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'Burning Down the House'

Lawsuit: S&P boasted about rating deals 'structured by cows'

NEW YORK -- Standard & Poor’s employees sang and danced to a mock song inspired by “Burning Down the House,” and joked about the company’s willingness to rate deals “structured by cows” before the 2008 global financial collapse, according to a U.S. government lawsuit.

Two S&P analysts in April 2007 discussed the company’s model for collateralized debt obligations (CDOs), with one messaging that a deal was “ridiculous” and that S&P “should not be rating it,” according to the complaint filed Feb. 4 in federal court in Los Angeles.

“We rate every deal,” the other replied, prosecutors said. “It could be structured by cows and we would rate it.”

The analysts’ messages are among internal communications cited in the Justice Department’s complaint against S&P and its parent, New York-based McGraw-Hill Cos. (NYSE: MHP).

The U.S. claims S&P, driven by a desire to increase revenue and market share, defrauded investors as it issued ratings on mortgage products while ignoring market risks.

It rated more than $2.8 trillion of residential mortgage backed securities (RMBSs) and about $1.2 trillion of CDOs from September 2004 to October 2007, the government said.

A 2008 investigation into credit rating companies by the U.S. Securities and Exchange Commission found that that the firms improperly managed conflicts and weighed the risk of losing market share based on their ratings.

Ratings report

The report on Moody’s Investors Service (NYSE: MCO), S&P and Fitch Ratings cited the discussion about the deal structured by “cows” and quoted an analyst who wrote in an email: “Let’s hope we are all wealthy and retired by the time this house of cards falters.”

According to the U.S. lawsuit, S&P in 2004 was considering a process for changing its rating criteria and reached out to investors and issuers of mortgage securities for their feedback.

One executive questioned this practice, saying, “[We] NEVER poll them as to content or acceptability!”

Employees, meanwhile, were raising concerns about losing deals to competitors, according to the complaint.

One analyst in May 2004 wrote that the company was losing a “huge” deal to a competitor because S&P was more conservative than others, the government said.

“This is so significant that it could have an impact on future deals,” the analyst wrote, according to the complaint. “There’s no way we can get back on this one, but we need to address this now in preparation for future deals.”

Volume, standards

In 2007, one CDO analyst wrote to a former co-worker: “Does company care about deal volume or sound credit standards?”

Emails and text messages can give prosecutors insight into the “unvarnished perspective” of company insiders and help them win trials because they’re easier for jurors to understand than more formal documents, said Robert Mintz, a partner at McCarter & English.

“They tend to give jurors a flavor for the general atmosphere inside a company, and that in connection with other documents can often be quite damning,” said Mintz, a former federal prosecutor in New Jersey.

S&P said in a statement that the government’s lawsuit is “meritless” and that at all times the company’s ratings “reflected our current best judgments” about mortgage securities and CDOs.

“Unfortunately, S&P, like everyone else, did not predict the speed and severity of the coming crisis and how credit quality would ultimately be affected,” the company said.


The reference to a deal “structured by cows” had “nothing to do with RMBS or CDO ratings or any S&P model,” it said, contradicting the complaint.

“The email excerpts cherry-picked by DOJ have been taken out of context, are contradicted by other evidence, and do not reflect our culture, integrity or how we do business,” it said.

Ken Scott, a professor at Stanford Law School, said the government may have a hard time prevailing on its claim that S&P’s practice of making issuers pay for securities ratings contributed to a fraud.

“The allegation in the complaint that S&P concealed this conflict and therefore presumably buyers were unaware of it, that’s total nonsense,” Scott said.

‘Subterranean influence’

The government will have to present proof not that the conflict of interest had “almost a subterranean influence but that there was actual intent to defraud,” Scott said.

The burden of proof, while not as high as in a criminal case, is significant, Scott said, and “whether they can meet that or not will be what the trial is all about.”

Beginning in the fall of 2006 and continuing to about the spring of 2007, one S&P executive regularly expressed frustration to colleagues that she was prevented by other executives from downgrading ratings of subprime mortgage securities because of concern that the company’s business would be affected, the government said.

“This market is a wildly spinning top which is going to end badly,” said another executive in 2006, according to the complaint.

In March 2007, an analyst set wrote lyrics to the tune of “Burning Down the House” by the rock group Talking Heads.

According to the complaint, it began:

“Watch out / Housing market went softer / Cooling down / Strong market is now much weaker / Subprime is boi-ling o-ver / Bringing down the house.”

The government said the analyst later sent a video of himself singing and dancing the first verse “before an audience of laughing S&P co-workers.”

Catherine Mathis, an S&P spokeswoman, called the video “obviously in poor taste.”

“While it may reflect a terrible sense of humor, it in no way reflects the hard work and analysis by the analysts rating securities,” Mathis said Monday.

The case is U.S. v. McGraw-Hill, 13-00779, U.S. District Court, Central District of California (Los Angeles).

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