Rounding Up Some Critical Commentary on the DOJ’s Suit Against Standard & Poor's

As the Huffington Post reports, this past Tuesday:

The Justice Department accused S&P of knowingly inflating its ratings of risky mortgage investments that helped trigger the crisis. It's demanding $5 billion in penalties.

I’ve been reading some of the commentary on the suit, and there seems to be a lot of skepticism about its viability.

Over at DealBook, Peter J. Henning and Steven M. Davidoff cite the following hurdles the DOJ must overcome:

[1] The government will have to prove that ratings were in fact faulty, and published intentionally so as to deceive investors in the securities…. [2] Even if the Justice Department can prove the agency acted to deceive investors, it still has to deal with something lawyers call reliance. In other words, did investors rely on these ratings to make their decisions? … [3] Even if a fraud claim is established, S.& P. is sure to raise an old defense: the First Amendment’s protection for freedom of the press.

As to the latter point, Henning & Davidoff do note that:

By accusing S.& P. of fraud, the Justice Department may be able to undermine any First Amendment claim by the company. The protections afforded by the Constitution do not extend to statements made as part of a fraudulent scheme.

Henning & Davidoff conclude that:

While one might think disgust with financial institutions and distaste for ratings agencies will carry the day, the government has had a hard time winning fraud cases in court when juries actually look at the facts. It all means that the Justice Department will have its work cut out for it this time. 

Personally, I came away from their review unconvinced that the DOJ couldn’t overcome each of the hurdles Henning & Davidoff cite.  Go read the whole thing and see what you think.

Meanwhile, John Carney had the following to say over at CNBC.com:

The 119-page civil complaint filed Monday night by the Justice Department abounds with evidence, much of it from emails and instant messages between S&P employees, that concern over the company's market share influenced its ratings decisions…. But this only looks bad if you make the additional assumption that the issuers of the credit products S&P was rating did not care about the quality of the ratings. That is, for the Department of Justice's basic theory of the case to make sense you have to believe that the investment banks creating collateralized debt obligations wanted high ratings at any cost—even if the ratings were highly inaccurate…. Which means that the Justice Department will have to prove that issuers demanded fraudulently high ratings in order to establish the claim that the agencies engaged in fraud by changing ratings in pursuit of market share.

I’m not so sure the DOJ will have to prove that.  Rather, it might be enough simply to prove that S&P thought that issuers demanded higher ratings.  By the way, I couldn’t help but be impressed by Carney’s ability to work a pejorative “socialist” reference into his review of the complaint:

The Justice Department … includes in its complaint an email from an executive … upset that proposed changes to rating criteria would include consideration of "market insight," ratings implications, and interviews with "3 to 5 investors in the product." … This isn't the voice of someone who believes in market processes. It's more like the voice of a socialist planner who thinks that his "search for truth" gives him unique access.

Speaking of the truth, over at Dealbreaker Matt Levine noted (apparently in defense of S&P) that:

[T]ruth-seeking is just one means to an end; the end is sales ….

Matt goes on to complain that:

Ten pages of the DoJ’s complaint ... are to the effect of “S&P kept telling people that its ratings weren’t influenced by commercial factors,” and that’s true [S&P did repeatedly proclaim that], but it’s in such obviously meaningless boilerplate that if you believed it you have no business investing in anything.

Again, I’m not sure that’s the greatest defense for S&P.

Finally, the fact that the DOJ is only suing S&P, while apparently leaving Moody’s and Fitch alone, was repeatedly mentioned as a weakness of the DOJ’s case.  In the meantime, however, it turns out that Moody’s and Fitch are also in the regulatory cross-hairs.