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U.S. Federal Judge Calls S&P Defense "Deeply and Unavoidably Troubling"

Source: Dow Jones

Posted on 18 Jul 2013 by Neilson

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S&PIn a ruling allowing the Justice Department's $5 billion lawsuit against Standard & Poor's Ratings Services to move forward, a U.S. district judge said the rating firm's "puffery" defense is "deeply and unavoidably troubling."

U.S. District Judge David O. Carter for the Central District of California in Santa Ana denied S&P's request to throw out the Justice Department's lawsuit in a court filing published late Tuesday.

The decision affirms a tentative ruling Judge Carter issued last week but uses more pointed language.

Judge Carter said at the time that he would issue a definitive ruling this week. Lawyers not involved with the lawsuit said they had expected that Judge Carter's final ruling would mirror that earlier decision.

In a statement, an S&P spokesman said the court's decision "was not on the merits of the case as the judge was required at this preliminary stage to accept as true all the factual allegations in the complaint."

He added: "We now welcome the opportunity to demonstrate the lack of merit to the Department of Justice's complaint. We firmly believe S&P's ratings were and are independent and expect to show just that in court."

A spokeswoman for the Justice Department declined to comment.

The federal government claims that S&P was fraudulently misrepresenting its ratings process as independent and objective when behind the scenes the company was allegedly catering to bankers and other clients that wanted high ratings.

Lawyers for S&P have claimed that the statements about independence and objectivity highlighted by the federal government as alleged fraudulent misrepresentations--such as employee codes of conduct and official policy statements about the company's process for rating deals--were generic, corporate "puffery" statements that were not meant to be taken at face value by investors.

That means S&P's statements to investors about its ratings process for mortgage-linked securities can't form the basis for a fraud lawsuit, lawyers for the world's largest credit-rating firm have said.

In his ruling Tuesday night, Judge Carter pushed back against that defense. "Defendants lead off with a proposition that is deeply and unavoidably troubling when you take a moment to consider its implications," Judge Carter said. "They claim that, out of all the public statements that S&P made to investors, issuers, regulators, and legislators regarding the company's procedures for providing objective, data-based credit ratings that were unaffected by potential conflicts of interest, not one statement should have been relied upon by investors, issuers, regulators, or legislators who needed to be able to count on objective, data-based credit ratings."

Then, using identical language to his tentative ruling, Judge Carter said: "Despite defendants' protestations to the contrary, the court cannot find that all of these 'shalls' and 'must nots' are the mere aspirational musings of a corporation setting out vague goals for its future."

He added "Rather, they are specific assertions of current and ongoing policies that stand in stark contrast to the behavior alleged by the government's complaint."

Judge Carter's ruling builds momentum for the Justice Department in a case that is a key part of the U.S. federal government's bid to try cases stemming from the financial crisis. The stakes are equally high for S&P, a unit of McGraw Hill Financial Inc. (MHFI). The Justice Department says it is seeking to recover more than $5 billion in losses allegedly suffered by federally-insured banks and credit unions. S&P has pushed back on that figure, saying the federal government hasn't specified how it got to that number.

S&P had asked the judge in an April 22 court filing to dismiss the Justice Department's entire lawsuit, setting up an initial legal hurdle for the federal government. Judge Carter could still ultimately throw out parts--or even all--of the government's lawsuit against S&P as the case moves through the court, lawyers not involved with the lawsuit said.

The case could stretch on for years if a settlement isn't reached. S&P balked at earlier settlement talks. The U.S. has asked the judge to approve a Feb. 2015 jury trial date.

The U.S. sued S&P, the world's largest credit-rating firm, on Feb. 4, alleging the company placed profits ahead of standards when it assigned top-notch, triple-A ratings to deals backed by subprime mortgages and other assets. S&P has said the lawsuit is "meritless" and that the federal government is seeking to unfairly pin the financial crisis and its aftermath on the company. The company's top rivals and federal agencies also failed to foresee the strength and pace of the housing crisis, S&P says, and therefore it shouldn't be singled out as the sole culprit.