S&P Fraud Trial: Is the DOJ Looking for a Scapegoat?

Federally insured financial institutions that relied on ratings assigned by McGraw-Hill’s (NYSE:MHP) Standard & Poor’s suffered huge losses during the financial crisis, and during its aftermath, the Justice Department has attempted to prove that the company’s mortgage-backed securities ratings were fraudulent. Filing a civil complaint back in February, government officials said that S&P could face more than $5 billion in civil penalties if its ratings are found to have been incorrect.

The Justice Department brought its lawsuit under the 1989 Financial Institutions Reform, Recovery, and Enforcement Act  – a legislation that allows the government to obtain civil penalties for fraud affecting federally insured financial institutions.

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S&P — the largest rating company in the United States — must file its response to the claims in federal court in Santa Ana, California by Tuesday, which will be the rating firm’s first attempt at fighting off the Justice Department’s allegations. “They won’t get the entire complaint dismissed at this stage,” John Hueston, a former federal prosecutor, told Bloomberg. “At best, a part of it might get dismissed”…

In his estimation, S&P cannot support its request to have the case dismissed by supplying evidence that contradicts the accusations. The firm can only argue that the federal government will be unable to prove its civil fraud claims even if the allegations in the complaint are true, he added. In basic terms, this means that S&P can claim that the Justice Department was not as specific in its complaint as required by law. However, if U.S. District Judge David Carter, who is overseeing the case, supports that claim, the government would likely be allowed to file a new complaint, Hueston told the publication.

The Justice Department’s claim alleged that S&P “knowingly and intentionally defrauded investors in residential mortgage-backed securities and collateralized-debt obligations that included those securities for which the company provided credit ratings,” stated Bloomberg. Its investigation into the matter — a probe code-named “Alchemy” — began in November 2009, making this lawsuit the culmination of a “massive, multiyear investigation” by a team of almost two dozen lawyers, as Stuart Delery, principal deputy assistant attorney general, told the publication.

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In particular, the department alleged that S&P had misled the government when it stated its credit ratings were free of conflicts of interest because the firm actually downplayed or disregarded credit risks to secure business from investment banks and other issuers of the securities. These institutions, noted Bloomberg, paid S&P to provide the ratings and sought to obtain the highest possible ratings. In the 119-page complaint, the government based its allegations on meetings, messages, and memos that it said showed S&P analysts assigned ratings with no regard to accuracy.

One email read, “We rate every deal,” according to the government. “It could be structured by cows and we would rate it.”

However, the S&P said in a February statement seen by Bloomberg that the “e-mail excerpts cherry-picked by DOJ have been taken out of context, are contradicted by other evidence, and do not reflect our culture, integrity or how we do business.” In its motion to dismiss, the firm has claimed that the emails were written by individual employees, and therefore they are not evidence of systemic fraud.

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Neil Kaufman, chairman of the corporate department at the law firm Abrams Fensterman, told the publication that the S&P probably will be unable to dismiss the lawsuit because the standard for throwing out such a complaint is high. “I doubt this case is going to trial,” he said, predicting that the company will eventually reach a settlement with the Justice Department. “I think the government is looking for a scapegoat.”

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