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S&P Settles DOJ Lawsuit For $1.5 Billion; Agrees Not To Accuse Government Of Retaliation For US Downgrade

As had been widely rumored in the past two weeks, and as the WSJ reported overnight, moments ago McGraw Hill, parent of disgraced rating agency S&P, entered into a $1.5 billion settlement to fully resolve the DOJ lawsuit regarding S&P ratings on RMBS and CDOs. As the WSJ reported overnight, In the "span of about 30 hours, the Justice Department lowered its asking price and backed off demands that S&P admit to violating laws when it issued rosy grades on risky mortgage deals, the people said."

The details per the WSJ which broke the original story:

Under the settlement, the Justice Department will receive $687.5 million. Some 19 states and the District of Columbia will share a similar amount, the people said.

 

Separately, S&P completed a $125 million settlement late Monday with the California Public Employees’ Retirement System, or Calpers, the country’s biggest public pension fund by assets, over another crisis-era lawsuit. That brings the total payout to $1.5 billion.

 

Meanwhile, the Justice Department is in the early stages of a probe into ratings by Moody’s Investors Service of mortgage securities before the crisis, people familiar with the matter have said. A Moody’s spokesman declined to comment.

Of course, everyone knows that the original lawsuit, and today's settlement, were over something far simpler: S&P daring to downgrade the US back in 2011. After all none other than Tim Geithner is on the record as saying that "S&P’s [downgrade] would be looked at very carefully," Geithner told McGraw according to the filing. "Such behavior would not occur, he said, without a response from the government."


It also explains why Buffett's favorite Moody's was not one of the named parties in a lawsuit that allegedly involved rating agencies transgressions: after all Moody's and Fitch rated just as many RMBS and CDOs.

The WSJ walks us thorugh the timeline of the suit:

The relationship between the two parties began to unravel after August 2011 when S&P was the only one of the three big rating firms to downgrade U.S. debt. Days after the move, then-Treasury Secretary Timothy Geithner , after a meeting with President Barack Obama , placed an angry phone call to Harold McGraw III, then chief executive of McGraw Hill, in which he said the firm’s conduct would be “looked at very carefully,” according to an affidavit submitted by the company. Mr. Geithner has denied, through a spokeswoman, that he threatened or took any action to prompt retaliatory action against S&P.

 

The Justice Department has also denied the lawsuit was retaliation for the downgrade. Privately, officials described the argument as an offensive attack on the department’s independence.

 

Over the next 18 months, the two sides tried and failed to reach a settlement as S&P balked at the government’s demand for more than $1 billion and admissions of wrongdoing. The Justice Department brought its suit against S&P in February 2013.

 

S&P lawyers on the day the suit was announced called the government’s case “simply indefensible.” Tony West, then associate attorney general at the Justice Department, called S&P’s bond grades a “misguided venture.”

Soon, however, it would all become a game of how much S&P ends up paying, with both parties trying to find an appropriate bid and ask:

Settlement talks were quiet until Feb. 18, 2014, when George S. Cardona, the main Justice Department lawyer handling the S&P case in California, called S&P’s lawyers with an offer: $3.2 billion.

 

That figure startled S&P, which didn’t submit a counteroffer. Negotiations stalled again.

 

Informal conversations between S&P and government lawyers started again over the summer. Talks got a jolt later in the summer with the entry of a pair of relatively new faces— Stuart Delery, the Justice Department’s No. 3 official and Mr. West’s successor, and Lucy Fato, the new general counsel of McGraw Hill. Ms. Fato, a ratings-world outsider, started on the job in early August. By 9:15 a.m. on her first day, she had phoned several government lawyers expressing a desire to reopen dialogue about a settlement.

 

More than three months later, following a meeting with all parties in Hartford, Conn., Ms. Fato laid out S&P’s first counteroffer: a $750 million settlement that would resolve the suits with the Justice Department, the states and with Calpers.

 

The government countered in mid-December with a $1.9 billion offer, minus a Calpers deal and plus the admission of wrongdoing by S&P.

 

Those two offers represented the starting points for the final settlement talks at the Justice Department’s Washington offices on Jan. 14 and 15, where more than 30 people crowded into a fifth-floor conference room next to Mr. Delery’s office.

 

With winter coats draped over chairs and suitcases shoved off to the side, Ms. Fato disclosed the company’s first offer: $900 million for a settlement with the states and Justice Department, excluding Calpers and with no admissions of wrongdoing. Government lawyers took that as the first major sign S&P was serious about cutting a deal. “We know that’s a real step in the right direction,” said Mr. Delery at the meeting.

 

The government countered with a $1.8 billion offer.

 

S&P didn’t want to budge past $900 million, arguing it matched the revenue over several years that the company generated during the precrisis boom period. But Mr. Delery said the government was suing for fraud, and S&P also needed to pay a penalty.

 

On Wednesday evening, Ms. Fato and Mr. Delery stepped out of the conference room for a series of one-on-one chats. When Ms. Fato walked back into the conference room, she announced S&P was now willing to pay above $1 billion, which government lawyers had viewed as a key barrier.

 

The day ended with S&P at $1.2 billion and the government at $1.5 billion.

Until finally... "Negotiations kicked off at 9:30 a.m., and as the final details toward $1.375 billion got sorted out, there were long waits in between counteroffers. S&P’s legal team spent much of that time lounging on a sofa in the fourth-floor conference room and toying around with a child’s wooden puzzle game."

And that is how you negotiate the price of justice in the US.

As for the underlying reason behind the lawsuit, it couldn't be clearer:

It was important to the Justice Department for the political retaliation argument to be dropped. Mr. Delery argued it unfairly besmirched the integrity of the career attorneys who worked on the S&P case and told the room it was “of grave importance to the people of the United States of America.”

 

The two sides hashed out wording that would be included in S&P’s statement of facts as part of the settlement. S&P, which was drafting motions to bolster its defense as recently as last week, eventually signed off on language that acknowledged its current evidence wasn’t sufficient to prove political retaliation. In return, S&P avoided having to admit it violated any laws.

Bottom line: "S&P agreed to ... withdraw its assertion that the Justice Department lawsuit was political retaliation for the ratings firm’s 2011 downgrade."

And now you know what will happen the next time anyone dares to downgrade the US, pardon, to set incorrect ratings on RMBS securities.

Because when it comes to the First amendment all are equal, but some are more equal.