TOPICS > Economy

Justice Department Charges Standard & Poor’s Defrauded Investors

February 5, 2013 at 12:00 AM EDT
The Justice Department filed a lawsuit against Standard & Poor's, claiming it committed fraud by inflating mortgage ratings between 2004 and 2007, helping fuel the financial crisis. Jeffrey Brown examines both sides of the case with Illinois Attorney General Lisa Madigan and Floyd Abrams of Cahill, Gordon & Reindel.

JEFFREY BROWN: In what’s seen as the first major federal action against a credit rating agency in the aftermath of the financial crisis, the Department of Justice announced today it had filed a civil suit against Standard & Poor’s.

The suit says that from 2004 to 2007, S&P committed fraud by falsely inflating ratings of risky mortgage investments, in order to increase its own profits, and that, in turn, helped fuel the financial crisis.

Tony West, the acting associate attorney general, said S&P’s false votes of confidence helped convince investors that those securities were safe to buy.

ACTING ASSOCIATE ATTORNEY GENERAL TONY WEST: The evidence reveals that S&P promised investors and the public that their ratings were based on data and analytical models reflecting the company’s true credit judgment, when, in fact, internal S&P documents make clear that the company would regularly tweak or bend, delay updating or otherwise adjust its ratings models to suit the companies’ business needs.

It’s sort of like buying sausage from your favorite butcher, and he assures you that the sausage was made fresh that morning and is safe. What he doesn’t tell, what he doesn’t tell you is that it was made with meat he knows is rotten and plans to throw out later that night.

JEFFREY BROWN: The government says S&P could be liable for $5 billion in damages. So far, it has not announced legal action against other leading credit agencies.

The Department of Justice declined our request for an interview, but 16 states and the District of Columbia have filed similar suits against S&P.

And we hear first from the attorney general of one of those states, Lisa Madigan of Illinois. I spoke to her earlier this afternoon.

Lisa Madigan, welcome.

LISA MADIGAN, Illinois Attorney General: Thanks for having me.

JEFFREY BROWN: So, what do you see is the essence of the case against Standard & Poor’s?

LISA MADIGAN: The essence of the case is that Standard & Poor’s repeatedly represented that their ratings were independent and objective, but in fact when you look at internal e-mails, as well as congressional testimony, what you learn is that their ratings were in large part motivated by retaining their clients and also gaining market share and increasing their profits.

They were not independent and they were not objective.

JEFFREY BROWN: So, the CDOs, the collateralized debt obligations, these are — this is tough stuff to explain, but can you give us an example of how it could work?

LISA MADIGAN: Well, I can break it down for you.

So, really, we’re talking about mortgage-backed investment. So the subprime loans that a lot of people have heard about over the last five or six years because of what happened when the economy collapsed, it was those types of products that were securitized. They were put into investment vehicles.

But in order for those investment vehicles to actually be purchased by pension funds, mutual funds, they had to be rated. So it was Standard & Poor’s that would come in and say that some of these, as you refer to them, CDOs, the RMBSes, had the highest rating, the AAA rating. Only then were they able to be purchased by some of these investors.

But all along, it was well known that those investments and that collateral wasn’t really not as good as they said. And so, at the end of the day, if you really look at why the financial collapse took place and why it was so large, it was because you had Standard & Poor’s saying that these were good, and they were really bad.

JEFFREY BROWN: Now, S&P put out a statement right away.


JEFFREY BROWN: In fact, they put it out yesterday, when this was — they knew this was coming.

They said, look, we used our best judgment, and they said in essence everybody was wrong. A quote: “Unfortunately, S&P, like everyone else, didn’t predict the speed and severity of the coming crisis.”

So, how do you prove otherwise?

LISA MADIGAN: Well, you prove it when you actually look at their internal e-mails. You prove it when you look at the fact that they had models they could have used that had better information.

And you see repeatedly really what was driving them were their profits. In addition, you also end up saying to yourself well, it’s no defense that to people were engaged in the same illegal behavior. Right? I’m a drug dealer. It’s no defense for me to say when I’m indicted, well, there’s a guy on the corner next block who is doing the same exact thing.

JEFFREY BROWN: The standard of proof in this case is to show that the ratings were faulty, but also — and they were intentionally so?

LISA MADIGAN: Well, it’s actually the standard of proof with the Consumer Fraud Act in the state of Illinois is to show that they made fraudulent statements regarding their independence and their objectivity.

In addition, when you look at what the federal people have to actually allege and prove, they do have intent to deal with, but they are going to be looking at whether or not Standard & Poor’s actually knew that those things were not the case.

JEFFREY BROWN: Now, what about the other ratings company — companies, because S&P wasn’t operating in a vacuum here? Neither were investors, right? Didn’t issuers — issuers and investors also have to look to the other ratings companies, and didn’t they often give similar or even identical ratings?

LISA MADIGAN: Right now, you do have out of Connecticut and Mississippi lawsuits against Moody’s, and it’s probably unlikely that you’re going to find anybody in my position or at the federal level who is going to comment on whether or not there are additional investigations that are going on.

JEFFREY BROWN: But that’s possible?

LISA MADIGAN: It is possible.

JEFFREY BROWN: You also have the problem, do you not, of determining who exactly was hurt and that that hurt came from relying specifically on these ratings?

LISA MADIGAN: Well, I don’t think there’s an enormous with proving who was hurt. I mean, we’re all well aware of what happened to our economy and the fact that there were millions of people who lost their jobs, who lost their homes, who lost their financial security in terms of their retirement savings.

