The S&P Fraud Case as Theater of the AbsurdPaul M. Barrett
Sometimes litigation throws such weird light on business and human affairs that it’s best to view the proceedings as ironic commentary on the underlying issues, rather than a rational search for truth, let alone justice. Such is the case with Standard & Poor’s defense against the federal government’s $5 billion fraud lawsuit.
The Justice Department, as you’ll recall, has accused S&P of helping cause the 2008 financial crash by inflating its ratings of esoteric subprime-backed securities. The company’s purported motive: pleasing the investment banks that pay its fees. The rating agency’s first line of defense was that it couldn’t be held liable for its claims of integrity because no sensible investor would believe its “AAA” rubber stamp.
In July, a federal judge in Santa Ana, Calif., brusquely rejected S&P’s “mere puffery” defense. If one read between the lines of his ruling, U.S. District Judge David Carter seemed incredulous that a company that bases its reputation on independent judgment would maintain with a straight face that it’s immune from legal consequences because no one takes its judgment seriously. “If no investor believed in S&P’s objectivity,” the judge wrote, “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?” It seemed like something from the theater of the absurd.
Now S&P has a new pitch that would make Samuel Beckett and Eugene Ionesco proud. The rating company has accused the Obama administration of “retaliation” for S&P’s downgrade of U.S. creditworthiness in 2011. “Only S&P Ratings downgraded the United States and only S&P Ratings has been sued by the United States, even though the S&P ratings challenged by the United States were no different than those of at least one other rating agency and other rating agencies have made the same assertions of ‘independence’ that are challenged in the complaint as against S&P,” the New York-based company said in the Sept. 3 court filing. In August 2011, S&P downgraded the U.S.’s 60-year-running “AAA” credit rating to “AA+” with a “negative outlook.”
The government, unsurprisingly, denies that its suit is merely a gesture of revenge. The Justice Department responded to questions about S&P’s filing by citing a Feb. 5 press conference announcing the case during which Associate Attorney General Tony West said there was “no connection” to the downgrade. S&P has presented no plausible evidence—in the form of memos or whistle-blower testimony—to support its retaliatory conspiracy charge.
More interesting than the pretrial finger-pointing itself are the bizarre, if inadvertent, incongruities S&P continues to highlight in court. Having initially gone with don’t-mind-our-puffery, S&P proceeds to invite comparisons between its woefully inaccurate (and suspiciously rosy) precrisis ratings and its so-far woefully inaccurate 2011 prediction that the entire U.S. government had become a less reliable investment. S&P was dead wrong about subprime securities during the housing bubble, and as the U.S. economy has slowly recovered from recession, it has been wrong again about the safety of buying Treasury securities. Maybe S&P is still trying to prove its point that no one ought to take it seriously.
S&P’s retaliation defense also highlights that its rivals, Moody’s and Fitch, issued ratings similar to S&P’s and yet haven’t been named as defendants. Granted, the Justice Department hasn’t explained why it singled out S&P. Yet if one thinks about this a little more, S&P’s objection isn’t much different from that of any target of government law enforcement. It’s always sort of unfair when the feds go after some but not all alleged offenders. Unable to police misconduct on a truly systematic basis, the authorities often crack down on one high-profile player to send a message to the marketplace. The unlucky recipient of the government’s unmerciful attention almost always feels persecuted. Just ask Steven Cohen and his hedge-fund firm SAC Capital Advisors. The question is not whether “everyone is doing it”—it’s whether the Justice Department can show by means of testimony and documents that you did it.
Can the government make its case against S&P? That’s far from obvious. There’s a big difference between incompetence and fraud. Eventually, S&P will have to narrow its defense to the matter of whether its closely followed and highly lucrative predictions were faulty or dishonest. In the meantime, enjoy the strange theater.