of California (Los Angeles).

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S&P May Face Suits by More States, Connecticut’s Jepsen Says

Standard & Poor’s may be sued by more states over credit ratings on mortgage products, adding to state and federal lawsuits filed against the company, Connecticut’s attorney general said.

Connecticut Attorney General George Jepsen, who is leading a multistate coalition, said some states are considering lawsuits against the McGraw-Hill Cos. unit in addition to at least 16 that have already sued.

“We know some states are actively considering it,” Jepsen said Feb. 7 in a phone interview.

Connecticut, Mississippi and Illinois sued Standard & Poor’s previously. Thirteen states and the District of Columbia sued this week with the Justice Department, according to a statement from Jepsen’s office. Connecticut also has a lawsuit pending against Moody’s Investors Service.

Jepsen declined to comment on how many states are considering lawsuits and whether officials are investigating Moody’s and Fitch Ratings.

New York Attorney General Eric Schneiderman is investigating whether S&P, Moody’s and Fitch violated a 2008 settlement that was reached with his predecessor Andrew Cuomo as well as conduct by the companies since that agreement expired at the end of 2011, according to a person familiar with the matter.

Massachusetts Attorney General Martha Coakley is also investigating S&P, spokesman Brad Puffer said in an e-mail.

S&P Lawyer John Keker Brings Slash and Smash Tactics to Defense

San Francisco lawyer John Keker, the Vietnam War platoon leader who later prosecuted Oliver North and represented clients from Eldridge Cleaver to Lance Armstrong, may deploy his “slashing and smashing” approach to defend Standard & Poor’s Financial Services LLC.

Keker will work with the company’s New York law firm Cahill Gordon & Reindel LLP and its partner Floyd Abrams. Keker, 69, a founding partner of Keker & Van Nest LLP, was once voted by 100 of his California colleagues as the first lawyer they’d hire if charged with a serious crime.

In a 2003 Bloomberg News profile, Keker said he honed his “slashing and smashing” defense tactics in white-collar crime trials and corporate litigation. He didn’t respond to an e-mailed request seeking comment on his hiring by S&P.

Lawyers from both firms will be in court for any trial, Abrams said Feb. 7 in a phone interview. He said the precise division of labor among the lawyers hasn’t been determined.

Cristina Arguedas, a criminal defense lawyer who has known Keker since 1980, described Keker as someone who “lives to try cases.”

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Compliance Policy

EU’s Karas Says Draft Deal on Basel Banking Law Reached

European Union lawmakers and representatives of member states reached a preliminary compromise on the bloc’s new banking rules, the lawmaker leading the talks said.

The draft deal was made during discussions last week between legislators and Ireland, the current holder of the EU presidency, Othmar Karas, vice president of the European Parliament, said at a conference in Vienna today.

Compliance Action

CBOE in Settlement Talks Over SEC Probe, Sets Aside $5 Million

CBOE Holdings Inc. said it’s in settlement talks over a U.S. Securities and Exchange Commission investigation and has set aside $5 million to cover the resolution.

The biggest U.S. options market by volume said a year ago that regulators were probing whether the company complied with its obligations as a self-regulatory organization. American exchanges are required to write rules for their markets, monitor trading and seek to ensure that they and their customers aren’t breaking securities laws.

“We’re engaged in ongoing settlement discussions with the SEC staff on the resolution of this matter,” Chief Financial Officer Alan Dean said on a conference call with analysts. “No agreement has been reached.”

John Nester, a SEC spokesman declined to comment. Gail Osten, a spokeswoman for CBOE, declined to provide more information.

Interdealer Brokers Emerge as Key Enablers in Libor Scandal

Interdealer brokers, the middlemen who line up buyers and sellers of securities for banks, are emerging as key enablers in the Libor scandal after three firms paid a total of $2.6 billion for rigging global interest rates.

Employees at firms including ICAP Plc, the world’s biggest interdealer broker, and RP Martin Group Ltd., a smaller British competitor, passed on requests from derivatives traders asking rate-setters at others banks to make favorable submissions, e-mails released as part of the global probe of interest rate-rigging show. In some cases, the middlemen took bribes as payment for the services in the form of so-called wash trades, regulators said, without identifying the firms that did.

The brokers assumed greater influence as credit markets froze at the start of the financial crisis in 2007. Bankers charged with making submissions to the London interbank offered rate increasingly relied on information from the brokers to determine what figures to contribute.

Brokers were willing to help traders to win future work. Some were also rewarded with so-called wash trades, where counterparties place two or more matching trades through a broker that cancel one another out while triggering a payment of fees to the middle man, according to transcripts released by regulators on Feb. 6.

Spokesmen for RP Martin and the FSA declined to comment. involved with.