JEFFREY BROWN: But to make those direct connections to S&P, to the rating?

LISA MADIGAN: It’s actually doable. So you actually look at, were there pension funds invested in these securities? And when they got a AAA rating, and they were ultimately downgraded to junk and they exploded, you can obviously determine what the damages are.

JEFFREY BROWN: This is a civil case, not a criminal case.

LISA MADIGAN: It is a civil case.

JEFFREY BROWN: And I ask you because there have been so many questions for the last few years about …


JEFFREY BROWN: … why so few individuals and institutions have been held to account for what happened.

Have the — has the federal government, have the states been aggressive enough? Why has so little actually happened?

LISA MADIGAN: Well, I think they have, and there’s a tremendous amount that has happened.

When you look at the robo-signing settlement, the $25 billion settlement, and you look at the fair lending settlements that have taken place, you will see that methodically, states, as well as the federal government, have been going through and have been really going, working their way up the chain, really starting with the mortgage lenders, working their way through the banks.

At this point, we’re looking at credit rating agencies. You have to obviously use the statutes that you have available. And you have to use the evidence that you have got. So I think this is a very strong suit to the federal government’s brain, and we now have 16 states and the District of Columbia that also have lawsuits on file against S&P.

JEFFREY BROWN: This is a strong suit, but it’s going to be a tough one to prove, though.

LISA MADIGAN: No, I don’t think it’s tough to prove.


LISA MADIGAN: If you read the complaint, there is an enormous amount of internal information that shows that they knew they weren’t being independent or objective. They knew they were rating junk, but saying it was high-quality.

JEFFREY BROWN: All right, Lisa Madigan, Illinois’s attorney general, thanks so much.

LISA MADIGAN: My pleasure.

JEFFREY BROWN: And now a response by Standard & Poor’s.

It’s represented by attorney Floyd Abrams. He’s a partner with the firm of Cahill, Gordon & Reindel.

So, Mr. Abrams, Lisa Madigan suggests this is a pretty clear-cut case of fraud. What’s the essence of the defense?

FLOYD ABRAMS, Cahill, Gordon & Reindel: Well, the defense is, first of all, there was no fraud.

There was no intent on the part of Standard & Poor’s to say anything, to rate anything other than what they thought the rating was. It’s perfectly true that there were internal debates, that there are some e-mails going back and forth by angry people, sometimes accusatory of each other.

But the underlying reality here is that the ratings at issue in this case are not only the same as that from other ratings agencies, but based on the same view of the economy that the secretary of the treasury, Mr. Paulson, had, and the head of the Council of Economic Advisers had and the people in the Fed had, that this wasn’t an outlying view.


There was a view as to — by how much the housing market might go down which was central to all of this, and there was disagreement, but the notion that there was fraud on the part of S&P for basically agreeing with all of these people about where the economy stood and how it was going is fanciful.

JEFFREY BROWN: Well, several issues you have raised there, but let’s go to the e-mails, because some of them seem quite damning, some people suggesting that the ratings were being handed out improperly.

I will just read one: “Let’s hope we are all wealthy and retired by the time this house of cards falters.”

That sounds like more than a disagreement about strategy. That sounds like — that language house of cards sounds quite strong.

FLOYD ABRAMS: Sure. And it was when it was first released in 2008 in front of congressional committees, and has been cited again and again.

That’s an angry person making an observation, obviously, obviously overstating it. It surely wasn’t meant literally. And to build a case, a fraud case, a case saying these people issued these ratings knowing that they weren’t right, that that’s not what really they meant, based on anecdotal evidence like that, is simply insufficient, because it’s not enough.

The government looked at 20 million documents of S&P. And, yes, no surprise, they find some embarrassing ones, they find some ones no lawyer would want his client to write. But I know what’s in the other 19,999,000 documents. And the case will be one in which we will be able to show, I believe, in a very straightforward manner that, taken as a whole, what the company was doing was simply trying its best in trying times to make a good judgment about what was going to happen in the future, a hard judgment.

That’s what ratings are. They’re predictions. And the predictions were the same as just about everyone else.

JEFFREY BROWN: But you heard Attorney General Madigan talking about everyone is doing it is no defense.

Now, they have not gone after — the feds at least haven’t gone after some of these to agencies, but if they do, then that sort of suggests looking at the ratings agencies for more than making bad bets, but for actually manipulating things.

FLOYD ABRAMS: Well, if they do and they’re right.

My point is not just that the ratings were consistent with those of other ratings agencies, but that they were consistent with the views, the dominantly held views of the secretary of the treasury and the head of the Council of Economic Advisers, the incorruptible, honorable, unchallenged on that level leadership in Washington, in the same government that is now bringing this lawsuit, who had the same view that the housing market wasn’t about to collapse in such a catastrophic manner that we would have a near depression in America.

That’s what happened.

JEFFREY BROWN: So, let me just — let me just ask you briefly, in our last 30 seconds, why do you think the government is bringing this case right now?

FLOYD ABRAMS: I don’t know why they’re bringing it. This has been a priority. They have looked for three years. They have had tons of people on this case. A lot of them, I’m sure, believe in it.

The point isn’t why they’re doing it. It’s just that they’re wrong in doing it.

JEFFREY BROWN: All right, Floyd Abrams, representing S&P, thanks so much.

FLOYD ABRAMS: Thank you.