S.&.P. Announces $1.37 Billion Settlement With Prosecutors

http://dealbook.nytimes.com/2015/02/03/s-p-announces-1-37-billion-settlement-with-prosecutors/?_r=1

Posted by Joel CHUA Yong Sheng, Year 4 undergrad at the School of Economics, Singapore Management University

S.&.P. Announces $1.37 Billion Settlement With Prosecutors

By BEN PROTESS FEBRUARY 3, 2015 8:40 AM February 3, 2015 8:40 am 84 Comments Updated, 10:08 a.m. | 

Nearly a decade after credit rating agencies fed a subprime mortgage frenzy that imperiled the global economy, one of the industry’s biggest players now faces a costly reckoning. Standard & Poor’s, a rating agency accused of inflating its assessment of mortgage investments that spurred the 2008 financial crisis, said on Tuesday that it had agreed to pay $1.37 billion to settle wide-ranging civil charges from the Justice Department as well as 19 state attorneys general and the District of Columbia. S.&P. also signed a statement of facts that outlined its role in the mortgage crisis, but the ratings agency did not admit to wrongdoing, securing a major concession from the government.The settlement, which does not require judicial approval, all but closes the book on one of the government’s signature Wall Street cases. The Justice Department sued S.&P. two years ago this week, setting in motion a wave of lawsuits from states across the country. The government’s decision to settle signals that its pursuit of crisis-era misdeeds has entered a final stage. The settlement of the S.&P. case, coming on the heels of banks and other financial firms collectively paying more than $40 billion to end federal and state investigations, was among the government’s few remaining items of unfinished business from the crisis. “The settlement we have reached today not only makes clear that this kind of conduct will never be tolerated by the Department of Justice – it also underscores our strong and ongoing commitment to pursue any company or entity that violated the law and contributed to the financial crisis of 2008.” Attorney General Eric H. Holder Jr. said at a news conference Tuesday. As for S.&P., he said that “on more than one occasion, the company’s leadership ignored senior analysts who warned that the company had given top ratings to financial products that were failing to perform as advertised.” In its own statement, S.&P. said that “after careful consideration, the company determined that entering into the settlement agreement is in the best interests of the company and its shareholders and is pleased to resolve these matters.” In a separate settlement also announced on Tuesday, S.&P. agreed to pay the California Public Employees’ Retirement System, the large public pension fund, $125 million to resolve claims over ratings of three investment deals. Like the Justice Department case, the terms of the Calpers settlement are not subject to judicial approval. For S.&P., the battery of settlements provides some peace to a process rife with animosity. After years of low offers and sharp-tongued barbs — S.&P. claimed the Justice Department’s case amounted to “retaliation” after it cut the stellar AAA credit rating of the United States years earlier — it was unclear whether the rating agency would ever back down. But in the statement of facts, S.&P. acknowledged that “the voluminous discovery provided to S.&P. by the United States to date” does not “support its allegation” that the Justice Department had acted out of spite. It agreed to withdraw that allegation in court, a surprising about-face for S.&P. Yet the ratings agency did not address in the statement of facts whether additional evidence would have yielded a different conclusion. The $1.37 billion penalty, like the statement of facts, is the product of compromise. The penalty, half of which is earmarked for the federal government and the rest for the states, is large enough to wipe out S.&P.’s operating profit for a year, and is three times what S.&P. originally offered to settle before the Justice Department filed its lawsuit. But it also falls far short of the $3.2 billion that the government demanded after S.&P. initially refused to settle. S.&P.’s decision to fight the Justice Department’s case caught Wall Street and Washington by surprise. It is one thing to challenge, and defeat, a private lawsuit. But nearly every financial institution that faces a Justice Department lawsuit eventually breaks down and settles, fearing that a courtroom fight might antagonize the government and unnerve shareholders. Such outcomes — $1 billion is now a floor rather than a ceiling for a settlement — have led Wall Street lawyers to criticize what they call a government shakedown. And yet, some lawmakers and consumer advocates complain that the civil lawsuits are little more than a slap on the wrist for companies that helped ignite the worst financial crisis since the Great Depression. Not one top executive at S.