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Comments on Judge's Message to Rating Agencies: Free Speech Not Freedom to Defraud
by Jonathan Bernstein
  •  
    Many people under estimate how big a factor the rating agencies were in the financial crisis. They were central to it - one of the primary causes. Bankers felt absolved of the need to fully understand complex products "because it was AAA". The agencies knew what game they were in. Your statement that they "may have had at least some incentive to curry favor with the issuers of structured products" is perhaps the understatement of the decade.

    This problem is similar to the accounting problem that surfaced around Enron. In both cases the accountant/agency is subject to a conflict of interest because of the way they are paid. Until we can figure out a better way of rewarding them this will remain a problem. In the case of the accountants, big moves were made to separate out audit and consulting. In the long run, that makes little difference. The only thing that works at the moment is the legal process. Enron resulted in criminal charges and Arthur Andersen being put out of business. Something similar needs to happen with the rating agencies. Without visible action and results, we can not claim our form of capitalism to be any better than Russia's.
    2009 Sep 09 06:13 AM Reply
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    This is an excellent article, thanks. I agree that the role of the rating agencies has been vastly underplayed in reporting on the financial crisis. So has the role of property appraisers. In both instances, the "rater" is paid by the entity seeking a favorable rating. This situation is obviously rife with conflicts of interest. Let's not get too excited about the ruling though. It did not invalidate the free speech defense. It merely said this case could go forward. If the free speech defense is abrogated, that will come later, far down the road, and would come as the result of an appelate decision, not a verdict in a single case. I would not be surprised to see this case settled, with no verdict and no appellate opinion.
    2009 Sep 09 08:38 AM Reply
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    We believe in protecting "free speech." But we don't advocate protecting rating agencies in this context, because what they claimed as free speech really wasn't "free" (costless). The attached blog explains why.

    seekingalpha.com/insta...
    2009 Sep 09 08:59 AM Reply
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    I guess only Einhorn can have an opinion these days, right?
    Nobody else can use their 1st Amendment Rights?
    Thrash.
    Einhorn loses this one.
    No more Lehman's...
    2009 Sep 09 09:40 AM Reply
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    Very thoughtful article - thank you. Same also for Chap08's comments.

    In regard to the last 3 paragraphs of the article, if you live and do business outside the USA as I do, you do hear opinion at times that the US borrowed for its own low income housing on the basis of false information, US Banks securitised the loans, S&P and Co then give the securities AAA ratings, which were then used to market those securities to foreign pension funds (like mine).

    Whether or not it's fair, there's a feeling that the US mortgage industry mugged foreign pensions as well as its own.

    Many funds and banks in my part of the world had rules which explicitly stated that AAA rated (and also one or two grades below that) investments did not require additional analysis.

    Everyone agrees those rules now look pretty stupid, but I believe the damage done to reputation is permanent.
    An S&P rating on a bond will forever more be regarded as a superficial and light-weight analysis.
    This seems especially true now in Asia and the ME.
    2009 Sep 09 09:44 AM Reply
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    Very good article and comments, especially Chap08 and MikeOz. Thank you.

    Reform of ratings agencies is the main piece of business needed to restore financial health and to allow the central bankers to draw down government issued liquidity. An effective reform will probably require changing the notion of a "rating".

    Transparency is the key issue. A ratings service that enables investors to run their own internal models against the underlying assets would go a long way to restoring confidence in asset-backed paper. The technology to do this is all based on Monte Carlo simulation of cash flows from an underlying factor model. As I understand it, these models and their assumptions are part of the material reviewed by a CRA to justify the ratings application.

    How to make this transparent to investors? Well, the models and assumption are captured in computer programs that are run against a database of assets, the results of which are part of the submission to the CRA. Computer programs have interfaces that enable users to change their input assumptions (for example: HPA, interest rate trends, etc). If these computer programs are required to have standardized interfaces, then investors could substitute their own models for those reviewed by the CRA - without needing access to the details of each and every asset in the portfolio.

