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Justice Department suit against S&P may trigger general liability claims

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Justice Department suit against S&P may trigger general liability claims

The Justice Department suit accusing Standard & Poor's Financial Services L.L.C. of defrauding investors and being a major factor in the 2008 financial crisis may lead to insurance claims.

The suit filed last week accuses S&P and parent McGraw-Hill Cos. Inc. of misrepresenting the true risks of residential mortgage-backed securities and collateralized debt obligations to increase its revenue and market share, thus defrauding investors who relied on its ratings out of billions of dollars.

S&P denied the allegations.

The fact that the government chose to sue under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 is consequential, said Kevin LaCroix, Beachwood, Ohio-based attorney and executive vice president of RT ProExec, a division of R-T Specialty L.L.C.

The law enables the Justice Department to seek civil penalties equal to losses suffered by federally insured financial institutions. The fact that the suit does not name individual defendants will present a high hurdle for S&P to collect on any directors and officers coverage that it may have, Mr. LaCroix said.

“It's an open question if this would meet the definition of securities claim,” Mr. LaCroix said. “The carrier would have a good argument that it does not; and since no individuals are named as defendants in the claim itself, it might not trigger D&O” coverage.

Nonetheless, S&P may be able claim defense costs and the costs of potential settlement under a general liability policy, said William G. Passannante, shareholder and co-chair of the insurance recovery group at Anderson Kill & Olick P.C. in New York. “A claim like this would be something they would be able to present to their liability insurance companies.”

After reviewing the 119-page suit, Mr. Passannante also said the outcome of the case against the rating agency is an open question.

“The complaint looks pretty straightforward, but the claims are probably defensible,” Mr. Passannante said.

He also expressed skepticism about the government's ability to collect the $5 billion in damages the suit is seeking given the wording of FIRREA, which limits damages to $5.5 million for a continuing violation.

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“FIRREA is fairly recent, so there's not a huge body of case law,” Mr. Passannante said, noting that media reports indicated the Justice Department and S&P previously were in talks to settle the charges in the neighborhood of $100 million.

“To get to $5 billion in damages, there would need to be a lot of underlying counts, but the complaint only lists 24. So the headline number is very scary, but $100 million is a probably lot closer to reality,” he said.

Mr. LaCroix said the case's direct effect on the larger insurance market is likely to be muted, but also said its indirect effect could be substantial.

“There's only a limited number of rating agencies,” Mr. LaCroix said. “Even if all three suffered losses, while it would be a significant event for the carriers paying the losses, it won't be the type of systemic event that is going to cause major disruption in the marketplace.”

He said the more likely effect of the case would be in altering the dynamic of previously filed litigation against rating firms where individuals were named as defendants. “The government's case could make it harder to settle all those cases and make them costlier to defend,” Mr. LaCroix said.

Bob Friedman, a partner at Boston-based Burns & Levinson L.L.P., said a settlement between S&P and the government is possible, but the public nature of the case and public resentment over the 2007-2009 financial crisis make a rapid resolution unlikely.

“In the complaint, the Department of Justice makes a pretty bold public statement about the merits of the case,” Mr. Friedman said. “Cases usually don't get settled in the wake of that.”

Reacting to the litigation, S&P described the charges as “meritless.”

The allegations filed by the Justice Department “are simply untrue. Our ratings were issued in good faith,” S&P said in a statement.