Chutzpah redefined? Rating agencies want FHFA to share discovery costs

May 20, 2013

One of the most salient bits of information in the Justice Department’s civil complaint against Standard & Poor’s and its parent, McGraw-Hill – aside from the revelation that one S&P analyst devised a 2007 dance video riffing on the Talking Heads song “Burning Down the House” – is the amount S&P supposedly earned for rating mortgage-backed securities as banks rushed to squeeze every last dollar from the securitization boom. According to the government, the agency’s Global Asset-Backed Securities Unit was assessing MBS in such a hurry in 2006 and 2007 that S&P rating committees spent less than 15 minutes reviewing analyst evaluations. Yet the agency was rewarded munificently for its efforts. In 2006, S&P was supposedly paid $278 million in fees by the banks whose MBS deals it rated. In 2007 it was paid $243 million for rating MBS.

I’m resurrecting Justice’s report on those fees because last week, S&P’s lawyers at Cahill Gordon & Reindel informed U.S. District Judge Denise Cote of Manhattan that it should not have to bear the entire $180,000 cost of producing in electronic form about 400 MBS files to the Federal Housing Finance Agency, which has served third-party subpoenas on S&P, Moody’s and Fitch in 15 securities suits against MBS issuers and underwriters. Satterlee Stephens Burke & Burke filed a similar letter to Cote on behalf of Moody’s, which claims vendor costs of $46,000 to produce files on 470 MBS deals it rated. Fitch’s lawyers at Paul, Weiss, Rifkind, Wharton & Garrison  protested over the agency’s $50,000 in vendor costs on 150 securitizations.

FHFA, let’s remember, is basically bringing its MBS claims on behalf of taxpayers, since it’s the conservator of Fannie Mae and Freddie Mac, the government-sponsored mortgage funders that were the biggest MBS investors in the securitization market. So to reduce the dispute over who should bear the cost of the rating agencies’ compliance with FHFA’s subpoenas to its most basic terms, companies that earned hundreds of millions of dollars by conferring unwarranted blessings on suspect deals are balking at thousands of dollars in costs to help taxpayers determine if they were duped.

Anyone else think the credit rating agencies might want to reconsider the optics of their protest?

Of course, the cost dispute isn’t quite as simple as it might seem. (In litigation, what is?) FHFA’s lawyers atQuinn Emanuel Urquhart & Sullivan and Kasowitz, Benson, Torres & Friedman served third-party subpoenas on the rating agencies in August 2012. FHFA has 15 cases under way in Cote’s court (and one in Connecticut federal court), so it demanded rating agency files on nearly a thousand MBS deals in total, spread across the three agencies and 15 cases. Though FHFA assured the rating agencies that in its theory of liability, S&P, Moody’s and Fitch were also deceived by MBS sponsors and should produce files to vindicate the ratings they conferred, the agencies balked at the housing agency’s demand. It would cost millions of dollars in attorney and paralegal time to review the millions of pages of documents FHFA had demanded, the agencies said. Perhaps forgetting that the government contends S&P committees spent only 15 minutes deciding whether to approve MBS ratings, the agencies told FHFA that it would take about three hours to go over each deal file before it could be imaged for production.

The agencies proposed producing sample files or turning over files they’ve already produced in other cases. FHFA rejected those alternatives to its subpoenaed demands. As a last-ditch compromise, the credit rating agencies proposed that FHFA share only the vendor cost of turning MBS files into electronic form.

Instead, FHFA sent a letter to Cote on May 6, asking her for an order compelling the rating agencies to produce the documents at their own expense. Under the rules of civil procedure, FHFA said, three factors determine how to allocate the cost of third-party subpoena compliance: whether the third party has an interest in the litigation; which side can more readily bear the cost; and whether the litigation is of public importance. All of the factors, FHFA argued, weigh in favor of the rating agencies paying their own costs.

The S&P, Moody’s and Fitch letters last week came in response to FHFA’s. The rating agencies didn’t dispute FHFA’s description of the procedural rule that applied to their dispute, but said that the housing group had neglected to mention that in none of the reported cases in the Southern District of New York, including the leading case, Prescient Acquisition Group v. MJ Publishing, were third parties ordered to pay all of their costs. Here, the agencies argued, they had asked only that FHFA pay their vendors, whose fees represent a small percentage of the agencies’ total outlay for subpoena compliance. Even that eminently reasonable request, they said, was rejected by FHFA. “Neither the law nor principles of fairness support the outcome demanded by FHFA: payment of 100 percent of the extraordinary expense for subpoena compliance by a non-party, with no contribution whatsoever by the requesting party,” Moody’s wrote.

The rating agencies asked Cote to force FHFA to share all of their costs, including attorney time and the cost of litigating the dispute. Fitch asked, in the alternative, that costs be shifted to defendants in the FHFA cases.

I have a feeling that Judge Cote, who has consistently sided with FHFA in this litigation, isn’t going to have much sympathy for the rating agencies. But we’ll find out.

FHFA counsel Philippe Selendy of Quinn declined comment, as did a representative of S&P. A Moody’s representative and a lawyer for Fitch did not respond to my requests for comment.

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