The United States Justice Department filed a five billion dollar lawsuit on February 3 against credit-ratings agency Standard & Poor’s, over its ratings of mortgage-backed collateralized debt obligations lying at the heart of the last decade’s financial crisis (see here and here).
Settlement talks had broken down, over S&P’s reluctance to admit to fraud charges. But the wager here is not the over/under on S&P’s eventual and inevitable settlement. Before that, there will be much posturing and a long way to run.
For sure, McGraw-Hill subsidiary S&P has lawyered up for the battle, adding to its team the trial capability of über-barrister John Keker – advocate for such luminaries of civic virtue as Enron’s Andy Fastow, Credit Suisse’s Frank Quattrone, Lance Armstrong, Eldridge Cleaver and de-frocked king of the securities class action bar Bill Lerach.
Of concern, rather, is the longer-term impact on the roles, relationships and exposures of the various gate-keepers, ambiguously deemed critical by society to the global capital markets.
The New York Times’s Floyd Norris scratched the surface of this issue – here – but beneath lies much more.
Consider this menu of common attributes:
- A standard, commoditized report, without which financial products cannot be brought to the investor market.
- Providers not engaged by or in direct contact with investors, but competing to be engaged and paid directly by the issuers.
- Despite which, elaborate assertions of “independence” – widely criticized as resting on the intellectually shaky platform of “appearance.”
- Severely constrained choice among providers to large issuers, from a number of players limited to the low single-digits.
- Barriers to new competitive entry based on market demands for global scale, competence and resources – although tightly regulated, the provider cartel is not constrained by limits on government licenses or other franchise restrictions.
- Claims that, broadly speaking, the reports reasonably reflect reality, most of the time – except under highly stressed conditions, when they do not – a position not unlike the claim that the Boeing 787’s lithium-ion batteries work reasonably well, most of the time -- except when they catch fire.
- Provider claims to have adjusted and improved methodologies and process in light of recent criticisms – proclamations echoing those of my college era, before political correctness, that “Vassar girls don’t do those things -- and besides, the grass was wet.”
- Finally, the standard document noted at the head of this list, explicitly couched in the language of an “opinion” – as if, despite the construction of an elaborate and expensive pyramid of supportive analysis and procedures, the result were intended as a Zagats review or a “like” on Facebook.
Up to the last, this list of attributes would apply equally to the three dominant ratings agencies – S&P, Moody’s and Fitch – as to the accounting tetrapoly of Deloitte, E&Y, KPMG and PwC.
Except for the dissonance at the expectations gap, where the global accounting networks face existential litigation exposure for each large-company audit report they sign, while the ratings agencies have – until now – successfully wrapped themselves in the armored blanket of the First Amendment.
Does the government’s suit against S&P portend a realignment of the exposure realities? S&P’s free-speech advocate Floyd Abrams has forsworn a First Amendment defense (here), so a new era of litigation risk may confront S&P as well as its brethren.
From the audit firms’ perspective, though, any temptation to schadenfreude is hazardous – because of the speed and vigor with which the slightly guilty pleasure taken at another’s misfortune can turn to ashes.
Especially if there should be a contagion effect.
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