“I’m pleased that the FSA and other regulators are investigating this thoroughly and rooting out any wrongdoing so that the industry can, in time, heal and move on and learn from it and be better for it,” Chief Executive Officer Michael Spencer told reporters last week.

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Citigroup Argues for Approval of $285 Million SEC Settlement

Citigroup Inc. asked a U.S. appeals court to overrule a trial judge and let its $285 million mortgage-securities settlement with the Securities and Exchange Commission go forward.

The bank is challenging U.S. District Judge Jed S. Rakoff’s 2011 refusal to approve the agreement, which would resolve claims that New York-based Citigroup misled investors in a $1 billion financial product linked to risky mortgages. The SEC claimed Citigroup cost investors more than $600 million.

Rakoff criticized the SEC practice of agreeing to settlements that don’t require defendants to admit wrongdoing. He said the parties didn’t give him “any proven or admitted facts” he could use to determine whether the settlement was fair.

Brad Karp, a lawyer for Citigroup, argued Feb. 8 to a three-judge panel of the U.S. Court of Appeals in New York that if companies are forced to admit wrongdoing as part of a settlement, lawyers for shareholders will use the information to sue in securities-fraud cases. The companies would be better off not settling, he said.

SEC lawyer Michael Conley argued that courts should give deference to the agency’s judgment that a particular settlement is in the public interest.

John Wing, a lawyer appointed by the appeals court to defend Rakoff’s ruling, agreed that Rakoff can’t require Citigroup to admit liability as the price for approving the settlement.

Wing said the parties didn’t give Rakoff sufficient facts for him to determine whether the settlement was fair, adequate, reasonable and in the public interest, as required by law. He said Rakoff could require the parties to submit evidence from depositions, documents or affidavits.

The case is U.S. Securities and Exchange Commission v. Citigroup Global Markets Inc., 11-05227, U.S. Court of Appeals for the Second Circuit (New York).

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SEC Says Chicago Man Lured Chinese Investors in Citizenship Scam

The U.S. Securities and Exchange Commission sued a Chicago man over claims he fraudulently raised more than $145 million primarily from Chinese investors by promising that their investments would provide a pathway to U.S. citizenship.

Anshoo R. Sethi, 29, over the past 18 months duped more than 250 investors into believing that backing his project to build a hotel would give them access to the EB-5 Immigrant Investor Pilot Program, the SEC said in a Feb. 6 complaint unsealed Feb. 8 at U.S. District Court in Illinois. Certain investors who create or preserve at least 10 jobs for U.S. workers can get U.S. residency permits through the program.

A phone call to a number listed for Sethi wasn’t immediately returned.

The Chicago Tribune reported last year that Illinois Governor Pat Quinn’s administration originally supported Sethi’s project. In January 2012, however, state officials demanded that Sethi remove Quinn’s image and the state’s seal from materials he used to solicit investors, the Tribune reported.


Lew Will Have to ‘Wrestle’ With Dodd-Frank, Sachs Says

Lee Sachs, co-chief executive officer of Alliance Partners and a former assistant U.S. Treasury secretary talked about Timothy F. Geithner’s legacy as U.S. Treasury secretary and the outlook for Jack Lew, President Barack Obama’s nominee to succeed Geithner.

Sachs spoke with Erik Schatzker, Stephanie Ruhle and Hans Nichols on Bloomberg Television’s “Market Makers.”

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Banks Should Have Tougher Internal Auditors, FSA’s Bailey Says

Banks should have tougher internal auditors to stand up to senior decision makers within the firm and oversee risk taking, said Andrew Bailey, head of banking supervision at the Financial Services Authority.

Regulators now expect banks to have internal auditors that can provide a challenge to management, “driving improved governance, risk management and internal controls,” Bailey said in an e-mailed statement.

Bailey’s comments came in support of draft guidelines published by the Chartered Institute of Internal Auditors that seek to improve governance within banks.

Comings and Goings/Executive Pay

Banks Should Defer Bonuses for Up to 10 Years, Jenkins Says

Bankers’ bonuses should be deferred for as long as 10 years to hold executives accountable for risks, said Robert Jenkins, a member of a Bank of England committee charged with ensuring financial stability.

“Five years might or might not be appropriate for some categories of risk, but if we are going to rely on remuneration as a key driver of financial stability then it should probably be between five or ten years,” Jenkins said in an interview Feb. 7 in Washington. “Ten years would capture the majority of risk cycles and therefore the gains and losses that came from any risk that was taken today.”

Jenkins’ comments echo those of Andrew Haldane, another member of the BOE’s Financial Policy Committee, and signal U.K. regulators may continue to push banks to reduce risks. The central bank, which is adding regulatory powers to its monetary-policy remit, said in November banks may need to raise more capital to cover loan losses and that they may have overstated their capital strength.

Banks are already cutting pay and increasing deferrals as investors demand higher returns.

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