Terry McGraw's New Problems At S&P

A little over a year ago, amidst the then-year-old unraveling of mortgage-backed securities which decimated the US banking industry, I wrote this post concerning Terry McGraw's push for growth at his Standard & Poors, McGraw-Hill's rating agency unit.

Now a case is moving through US courts that could spell the beginning of the payback by S&P and McGraw-Hill for its cavalier approach to ratings over the past few years. The Wall Street Journal covered it last week, and I noted to myself, upon reading the article, that it could spell disaster for the firm.

This morning, CNBC had McGraw-Hill CEO Terry McGraw on to defend the company's position. And Terry didn't disappoint. He claimed that the judge had tossed several charges on first amendment bases, and that only one remained, so the company was in great shape.

Ah, not so fast, Terry.

In a move calculated to boost ratings, which is understandable, the program then aired a telephone interview with occasional guest host and periodic guest, Greenlight Capital hedge fund manager David Einhorn.

Einhorn, though far from perfect, is noted for having correctly shorted Lehman last year, publicly dueling with its CFO and questioning the now-defunct firm's valuation of various real estate assets on its balance sheet.

Einhorn confirmed on the air this morning that his fund has shorted McGraw Hill's stock. He went on to give a very detailed explanation of how, in his opinion, Terry McGraw's prior defense was incorrect and overly-optimistic.

Basically, the case boils down to this. Publicly-available ratings by agencies are deemed 'protected speech' under the first amendment. You can't sue S&P for their public rating of a bond or CMO issue. Even if it was obviously, in retrospect, flawed and poorly-determined.

However, the case in question involves S&P providing ratings opinions on securities to a non-public investing group. This, the court found, is not protected speech. Thus, possible charges could involve fraud.

Einhorn stressed that S&P has never, in the past, had to worry about being sued for its opinion. The fact that this is now about to happen is a watershed event for it, and its competitors, Moody's and Fitch. He opined that other suits will likely now follow, especially if S&P loses this case.

Then there is the question of damages. Einhorn noted that none of the ratings agencies, similar to what occurred with MBIA's under-reserved financial situation, have the financial depth to actually pay damages on fraudulently-rated securities.

As the 5-year price chart for MHP and the S&P500 Index reveals, Terry McGraw's company has struggled for most of the past five years simply to remain comparable to the index. For the past two years, since late 2007, when the ratings mess began to become public, it's basically been underperforming the index.

It's a decent bet that any serious legal problems at S&P are going to really put pressure on the firm's performance, and maybe, in time, Terry's job. After all, per my post of last August, he was running S&P on a pretty thin funding stream while pushing for massively greater profits and volumes from the unit.

It looks like that strategy is now coming home to roost at the firm, in the form of the investor lawsuit based on the private securitized bonds ratings.