An odd defense for S&P

[fhdz]

http://online.wsj.com/article/SB10001424127887324235304578439010216689372.html

By JEANNETTE NEUMANN
Standard & Poor's Ratings Services has long declared that its letter-grade ratings are independent and objective, part of a bid to allay concerns over its business model.

Standard & Poor's, like all major credit-rating firms, is paid by issuers to rate the securities that they sell.

Regulators, lawmakers and investors have said the payment system presents a potential conflict of interest that could provide an incentive for Standard & Poor's and its rivals to cater to bankers and other issuer clients.

But Standard & Poor's , a unit of McGraw-Hill Cos., MHP -0.13%has long pushed back, saying its standards of objectivity and independence mitigate potential conflicts of interest.

Now, lawyers defending the company against the Justice Department's recent civil lawsuit say that statements about independence and objectivity are "puffery" and were never meant to be taken at face value by investors.

Standard & Poor's responded formally on Monday to the civil lawsuit that the Justice Department filed against the company on Feb. 4 in U.S. District Court in Los Angeles.

The federal government says that the rating firm committed fraud when it allegedly misrepresented its ratings as independent and objective.

In its formal defense filed Monday, S&P pointed to two earlier court decisions where judges ruled that such statements by the firm were puffery and therefore can't form the basis for a fraud claim.

Legally, that might be a tenable defense, some lawyers said.

But politically and reputation-wise, the assertion that S&P's longtime representation of its ratings process has been puffery comes at a sensitive time. U.S. and European regulators are hammering out new rules to step up regulation of S&P and its top rivals, such as Moody's Corp.'s MCO +0.15%Moody's Investors Service.

"Even if it's a viable legal argument, it's a pretty unattractive argument for S&P to be putting forward since they're basically in the business of charging clients for their reputation," said Samuel Buell, a law professor at Duke University and a former federal prosecutor. "What they're saying here is, 'When we're talking to investors about our own reputation, we're engaging in meaningless puffery.' "

"That's the whole point of the rating agencies, their seal of approval," Mr. Buell said.

One of the decisions highlighted by S&P's lawyers is a March 2012 ruling by U.S. District Judge Sidney H. Stein. The judge dismissed a securities-fraud lawsuit filed by McGraw-Hill shareholders, who maintained that they bought shares in the company believing that S&P's ratings were independent and objective.

"These statements were mere commercial puffery," and therefore can't form the basis for a fraud claim, Judge Stein wrote.

That decision was upheld in December 2012 by the U.S. Second Circuit Court of Appeals, which S&P also highlighted in its Monday filing.

"No reasonable purchaser of McGraw-Hill common stock would view statements such as these as meaningfully altering the mix of available information about the company," the three-judge panel wrote.

S&P lawyers, including First Amendment expert Floyd Abrams of Cahill Gordon & Reindel LLP, wrote in Monday's filing, that "most notably and revealingly, the government has simply chosen to ignore a Second Circuit opinion, filed just six weeks before the government filed its complaint and of which the government was fully aware, holding that the very same S&P statements the government relies upon here cannot be the basis for a finding of fraud under federal law."

The lawyers added: "S&P's ratings were objective, independent and uninfluenced by conflicts of interest. That, however, is beside the point."

The Justice Department dedicates about 10 pages of its 128-page lawsuit to documenting where and when S&P and company executives maintained that that its ratings were independent and objective.

S&P's code of conduct, adopted in October 2005 and maintained through July 2007, said that S&P's "mission" was to "provide high-quality, objective, independent, and rigorous analytical information to the marketplace," according to the Justice Department's complaint.

The federal government also includes additional statements made by an S&P executive at an April 2007 hearing in the U.S. Senate.

The executive told lawmakers that the firm's credit ratings were "grounded in the cornerstone principles of independence, transparency, credibility, and quality. These principles have driven our long-standing track record of analytical excellence and objective commentary."

Lawmakers, wary of the ability of rating firms to be objective and independent while rating a client's debt deals, proposed rules in the aftermath of the financial crisis to revamp the way credit-rating firms are paid to rate securities backed by mortgages and other assets.

Nothing has happened yet. The Securities and Exchange Commission is hosting a roundtable discussion on May 14 to discuss how regulators could change the payment model.

One option on the table is a proposal by Sen. Al Franken (D., Minn.) to create a board that would assign rating firms to rate deals. "As this lawsuit unfolds, it only becomes more clear that the credit rating industry is in need of serious reform, and that the American people and our economy are still at risk as a result of the conflict of interest in the industry," Mr. Franken said in a statement.

Jennifer Arlen, a securities-law professor at the New York University Law School, said that regardless of the outcome of the Justice Department's lawsuit, the evidence presented should bolster the case for a change in the way rating firms are paid to rate debt.

"Even if it is dismissed, one would hope that the recounting of this case and the conversations within S&P of all the market pressures that they were feeling subject to would highlight to the SEC that it cannot have a system that relies on credit rating agencies whose primary income comes from the issuers of the securities that it's rating," Ms. Arlen said. "This is a prescription for future disasters."

[Admiral Yi]

Very odd.

Only reasonable explanation is that they took at look at the expected legal costs of mounting a defense on the merits and said "that's a shitload of money."

[The Minsky Moment]

Marketing copy is marketing copy?  Whod've thunk?   

[The Brain]

My posts are objective.

[DGuller]

   "It wasn't fraud, it was just bullshit!"