    Extending this thought a bit further: CRAs in effect rate the qualities of a computer model that is seeded with assumptions and is run against a database of privileged information. There are many models out there in the financial world. Some models perform better than others in certain environments. If the interfaces are standardized, then investors could subscribe to multiple model providers. Ratings services could track and rate "model" performance!

    So how could we get started on this? I think the key requirements are 1) standardization of the inputs of the cash flow generation modules, and 2) the right of any investor to substitute their own model for those examined by the CRA.
    2009 Sep 09 10:46 AM Reply
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    What does free speech have to do with it??
    If I pay a doctor for advice, he can't just sit there and lie to me. The consequences could be fatal, just as the consequences with ratings agencies can be (and have been) fatal for one's financial health.
    2009 Sep 09 10:58 AM Reply
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    rating agencies cant be trusted no more, they only work in the bull market, in depression ratings dont work
    2009 Sep 09 11:49 AM Reply
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    An excellent article and very good comments too. I believe that once again Congress is sat the heart of this mess. Congress created the need to use the rating agencies when they designated them Nationally Recognized Statistical Rating Organizations and required large investors to use their ratings. This not only sanctified the raters business model of the issuer rather than the consumer paying for the ratings, it also created a high barrier to entry (read: monopoly) for any potential competitors.

    There will be no meaningful reform of these agencies (or anything else in government) until there is meaningful reform of Congress.
    2009 Sep 09 11:52 AM Reply
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    Good article.

    The background of the "free speech" issue is that the last time someone tried to sue the ratings agencies, they argued that their ratings were protected by the first amendment as "commercial speech"-- and the court let that argument win. That's a jaw-dropping anomaly: your billion-dollar investment relies on a standard of accountability that's the equivalent of advertising! So it's imperative that the courts revisit this question, and hold the agencies accountable.

    The danger is that they will find facts that distinguish the present situation from the previous case, slap the agencies on the proverbial wrist, and leave the precedent of "commercial free speech" intact. That would leave us back where we started. Watch carefully.
    2009 Sep 09 12:20 PM Reply
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    perfect exemple of ratings agency are lie, anyboby around the wolrd believe that:


    U.S., U.K. AAA ratings safe. Moody's said the triple-A sovereign debt ratings of the U.K. and the U.S. aren't at risk in the 'near future.' The ratings agency said only a sustained increase in government debt over several years would warrant a downgrade, but that it doesn't anticipate such an event. The comments could help lift the battered British pound.
    2009 Sep 09 12:47 PM Reply
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    Let us start from the beginning. Ex-President Carter, in his desire to help the poor, pushes the banks to lend to the poor. The banks refuse to go along - unsound banking practice. With the help of a Democratic congress, Community Redevelopment Act was enacted and banks were allowed to start securitizing loans. Fannie Mae and Freddie Mac refuse to buy the loans - again unsound banking practice - but agreed after Democratic appointees were put in management positions. The appointees saw this as an opportunity to get sky high bonuses. The Fed (Greenspan) with his myopic vision (we did not know this then) went along and allowed securitization and derivatives to florish. The laws enacted after the 1907 and 1929-33 financial disasters (Glass-Steagall among others) were slowly whithered away, first by the Democratic congress and later by the Republicans and now the Democrats again - because they were getting millions in campaign money from the financial institutions and wall street --- same institutions that caused the 1907 and 1929-33 crisis.

    All this could have been stopped at the doors of the rating agencies, the last barrier. But again, big money (large executive bonuses) came into play. Those insider who had the moral turpitude recognized the scam and refused to go along...and as expected, were fired.