&P., or any major Wall Street firm for that matter, was charged criminally for the misdeeds during the era. From the onset of the crisis in 2007, lawmakers and investigators pinned blame on the rating agencies. A federal commission that investigated the crisis described the rating agencies as “essential cogs in the wheel of financial destruction.” The accusations centered on the role that rating agencies like S.&P., a unit of McGraw Hill Financial, played in the subprime mortgage market. In the run-up to the crisis, Wall Street’s mortgage machine hummed: Lenders churned out mortgages to families with checkered credit histories; banks bundled the mortgage into securities to sell to investors; rating agencies, bending to the will of the banks, awarded generous grades to the securities, inflating the mortgage bubble to a point of no return. In subsequent lawsuits against S.&P., state attorneys general and the Justice Department argued that the process went too far. Citing a series of errant emails that provide a glimpse inside S.&P. on the eve of the mortgage bubble bursting, the government agencies portray a company that ignored signs of a looming disaster to pump up its profits. In one March 2007 email, an S.&P. analyst parodied the Talking Heads song “Burning Down the House,” adapting the lyrics to fit the mortgage bubble: “Subprime is boi-ling o-ver. Bringing down the house.” At the news conference Tuesday, Mr. Holder took aim at the profit-driven strategy. “As S.&P. admits under this settlement, company executives complained that the company declined to downgrade underperforming assets because it was worried that doing so would hurt the company’s business,” he said. “While this strategy may have helped S.&P. avoid disappointing its clients, it did major harm to the larger economy, contributing to the worst financial crisis since the Great Depression.” The Justice Department’s lawsuit argued that the rating agency had a conflict of interest, because the banks that created the mortgage investments paid S.&P. to rate the deals. That conflict “improperly influenced” the ratings criteria, the Justice Department said. It also accused S.&P. of falsely claiming that its ratings “were objective, independent, uninfluenced by any conflicts of interest.” “In effect, S&P considered its own business interests, contrary to its public statements that its ratings were objective,” said George Jepsen, the Connecticut attorney general, one of the first to sue S.&P. “These actions had a very direct and serious impact on our national economy that is still being felt in communities and households in Connecticut and across our country.” S.&P. argued that its claims of objectivity were mere “puffery,” akin to corporate marketing, and could not be taken seriously. The ratings agency called the Justice Department’s lawsuit “meritless” and vowed to fight it “vigorously.” That fight turned hostile when S.&P. claimed in a legal filing that prosecutors “commenced this action in retaliation” for the rating agency’s 2011 downgrade of the United States credit rating. And it sought to impugn Timothy F. Geithner, the Treasury secretary at the time of the downgrade, saying he called a McGraw Hill executive to warn that S.&P.’s conduct would be “looked at very carefully.” At the time, a spokeswoman for Mr. Geithner said that “the allegation that former Secretary Geithner threatened or took any action to prompt retaliatory government action against S.&P. is false.” Last year, both sides softened their stance. The rating agency’s lawyers met with state and federal authorities, drawing up the contours of a settlement. The ensuing deal, announced on Tuesday, represents a central plank in a broader strategy shift at S.&P: forgoing costly litigation to make peace with the government. Last month, S.&P. settled an unrelated case with the Securities and Exchange Commission as well as state attorneys general in New York and Massachusetts, paying nearly $80 million for accusations that it misled the public about its approach to rating certain commercial mortgage investments. The settlement mentality reflects a change atop McGraw Hill’s legal department, which recently installed a new general counsel, Lucy Fato, formerly a partner at the law firm Davis Polk. Ms. Fato has led many of the negotiations in the settlement with the Justice Department and state attorneys general. The settlement with the Justice Department captured that push. Both sides, the agreement said, settled “to avoid the delay, uncertainty, inconvenience, and expense of further litigation.”

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