By: David Najera
Between 2004 and 2007, Standard and Poor’s Rating Services (“S&P”) was one of the few companies licensed to provide letter grade ratings to Residential Mortgage Backed Securities (“RMBS”) and Collateral Debt Obligations (“CODs”). On November 14, 2006, the head of the RMBS and CDOs’ Surveillance Group at S&P informed to two senior analysts that fifty percent of the subprime RMBS, previously rated as non-risky securities, had severely delinquent loans.[i]
On January 11, 2007 the two senior analysts at S&P expressed their concerns about a “housing bubble,” that there was a “slowdown” in the economy and therefore a “Bubble deflation” was imminent.[ii] After a meeting with S&P’s senior officials, the Surveillance Group suggested putting at least thirty RMBS transactions on CreditWatch Negative[iii] and monitoring the entire list of transactions incurred in 2006 with possible rating actions. On February 7, 2007, the head of S&P’s Global RMBS Management wrote an email stating that S&P was “fine with where we are,”[iv] thus ignoring the suggestions made by the Surveillance Group. Four months after, the meltdown began. Four trillion dollars in investments were lost and Lehman Brothers went under. The U.S. Government spent 750 billion dollars to rescue the financial market. It was absolute chaos. The aftermath left a shaky financial system that has been trying to recover ever since. What happened with the credit rating agencies that rated RMBS and CDOs as “gold” and as safe investments? They were sued, or at least one of them was.
After reviewing 290 million documents in discovery and spending significant amounts of time, effort, and attorney’s fees, S&P and the Department of Justice (“DOJ”) reached a settlement agreement. In page five, paragraph six of the settlement[v] the parties agreed that S&P pay a total of $1,375,000,000.00. Half of that money ($687,500,000.00) transferred to the DOJ and the other half ($687,000,000.00) disbursed to the States part of this litigation.[vi] This settlement agreement contains several important provisions: (1) S&P reserved the right to assert defenses including Constitutional or Jurisdictional, such as lack of personal jurisdiction on the conduct alleged to constitute a violation of a State’s particular laws[vii]; (2) The Government released S&P from any liability under FIRREA[viii], the False Claims, Act, common law theories of negligence, gross negligence, payment by mistake, unjust enrichment, breach of fiduciary duty, breach of contract, misrepresentation, deceit, fraud, or aiding and abetting an unlawful activity[ix]; (3) The Government released S&P from any criminal liability, any antitrust liability, individual liability, private right of action, any liability under the Internal Tax Revenue Code, or any liability that a State may bring against S&P.[x] Finally, the settlement agreement states that the costs of reaching this agreement cannot be transferred to other parties besides the ones to the litigation. Thus, S&P cannot transfer the costs of the litigation and ultimate settlement agreement to banks, or other users of S&P’s financial services.
As of April 2016, the settlement agreement has been qualified and accepted by all State parties in the litigation. This settlement agreement carries tremendous consequences in terms of changing the business landscape. It is likely that as a result of this settlement, the DOJ may go after Moody’s– another credit rating agency licensed to rate RMBS and CDOs. Also, this trend may gain momentum and help change the current regulations that allow banks to pay credit rating agencies. These payments create a conflict of interest due on both sides of the transaction. The banks become partial when asking a rating agency to “objectively” rate RMBS or CDOs that the bank will ultimately have to sell. The rating agencies become biased because if they decline to give a high rate to a RMBS or CDOs they will lose their business.
All in all, this settlement will open the door to further investigations about the 2007 recession and could bring to justice the key players in this economic meltdown. Hopefully, this settlement agreement may also help scrutinize the current regulations on fees charged to rating agencies and change the current practices under which the banks run with the rating costs. Under an impartial system, the consumer should pay these costs, therefore allowing rating agencies to objectively rate a bond or stock that a bank will sell.
[i] See generally DEPARTMENT OF JUSTICE, ANNEX 1: STATEMENT OF FACTS (2015).
[ii] Id. at 2.
[iii] See id. (“A public announcement that makes the transactions and other twenty subordinate RMBS transactions be placed on internal watch to be closely review for possible rating action.”).
[iv] DEPARTMENT OF JUSTICE, ANNEX 1: STATEMENT OF FACTS (2015).
[v] DEPARTMENT OF JUSTICE, JUSTICE DEPARTMENT AND STATE PARTNERS SECURE $1.375 BILLION SETTLEMENT WITH S&P FOR DEFRAUDING INVESTORS IN THE LEAD UP OF THE FINANCIAL CRISIS, https://www.justice.gov/opa/pr/justice-department-and-state-partners-secure-1375-billion-settlement-sp-defrauding-investors (Last visited Apr. 5, 2016).
[vi] States of: Arizona, Arkansas, California, Connecticut, Colorado, Delaware, Idaho, Illinois, Indiana, Iowa, Maine, Mississippi, Missouri, New Jersey, North Carolina, Pennsylvania, South Carolina, Tennessee, and Washington, and the District of Columbia.
[vii] DEPARTMENT OF JUSTICE, JUSTICE DEPARTMENT AND STATE PARTNERS SECURE $1.375 BILLION SETTLEMENT WITH S&P FOR DEFRAUDING INVESTORS IN THE LEAD UP OF THE FINANCIAL CRISIS, https://www.justice.gov/opa/pr/justice-department-and-state-partners-secure-1375-billion-settlement-sp-defrauding-investors (Last visited Apr. 5, 2016).
[viii] Financial Institutions Reform, Recovery and Enforcement Act of 1989, 12 U.S.C. § 1833a.
[ix] See id.
[x] See id.