    All these events and actions were clearly explained and discussed on several programs for the last six months on 60 Minutes, NOW, Bill Moyers, Newshour with Jim Lehrer and even the 3 networks. I hope ... this is a big hope ... those who were fired would all be put on the witness stand to testify on what went on inside the CRA agencies and bring down this free speach defense. We shall see in the next few months if this Judge and the other one (can't remember his name) who is not accepting the BofA/SEC bonus case settlement can really do justice for the American people.
    2009 Sep 09 02:21 PM Reply
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    On agency AAA rating affirmation of U.S. and U.K. debt (noted by foxy44)... one wonders if the purpose of this act is, by its display of unjustified chauvinism (surely, the ratings agencies have lost a great deal of credibility, and likely irreparably), meant to provoke those interests in China and Russia pushing (with City of London and Wall Street prodding) for an end to the U.S. dollar's reserve currency status?
    2009 Sep 09 04:09 PM Reply
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    I could not agree more, excellent comment btw, we need more judges like this shira lady and others to stand up for the little people. Too much money and too few principles.


    On Sep 09 02:21 PM candooman wrote:

    > Let us start from the beginning. Ex-President Carter, in his desire
    > to help the poor, pushes the banks to lend to the poor. The banks
    > refuse to go along - unsound banking practice. With the help of a
    > Democratic congress, Community Redevelopment Act was enacted and
    > banks were allowed to start securitizing loans. Fannie Mae and Freddie
    > Mac refuse to buy the loans - again unsound banking practice - but
    > agreed after Democratic appointees were put in management positions.
    > The appointees saw this as an opportunity to get sky high bonuses.
    > The Fed (Greenspan) with his myopic vision (we did not know this
    > then) went along and allowed securitization and derivatives to florish.
    > The laws enacted after the 1907 and 1929-33 financial disasters (Glass-Steagall
    > among others) were slowly whithered away, first by the Democratic
    > congress and later by the Republicans and now the Democrats again
    > - because they were getting millions in campaign money from the financial
    > institutions and wall street --- same institutions that caused the
    > 1907 and 1929-33 crisis.
    >
    > All this could have been stopped at the doors of the rating agencies,
    > the last barrier. But again, big money (large executive bonuses)
    > came into play. Those insider who had the moral turpitude recognized
    > the scam and refused to go along...and as expected, were fired.<br/>
    >
    > All these events and actions were clearly explained and discussed
    > on several programs for the last six months on 60 Minutes, NOW,
    > Bill Moyers, Newshour with Jim Lehrer and even the 3 networks. I
    > hope ... this is a big hope ... those who were fired would all be
    > put on the witness stand to testify on what went on inside the CRA
    > agencies and bring down this free speach defense. We shall see in
    > the next few months if this Judge and the other one (can't remember
    > his name) who is not accepting the BofA/SEC bonus case settlement
    > can really do justice for the American people.
    2009 Sep 09 05:00 PM Reply
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    MikeOz:
    Sep 09 09:44 AM
    …Whether or not it's fair, there's a feeling that the US mortgage industry mugged foreign pensions as well as its own…

    SA Wall Street Breakfast: Must-Know News‏ 9/9/09:
    …Moody's said the triple-A sovereign debt ratings of the U.K. and the U.S. aren't at risk in the 'near future.'…

    I for one certainly hope the judiciary will hold the legislative and executive branches feet to the fire over this utter failure to protect the vital interests of the United States. Their irresponsible conduct has caused more international harm than Iraq’s military withdrawal from Kuwait. If our Judiciary allows them, Barney et al, to escape unscathed, we will descend further into the abyss, regardless of Moody’s attempt at resuscitation, IMHO.
    2009 Sep 09 06:52 PM Reply
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    Great title wih regards to ratings agencies: "Free Speech Not Freedom to Defraud". Ratings agencies are complicit in the improper valuation in the market of mortgage bonds, insurance, stock issuance, and bank risk. The question is determining the level and scope.

