Judge OKs S&P Fraud Suit, Nixing 'Puffery' Defense
The National Law Journal
The news just keeps getting worse for Standard & Poor's Financial Services.
Setting in stone a tentative decision reached last week, a federal judge in Santa Ana, Calif. refused late Tuesday to toss a Justice Department lawsuit accusing S&P of duping investors with inflated credit ratings for financial products backed by subprime securities. U.S. District Judge David Carter rejected arguments by S&P's lawyers at Cahill Gordon & Reindel and Keker & Van Nest that the company's statements about the integrity of its rating process are mere "puffery," allowing the government's potentially groundbreaking case to move forward.
In its Feb. 4 complaint, the DOJ accused S&P of presenting its ratings as objective and independent even as it catered to the whims of bankers, slapping top ratings on ill-fated securities that helped sink the economy. The DOJ is seeking $5 billion in civil penalties under the Financial Institutions Reform, Recovery and Enforcement Act of 1989, a law passed in the wake of the savings and loan crisis.
Following a July 8 hearing attended by The National Law Journal's Amanda Bronstad, Carter issued a tentative order concluding that statements S&P made about its ratings prior to the crash were plausibly relied upon by investors. S&P counsel John Keker had argued that the government's complaint rested on company statements that amounted to no more than "puffery" under the law. Given the generic nature of S&P's statements, Keker said, the allegations could pertain to as many as 5,000 securities offerings that S&P rated during in the run-up to the financial crisis. Assistant U.S. attorney George Cardona in Los Angeles countered that investors relied on S&P's statements as "material and important."
Carter forcefully rejected S&P's arguments in Tuesday's decision. Addressing S&P's contention that its statements were just corporate boilerplate, Carter wrote that S&P's statements on the objectivity of its ratings were not "the mere aspirational musing of a corporation setting out vague goals for its future." Rather, Carter wrote, they outlined "current and ongoing policies that stand in stark contrast to the behavior alleged by the government's complaint."
"The court finds that the government has sufficiently pleaded the intent required to support its fraud claims," the judge wrote.
S&P said in a statement that Carter's decision isn't based on the merits of the case. "We firmly believe S&P's ratings were and are independent and expect to show just that in court," the company said.
Keker declined to comment through a firm spokesperson. Cahill's Floyd Abrams, who also represents S&P, did not immediately respond to a request for comment.
The ruling continues S&P's recent reversal of fortune in financial crisis litigation. Prior to this year, S&P and other ratings agencies had defeated similar claims by casting their ratings as opinions and invoking their First Amendment rights. But in April, that streak started to sour when S&P and Moody's Investors Service paid a reported $225 million to settle two defective ratings suits brought by private plaintiffs lawyers in New York. The DOJ's suit before Judge Carter relies partly on discovery material marshaled by plaintiffs lawyers at Robbins Geller Rudman & Dowd in that case.
The day after prosecutors filed their complaint in February, 14 states and the District of Columbia filed their own cases against S&P over allegedly inflated credit ratings. Those state suits have since been consolidated in Manhattan federal court. The agency is also contesting a California False claims Act lawsuit filed by the California Public Employees' Retirement System and the California State Teachers Retirement System. And the suits don't seem to be letting up: Just last week, the liquidators of two Bear Stearns hedge funds filed suit in New York state court, accusing S&P, Moody's, and Fitch Ratings of misrepresenting the accuracy of their ratings.