Analysis: S&P paper trail may lead nowhere in government case

Mon Mar 11, 2013 7:44am EDT
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By Luciana Lopez, Peter Rudegeair and Matthew Goldstein

NEW YORK (Reuters) - In early 2007, as signs of distress began appearing in securities backed by residential mortgages, executives at Standard & Poor's began advising analysts responsible for rating mortgage bonds that they should put the phrase "privileged and confidential" on emails to one another.

Analysts working for the McGraw Hill Cos division also were discouraged from doodling on notepads and official documents during meetings to discuss pending deals and existing ratings, several former S&P employees said.

That was not the first time S&P had tried to caution employees about paper trails. In 2005, a full two years before the housing market began to melt down, several top S&P managers attended an off-site meeting at hotel in Old Saybrook, Connecticut, to discuss ways to increase the fees it collected from Wall Street banks for rating mortgage bonds. A former S&P executive said that after the meeting, employees were instructed to discard any notes they had taken from the meeting.

As it turns out, S&P employees didn't fully heed such warnings. The U.S. government's civil fraud lawsuit against S&P relies heavily on emails in which employees voiced doubts about the integrity of the agency's ratings.

But S&P may still come out on top. Legal and business experts, and even some critics of the role of the rating agencies in vouching for bonds during the financial crisis, aren't impressed with the prosecution's handiwork. Most legal experts interviewed said they expect S&P to prevail at trial, if there isn't a settlement before then for considerably less than the $5 billion the government is seeking in the lawsuit.

While a few lawyers said the government's case is a strong one, a dozen securities lawyers interviewed by Reuters saw significant weaknesses in the fraud claim.

The lawsuit suffers from many of the same problems that have plagued dozens of other unsuccessful cases against the rating agencies in recent years.

It will be hard for prosecutors to argue that S&P alone was privy to a unique window into the shaky state of the U.S. housing market in early 2007, which the Wall Street banks churning out the securities, or even the U.S. Federal Reserve, didn't have. Other lawyers point out that S&P's ratings on residential mortgage bonds in early 2007 weren't much different from those of Moody's Investors Service, a rival rating agency the government hasn't sued.   Continued...

A view shows the Standard & Poor's building in New York's financial district February 5, 2013. REUTERS/Brendan McDermid