    Sure the ratings agencies have conflicts of interest and may or may not know much more than they report. And sure the reporters are paid for good results to support issuance and not reports calling into question the new issuances they cover. Sadly, despite all that we know that is rotten in the Denmark we can call ratings agencies (more like fraud agencies) I have yet to see any reform that prevents such abuses they have enjoyed from being perpetuated into the next bubble. Buyers beware...
    2009 Sep 09 09:06 PM Reply
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    Another Scheindlin Case Exploding in Fed Court

    IVIEWIT TRILLION $$ FED SUIT DEFENDANT PROSKAUER ROSE SUED IN GLOBAL CLASS ACTION RE STANFORD PONZI
    www.free-press-release... for full press release

    IVIEWIT TRILLION $$ FED SUIT DEFENDANT PROSKAUER ROSE SUED IN GLOBAL CLASS ACTION RE ALLEN STANFORD PONZI

    Proskauer Rose Sued in Stanford Ponzi – Blood Oaths with Regulators – Iviewit Suit “LEGALLY” related to NY Supreme Court Whistleblower Christine Anderson Heading to Trial with Judge Shira Scheindlin

    Whistleblower Suit Set for Trial

    As the public federal trial of systemic corruption allegations inside the NY State Supreme Court Appellate Division First Department (First Dept) approaches, more bad news for the Proskauer Rose law firm erupted. Last week WSJ reported CFO of Stanford Financial Group, James Davis, involved in the $7 Billion Robert Allen Stanford Ponzi. Davis pleaded Guilty to fed charges while appearing to implicate counsel Proskauer & partner Thomas Sjoblom orchestrating a plan to Obstruct SEC & FBI investigations into Stanford & more. blogs.wsj.com/law/2009...

    Christine C. Anderson a former Staff Attorney at the First Dept filed WHISTLEBLOWER allegations in a fed suit slated for trial Oct 13 in US District Court Southern District NY (USDC), Anderson v State of NY, 07cv09599. iviewit.tv/press/press...

    Anderson’s suit adjudicated by Judge Shira Scheindlin contains allegations of retaliation against Anderson for termination from her job of 6 yrs, after Anderson exposed systemic Whitewashing & Obstruction inside the First Dept, claiming favoritism by the First Dept for favored law firms & attorneys. exposecorruptcourts.bl... & iviewit.tv/press/press...

    Anderson’s suit set to bring volcanic like testimony involving public office corruption & testimony by officials of the NY State Unified Court system, including Court of Appeals Chief Judge Jonathan Lippman, Presiding Judge at the First Dept during the firing of Anderson. Along with Lippman will be Defendants in Anderson, First Dept Supervisor Sherry Cohen, Former Chief Counsel Thomas J. Cahill, Hon John Buckley, David Spokony & Catherine O’Hagen Wolfe, Clerk @ US Second Circuit Court of Appeals (USCA), an initial Anderson defendant in her former job as Clerk for the First Dept, now witness in Anderson. Anderson claims Physical Abuse & Harassment by Cohen for her heroic WHISTLEBLOWING, Anderson gave riveting testimony to the NY Senate Judiciary Committee headed by former Proskauer asst Sen. John L. Sampson. Anderson testimony @ 30min www.youtube.com/watch?...

    Prior to permitting Anderson to trial, Scheindlin marked 7 suits, including Iviewit’s Trillion Dollar suit iviewit.tv/press/press... legally “related” to Anderson.

    Proskauer Ties to Stanford, Madoff & Dreier

    The Stanford Ponzi investigation may be the card that knocks down the house of cards at Proskauer. Uncovering of the $65 Billion Madoff Ponzi led the SEC & FBI to intensify investigations into Stanford,

    ‘Perhaps the most alarming is that Stanford Investment Bank has exposure to losses from the Madoff fraud scheme despite the bank’s public assurance to the contrary’, said the SEC. www.timesonline.co.uk/...

    Ironically, Sjoblom worked for the SEC & now is implicated in FBI & SEC actions, advising client Stanford on “how” to lie to the SEC. Huffington Post on Feb 20, 09 claims,

    Sjoblom, a partner at law firm Proskauer Rose doing work for Stanford’s company’s Antigua affiliate, told authorities that he ‘disaffirmed’ everything he had told them to date…Sjoblom spent nearly 20 years at the SEC, & served as an Asst Chief Litigation Counsel in the SEC’s Division of Enforcement from 1987-1999.

    www.huffingtonpost.com...

