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Standard & Poor’s (S&P), the bond-rating agency whose past practices have been tied to the mortgage crisis, is in negotiations with the U.S. Justice Department to settle allegations of civil fraud with a payout of over $1 billion. Unless the Justice Department specifically forbids it, the deal could allow S&P to claim the payment as a deductible business expense worth more than $350 million.
“These settlement agreements should strongly deter the kind of behavior that brought about the mortgage crisis,” said Michelle Surka, program associate with US Public Interest Research Group. “That’s lost if the agreements allow corporations to write off their misdeeds as just a cost of doing business.”
The Department of Justice complaint alleges that S&P knowingly downplayed the risk on securities. Allegedly, S&P would often rate subprime securities inaccurately, giving them high ratings when in reality they were composed of risky mortgages likely to default. This practice won the rating agency business from banks like Morgan Stanley and JP Morgan, which have also settled numerous allegations with the Justice Department in connection with the mortgage crisis.
“If the Justice Department’s settlement includes tax deductions, it would be a subprime deal for taxpayers. Americans have already paid the price for S&P’s allegedly poor practices, thanks to the mortgage crisis and recession it helped bring about,” said Surka. “S&P’s deceptive reporting practices led to millions of Americans going financially underwater. The Justice Department itself needs to be forthright about whether this deal can become a write off for S&P.”
Every dollar in tax windfalls claimed by deducting settlement agreements must be shouldered by everyday taxpayers in the form of higher taxes, more federal debt, or cuts to public programs.
In previous cases, the Justice Department has usually failed to prevent banks from taking tax deductions for payments meant to settle allegations of fraud in connection with the mortgage crisis. In August 2014, $11 billion of Bank of America’s $16 billion settlement could be classified as an ordinary cost of doing business for tax purposes.
The Department of Justice has the power to explicitly deny corporations tax deductions for settlement payments. Specific language in the legal agreement, which other agencies like the Securities Exchange Commission and the Consumer Financial Protection Bureau use regularly in their deals with corporations, can prevent such deductions and save tax payers millions.
Typically, when a settlement agreement is likely to become a tax write off, the Department of Justice does not even divulge the real, after-tax value of the payment.
“The American public counts on S&P reporting real numbers and accurately rating these financial instruments. If the company knowingly failed to do that, they should face consequences,” said Surka. “The Department of Justice should similarly report real, after-tax numbers when announcing its settlements.”
You can read U.S. PIRG’s research report on the tax implications of legal settlements, “Subsidizing Bad Behavior: How Corporate Legal Settlements for Harming the Public Become Lucrative Tax Write-Offs.
U.S. PIRG created a fact sheet on use of the settlement loophole by Wall Street financial firms.
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