Home > Uncategorized > S&P and the Puffery Defense

S&P and the Puffery Defense

February 4, 2015

Yesterday the ratings agency S&P settled a lawsuit with the Department of Justice for awarding ridiculously high ratings for mortgage-backed securities way back when. For their massive contribution to the world-wide financial crisis, they got fined $1.5 billion, nobody went to jail, and they didn’t even have to admit what they’d done is wrong.

But here’s something they did admit: their use of the word “objective” when describing their models was mere “marketing puffery,” not to be taken seriously. This is called the “puffery defense” by Bloomberg.

To be fair, this wasn’t just about the usage of the word objective. From Bloomberg’s piece:

S&P said in its request to dismiss the case that the government can’t base its fraud claims on S&P’s assertions that its ratings were independent, objective and free of conflicts of interest because U.S. courts have found that such vague and generalized statements are the kind of “puffery” that a reasonable investor wouldn’t rely on.

Now, as some of you know, I’m writing a book about destructive mathematical models. And pretty much all of the models make claims of being objective. It’s part of the marketing for those models, a requirement to lure people into using complex, mathematical black boxes instead of their own brains, and crucially, in place of their own sense of fairness and accountability.

Example: Value-added models for teachers are showered with claims of objectivity (see page 4 of this marketing brochure for example), even though those claims are questionable at best.

So, it makes me wonder, is the Puffery Defense going to be widespread? Is it a technical and legalistic approach? Are we going to have a redefinition of that word so that companies are officially allowed to claim objectivity while actually meaning nothing like objectivity?

Categories: Uncategorized
  1. JSE
    February 4, 2015 at 7:28 am

    I think the cutting edge of this is states defaulting on their pension obligations. “What, you thought we LITERALLY meant we were going to pay you the amount it says on your contract? Surely all reasonable people understood that was just marketing puffery!”


  2. February 4, 2015 at 7:41 am

    +1 to the JSE comment above.

    Regarding puffery . . . . Over the years I’ve noticed a funny evolution in confidentiality agreements when people are proposing / advising on deals. 15 years ago the confidentiality agreements just said that you would agree to keep the information confidential.

    Now they say something like – “we make no representation that the information provided is accurate or complete and you agree not to rely on it for any purpose whatsoever.”

    I’ll bet rating agency reports start to contain similar language (if they don’t already).


  3. mb
    February 4, 2015 at 8:07 am

    I agree with much of what you say, but like pharma companies sued for their packaging inserts (pfizer), I think this is pretty stupid. The models they used were regulated, the regulators told them what they had to do and what was acceptable (much like pharma companies can NOT say anything on a package/label/insert without FDA approval and many times the FDA has requirements of what they MUST say). On top of that, the SEC requires the issuer to pay for the rating and then other regulators base capital ratios for the buyers on those ratings. So the issuers shops for a rating, the buyer wants risk (return) that will meet its capital ratio requirements and the solution is to regulate a different model? In time that will be gamed too. Maybe you should look at the causes, not the effect.


    • February 4, 2015 at 8:10 am

      Actually, I have, and the news is incredible: nothing has changed with respect to the bad incentives in the rating agencies industry, due in part to the watering down of Dodd-Frank.


      • mb
        February 4, 2015 at 8:46 am

        Dodd Frank requires new models, as far as I know that was always the case ( well not require, congress would never actually require anything – since they could be blamed – they require someone else study the problem and then another group implement the solution – typical government CYA – never will understand why people think government is a solution to everything )


  4. February 4, 2015 at 8:17 am

    The Supreme Court of Canada recently ruled that a term of good faith performance is now an implied requirement in all contractual agreements.

    One wonders if this applies to advertising? And is there an American equivalent?



  5. February 4, 2015 at 8:30 am

    As any law school torts and contracts professor will tell you, courts have recognized and excused a certain degree of “puffing” at least as far back as the 19th Century. The idea was that “everyone” understood that businesses made claims that were, shall we say, a bit “exaggerated”. The Supreme Court even went as far as to strike down limits on commercial speeech.

    It’s Ayn Rand’s world, folks. We’re only getting fucked in it.


  6. February 4, 2015 at 9:19 am

    OK, “objective” doesn’t mean objective. Does “free from conflicts of interest” mean free from conflicts of interest?


  7. KathH
    February 4, 2015 at 9:23 am

    Regulators et al. need a standard-issue desk sign: The Puff Stops Here


  8. February 4, 2015 at 9:51 am

    Geee, apparently our financial system is simply all ‘puffed up’… and to think that all along I’d been using a slightly different verbiage…


  9. February 4, 2015 at 10:59 am

    There’s been several articles on this topic and it makes for an interesting comparison, but China now is putting out some interesting new rules for businesses and technology to work with Chinese banks, they want the “code” on some of these apps, hardware, software, etc. In other words, China has big corruption issues as well by all means, but they want to review our code before they step in and use any US technologies, especially any products that connect and allow access to any banks in China.

