The U.S. Justice Department announced plans to file civil fraud
charges against Standard & Poor’s (S&P) relating to the
atrocious ratings that Standard & Poor’s gave to toxic subprime
mortgage-backed securities. (It is unclear whether their cohorts at
Moody’s and Fitch will be targeted by prosecutors as well.) This is a
welcome—if long overdue—development for investors who have been waiting
for years for the Feds to take decisive action against those responsible
for crashing the world economy.
New York Times reporters Andrew Ross Sorkin and Mary Williams Walsh report that
smoking gun e-mails and instant messages cited by the Feds show that
the folks at S&P were not duped by the securities’ issuers. They
knew exactly what they were doing. One S&P employee wrote, “Rating
agencies continue to create an even bigger monster — the C.D.O. market.
Let’s hope we are all wealthy and retired by the time this house of card
falters.” Another wrote in an instant message, “We rate every deal. It
could be structured by cows and we would rate it.”
To any fair-minded observer, these e-mails sure look like fraud
because the rating agencies projected an image that they were
“objectively” rating securities that were purchased by pension funds,
institutions and ultimately the Mom-and-Pop investors who often had
their retirement savings tied up in these funds. Instead, it appears
they were slapping bogus ratings on poor-quality, high-risk mortgage
bonds just to ensure they got their fees, ignoring the fact that real
people were counting on them to give an independent view of the safety
of the investments.
The Justice Department action follows a landmark decision by a New York
Federal Court holding that investors who were harmed by phony ratings
could sue the rating agencies for damages. After years of successfully
hiding behind a First-Amendment defense that their ratings were
opinions—not objective statements—and therefore Constitutionally
protected as free speech, the Court ruled in 2009 that the ratings were
not just opinions but rather misrepresentations resulting from either
fraud or negligence. That ruling ripped off the ratings agencies’ cloak
of immunity and set the stage for the Justice Department’s move.
We now know that the rating agencies rated “cows”, “dogs” and plenty
of “pigs.” Every mortgage-backed security and the various tranches or
“slices” of these securities dumped on investors had to have the ratings
agencies’ seal of approval to get out the door. Simply put, nobody
would buy them and they couldn’t be sold without the rating agencies’
imprimatur.
It has been revealed that the rating agencies were paid by the
companies they rated. This is reminiscent of the stock analyst scandal
of the year-2000 tech bubble where Merrill Lynch, Citigroup
and others gave high ratings to companies that did investment banking
business with their firms. One hand washed the other, the companies that
were given high ratings in essence paid the stock analysts’
multi-million-dollar salaries.
Imagine if a new so-called four-star restaurant paid a New York Times
reviewer to give it a top rating. This is exactly what occurred with
the rating agencies during the financial crisis, rating “garbage” stocks
and bonds as “top-shelf” investment products.
The announcement of the prosecutor’s lawsuit crashed the stock price
of Standard & Poor’s parent, McGraw Hill, as well as the stock of
Moody’s.
It really seems that finally, after five long years of just hoping
the problem would go away, the chickens are coming home to roost for
S&P, and Moody’s and Fitch probably feel their collars tightening
just a bit as well.
Disclaimer: Zamansky & Associates (www.zamansky.com) are securities attorneys
representing investors in federal and state litigation and arbitration
against financial institutions, including issuers and sellers of
mortgage-backed securities.
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