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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