    Bloomberg on Jan 14, 09 states,

    The week after Bernard Madoff was charged with running a $50 billion Ponzi scheme, Proskauer Rose…offered a telephone briefing on the scandal for its wealthy clients. With only a day’s notice, 1,300 Madoff investors dialed in. ‘This is a financial 9/11 for our clients’, said Proskauer litigation partner Gregg Mashberg…‘People are dying for information.’ www.bloomberg.com/apps...

    Following the “client” call, investigations began into major “clients” involved in Madoff, Proskauer having perhaps the most Madoff “clients”, many who originally claimed to be victims may now be accomplice. SEC OIG delivered a stinging report on Madoff harshly criticizing lax regulators for overlooking the Madoff information from WHISTLEBLOWERS & others inside the SEC, for years. www.foxbusiness.com/st.../

    Proskauer has further ties to Madoff according to TPM, in 2004 an SEC attorney, Genevievette Walker-Lightfoot, notified the SEC of the Ponzi but was forced out of her job, the SEC later settling a claim filed by Lightfoot. Upon termination, Lightfoot turned over the Madoff file to Jacqueline Wood who then presumably buried the report that could have exposed the Ponzi in 04. SEC OIG’s report mentions Wood of Proskauer throughout the entire report as a key figure in the regulatory failure. www.sec.gov/news/studi...

    After leaving the SEC, Wood took a Proskauer partnership. tpmcafe.talkingpointsm...

    Laura Pendergest-Holt, Stanford’s CIO, criminally charged in the Stanford investigation, then filed a civil suit against Proskauer & Sjoblom claiming they “hung her out to dry” before the SEC. Meanwhile, Sjoblom solicited a multi-million dollar retainer from Stanford’s Chairman, A. Stanford, the night before the events with Holt at the SEC. www.memphisdailynews.c...

    WSJ reports filing of a Class Action suit against Sjoblom & Proskauer in TX after Davis’ incriminating plea agreement implicated Proskauer, seeking damages for the entire $7 Billion in damages for Proskauer’s role Aiding & Abetting,

    The civil suit is largely based on a plea agreement that we mentioned in this post yesterday, which focuses in part of the alleged actions of Sjoblom, who became outside counsel for Stanford’s international bank based in Antigua in the Caribbean starting in 05. blogs.wsj.com/law/2009.../

    Another defendant in the Iviewit Lawsuit, convicted felon Marc S. Dreier, found orchestrating yet another bizarre Ponzi, in the Dreier scheme, we find former Proskauer partner Sheila M. Gowan as bankruptcy trustee in the suit. blogs.wsj.com/law/2009...

    NY Attorney General Defendant in Iviewit Suit

    While acting as the NY Gov, Eliot Spitzer, former NY AG, reached out to his former Deputy AG Dietrich Snell who left the AG to take a Proskauer partnership, in order for Snell to act as defense counsel for Spitzer during the TrooperGate / HookerGate scandals, resulting in Spitzer’s resignation. www.nydailynews.com/ne...

    Snell working for Spitzer at the NY AG when Iviewit filed complaints with the First Dept & NY AG against attorneys involved in the patent thefts. Spitzer a named Defendant in the suit, other Defendants include First Dept, law firms ( Proskauer Rose, Meltzer, Lippe, Goldstein & Schlissel, Foley & Lardner ) & corp defendants include, Intel Corporation, Lockheed Martin Corporation, Silicon Graphics, Inc., IBM, MPEG-LA, LLC, Crossbow Ventures, Wayne Huizenga, & many more.

