By now, most know that the U.S. Justice Department filed a $5 billion lawsuit against S&P this week. Accusations include a massive scheme designed to defraud investors right before the financial crisis in 2008. The goal, says the lawsuit, was to gain as much business as possible before the bottom fell out.
As soon as the lawsuit announced, shares began falling. McGraw Hill Inc, which owns the S&P, has lost 25% this week. S&P said in a statement on Tuesday that the lawsuit is without merit and said it will vigorously defend itself.
The theory that the suit is being based is that the firm claimed its ratings on mortgages were objective and were in no way influenced by any type of conflict of interest. Ah – but many thought this suit and others like it would ever stand up to the litmus test. By avoiding individual ratings which can usually get past claims of free speech, prosecutors are focusing on proving one simple statement as a lie. That statement being that objectivity is used when it comes to ratings. The lawsuit also alleges ratings were inflated while risks were downplayed. Remember – this all began in the weeks and months before the mortgage meltdown that sent the U.S. economy into a downward spiral.
As part of the government’s suit against S&P, there are countless emails that have proven embarrassing and damaging for the agency. One email includes a realization that the email author, as well as his coworkers, noted that the subprime mortgage market was nearing a crash, though from the verbiage, it would appear as though it were a joke between the author and the addressee.
When you have that kind of evidence that looks bad, you don’t want to dismiss the case until you have more discovery,
said a government official. What could proven even more damaging is that many are saying this type of behavior and vulnerability isn’t limited just to the S&P or Moody’s. One analyst called it a “prelude to more action”.
It may very well be that the government’s testing their waters…they don’t want to bite off more than they can chew,
said Philip Hilder, who’s a former prosecutor for the governor but who now is the founder of Hilder & Associates in Houston. He stresses the importance that no one should take these types of cases – nor the potential for a domino affect – lightly.
Now, though, it seems as though Moody’s is in the crosshairs and could be in the same financial hot water as the S&P.
Not only is the Justice Department weighing its options, but there are several states that are discussing their legal options. The accusations are similar to what the S&P is facing. Among potential charges are defrauding investors. It’s not likely, though, to gain any momentum until after the S&P suit has been resolved. Those in the know are also saying the discussions are in the early states and that there are many dynamics at play, including both federal and state laws and a lack of resources. Most resources are being used in the current lawsuit.
Meanwhile, a spokesperson for Moody’s says it will use all of its own resources to fight any potential suits. Many may recall the 2011 report that revealed several ratings agencies had been manipulating various ratings. Moody’s defended itself and said at the time,
Moody’s takes the quality of its ratings and the integrity of the ratings process very seriously,
It also said the agency has built in protective mechanism that separate the commercial from the analytical considerations of the business model.
State and Federal Charges
It could be the most information will come from the state level and they continue to compile evidence. Moody’s continues to insist its code of conduct is solid and
not…affected by the existence of, or potential for, a business relationship between (Moody’s)…and the Issuer…
Connecticut is one of those states and it says in its own lawsuit that Moody’s did not adhere to even its own code of ethics. There are at least two more states suing with more likely to follow and both say they too have sufficient evidence to move forward.
This representation by Moody’s was false and Moody’s knew it,
the Connecticut complaint said.
What has been discovered, however, includes managers who were evaluated based on their ability to build market share. Former employees have already testified that many were fired, on the spot, whenever senior management had a problem with suggestions and calls to action.
The fear was real, not rare and not at all healthy. You began to hear of analysts, even whole groups of analysts, at Moody’s who had lost their jobs because they were doing their jobs, identifying risks and describing them accurately,
former Moody’s senior vice president Mark Froeba testified to the subcommittee several months ago.