S&P's Outrageous, Clever Fraud Defense

U.S. attorney general Eric Holder at a Washington news conference in February Photograph by Andrew Harrer/Bloomberg

Standard & Poor’s has filed its motion to dismiss the U.S. Justice Department’s big fraud suit, which accuses the rating agency of helping trigger the 2008 financial crisis. The company’s defense lawyers came up with a theory that seems on its face outrageous, even insulting. It just might work.

S&P, a unit of McGraw-Hill, former owner of Bloomberg Businessweek, has hired two of the nation’s best known attorneys to fend off the multibillion-dollar civil suit that the Obama administration filed in February. John Keker, a San Francisco-based white collar trial lawyer, and Floyd Abrams of New York, probably the country’s most prominent First Amendment media attorney, make for a formidable duo.

As expected, their motion, filed on April 22 in southern California, derides the government’s accusations as “a stretch,” emphasizing that rival agencies Moody’s and Fitch issued ratings of mortgage investments identical to S&P’s, yet weren’t named as defendants. That’s a logically appealing contention, as it’s far from obvious why the Justice Department singled out S&P.

More provocatively, the Keker-Abrams team says that S&P cannot be held liable for its prolific claims of integrity and analytic skill because those boasts were the sort of baloney that investors and the wider public never take seriously in the first place.

The Justice Department’s complaint does rest, in part, on S&P’s self-descriptions as “the world’s leading provider of independent opinions and analysis on the debt and equity markets,” as well as “the world’s foremost provider of independent credit ratings, indices, risk evaluation and investment research.”

“By their nature,” however, “these kinds of statements are not actionable,” S&P’s lawyers contend. The promotional rhetoric amounts to “classic puffery,” the defense adds. “Such statements are too general to serve as the basis of a fraud claim.” A “reasonable investor” would not rely on the statements in deciding whether to trust S&P’s ratings, according to the agency. In other words: Only a sap would believe the nice things we say about our work.

How’s that for cynical? The Justice Department alleges that S&P knowingly inflated its AAA ratings to earn more business from major banks that hired it to rate their complicated real estate-related securities. S&P counters that it honestly, if often incompetently, failed to anticipate that the instruments in question–CDOs, RMBSs, and so forth—would lose value when the housing market tanked. As for all the talk of fearless independence in passing these judgments, S&P now says: No one takes that kind of blather any more seriously than a billboard advertising, “Fred’s Used Cars—The Best in Town.”

Keker and Abrams seem to go out of their way to make fun of the Justice Department. They mock the nationally televised press conference that was called in Washington to announce the suit: “With much fanfare, a parade of senior officials congratulated one another for their efforts—the hundreds of subpoenas they had served, the thousands of hours their team devoted to the case, the millions of documents they had read. Notwithstanding all the back-slapping, the government’s complaint fails to state a claim.”

The real punch behind S&P’s motion comes from the lawyers’ invocation of precedent. It turns out that a series of federal courts around the country have recently dismissed similar allegations of fraud against S&P based on the identical don’t-take-our-puffery-to-heart defense. The most recent ruling came in December from the federal appeals court in New York, which affirmed a trial judge’s dismissal of a securities fraud action against S&P brought by a Florida-based pension fund.

U.S. District Judge David Carter has scheduled a hearing in Santa Ana, Calif., for May 20, when he will review S&P’s request that he toss the Justice Department’s suit. The precedents Keker and Abrams cite present a difficult obstacle that the government will have to distinguish—and somehow overcome—before it can move toward a trial.

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