    As I have read it in a few places I believe anything such as ratings and other analytical systems fall into this too. I just thought that was interesting as this all seems to unravel and it’s all about the math and basically the “foolery” that doesn’t seem to stop. Needless to say US tech companies are not really happy right now:)


  10. Josh
    February 4, 2015 at 11:03 am

    Cathy, if you haven’t already, you should read the original DoJ complaint against S&P. Some choice quotes (pages 51 and 52):

    An analyst whose model was rejected complains “If we are just going to make things up to rate deals, then quants are of very little value”. A later memo notes “we cannot ignore the real risk of losing transaction revenue. … the balance between market share and analytical integrity is complex.”

    So, we know they were very focused on risk — to S&P’s profits (and presumably the employee’s compensation or their future careers). Subsequent events show how they resolved the “complex” problem of balancing market share and integrity.

    Should be a case study for a business school ethics class.


  11. February 4, 2015 at 11:11 am

    Holy crap.


    • Josh
      February 4, 2015 at 12:44 pm

      I meant to include a link to the complaint. Really good case study of how business imperatives (profit) pressures integrity.

      Click to access U.S.-v.-SP.pdf


  12. Auros
    February 4, 2015 at 2:30 pm

    I think in a lot of cases, you’ll see quant-ish investment types exploit a misunderstanding of the word “objective”. If I went out and measured the temperature in ˚F each day, and based on that value, rounded to an integer and modded by 3, issued “buy / sell / hold” guidance for S&P 500 index funds, that would be completely absurd and useless, but it would be objective.

    Objective simply means that it’s based on factors that a different observer would be able to replicate by following the same methods, as opposed to being dependent on the irreproducible personal feelings and judgments of one or more people involved in the ratings process.


  13. February 4, 2015 at 8:36 pm

    Thanks for emphasizing the “puffery” involved in VAM… I’m sure VARC is ecstatic over Governor Cuomo’s decision to use VAM as 50% of the evaluation component for teachers in his never ending quest to prove that bad teaching is the reason schools in NYS fared poorly on the tests last year…


  14. February 5, 2015 at 1:09 pm

    Thanks for covering this Cathy; I was surprised to see so little comment. I witnessed the same issues when I worked at Moody’s in the run-up to 2008 doing product management and data collection in support of the structured finance team.

    With respect to “nobody went to jail, and they didn’t even have to admit what they’d done is wrong”:

    (1) They signed a “Statement of Facts” drafted by the Justice Department that contains several elements of the original complaint and is basically an admission of wrongdoing. See http://www.justice.gov/sites/default/files/opa/press-releases/attachments/2015/02/03/sp_statement_of_facts.pdf.

    (2) I don’t think the actions by S&P executives listed in the complaint warrant jail time. Rating agencies distorted their modeling parameters – or simply ignored their models – to produce inflated ratings that would keep them competitive. Buy-side users did not purchase the ratings, since they are given away. (Also, some buy-side participants pressured rating agencies to avoid downgrades so that they would not have to take mark-to-market losses and would have more AAA paper to choose from.) So rating agencies are guilty of debasing a free product. This is offensive but not criminal.

    (3) These shoddy practices continue in more obscure world of Commercial Mortgage Backed Securities as I discuss here: http://expectedloss.blogspot.com/2015/01/sec-shines-light-on-inflated-cmbs.html


    • Josh
      February 7, 2015 at 2:37 pm


      While it is true that the ratings of issues are given away,, the agencies do charge for reports and analysis that supports them. So, to the extent that your argument is based on the ratings being “free” it doesn’t entirely hold up.


      • February 7, 2015 at 3:41 pm

        Josh: This is a good point. A lot of the content that rating agencies sell to investors have little to do with ratings. When I worked at Moody’s Analytics, I was managing a commercial data set of information extracted from Collateralized Debt Obligation trustee reports that we sold to investors. That said, the research reports explaining ratings were a major source of revenue.


  15. February 14, 2015 at 9:55 am

    and which govt agencies have been reformed after 2008? it was a massive failure of govt regulation & capital controls. the game of merely fining big corporations is quite out of control. there are no major structural changes going on. the prez didnt have the NERVE. he stared down the beast in 2008 & the beast walked all over him. his instincts on economics have turned out to be nearly useless. way out of his league. playing on the jr varsity team.


    • Auros
      February 14, 2015 at 3:12 pm

      I think the administration has been too pro-Wall-Street in a lot of its appointments, but it’s also a massive over-simplification to just blame everything on the president without considering that he was trying to wrangle conserva-Dems in Congress (and Dems who are mostly OK, but bad on finance in particular, like Schumer). If he’d come out and tried to rally public pressure for stronger provisions in Dodd-Frank, he might well have lost the votes of several Democrats, making a Republican filibuster of the whole package viable.


  1. February 5, 2015 at 6:13 am
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