    Cease & Desist

    Iviewit secured seed funding from billionaire Wayne Huizenga & Crossbow Ventures whose investments were two-thirds SBA funds. Iviewit signed & executed NDAs, licensing agreements & strategic alliances starting in 1998 with many Fortune 1000 companies. Companies with signed agreements include; Real 3D, Inc., ( a consortium of Intel, Lockheed & SGI ) Dell, Wachovia, Warner Bros., AOLTW, Raymond James, Lehman Brothers, Bear Stearns, CIBC World Markets / Oppenheimer, Kodak, Motorola, General Instrument Corporation, Paine Webber, Pequot, Sony, MGM, NCR & more.

    Recent formal Cease & Desist & Demand Letters have gone out to major players Intel, Lockheed & SGI, who formed Real 3D, where leading experts & engineers from the companies tested & used the technologies. Iviewit filed a formal complaint to SEC Chairperson, Mary Shapiro against Intel & others. The complaints filed for possible violations of FASB No. 5 resulting from possible failure to report liabilities to Shareholders. Liabilities resulting from the Trillion Dollar suit they are named defendants in & failure to report liabilities resulting from knowing & willful infringement in violation of signed agreements for almost 10 yrs. Accounting for the liabilities should appear in the Annual Report to Stockholders as required under FASB. iviewit.tv/press/press...

    In recent patent disputes, settlement in excess of $600M was reached involving RIM Blackberry & NTP on the strength of an NDA. money.cnn.com/2006/03/.../

    Microsoft was issued an Injunction that awarded hundreds of millions in damages to i4i, for willful infringement of technologies embedded in MS Word. The injunction also forces a product recall of ALL products with MS Word since 2003. news.idg.no/cw/art.cfm...

    Injunction in the Iviewit suit forcing a Cease & Desist & product recall would shut down internet video, reduce digital TV channels by over 75%, recall hardware & software that uses the technologies since 1998, a recall unparalleled in history. The Iviewit matters involve investigations ongoing with the DOJ, DOJ OIG Glenn Fine, Harry Moatz, Director OED US Patent Office, the FBI OPR, the SBA OIG, former US AG Michael Mukasey, current US AG Eric H. Holder, Jr & more. Feb 09 petition to President Barack Obama & Holder @ iviewit.tv/press/press...

    News

    iviewit.tv/press/index...
    Eliot I. Bernstein
    Inventor
    Iviewit Holdings, Inc. – DL
    Iviewit Holdings, Inc. – DL
    Iviewit Holdings, Inc. – FL
    Iviewit Technologies, Inc. – DL
    Uview.com, Inc. – DL
    Iviewit.com, Inc. – FL
    Iviewit.com, Inc. – DL
    I.C., Inc. – FL
    Iviewit.com LLC – DL
    Iviewit LLC – DL
    Iviewit Corporation – FL
    Iviewit, Inc. – FL
    Iviewit, Inc. – DL
    Iviewit Corporation
    2753 N.W. 34th St.
    Boca Raton, Florida 33434-3459
    (561) 245.8588 (o)
    (561) 886.7628 (c)
    (561) 245-8644 (f)
    iviewit@iviewit.tv
    iviewit.tv
    iviewit.tv/wordpress/
    iviewit.tv/wordpresseliot/
    2009 Sep 10 08:32 AM Reply
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    Candooman, I don't buy your CRA argument. This was organized. Poor people or their representatives are not. The CRA's influence on this was minimal.
    2009 Sep 10 03:44 PM Reply
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    Rating agencies have always been worthless. Its not like the housing bubble was the beginning. They've typically always take a rearview picture when making ratings. For them to be useful, they must have a 'predictive' value which they don't. They still are telling people what they want to hear. They should be upgrading ratings as the economy improves but their still mostly just downgrading stuff. To me Eihorn is right that MCO is a short. I'm just worried that a great market will over rule and push them up as well.
    2009 Sep 11 01:53 PM Reply
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    I have always maintained that rating agencies must be paid in terms of the product they rate, with a discount rate proportional to the grade they assign to a product. That's the only way you can align rating agencies' incentives and good information.
    2009 Sep 12 03:50 PM Reply