US sues S&P over pre-crisis mortgage ratings

Updated 06 February 2013
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US sues S&P over pre-crisis mortgage ratings

WASHINGTON: The US government says Standard & Poor's knowingly inflated its ratings on risky mortgage investments that played a key role in triggering the 2008 financial crisis.
In charges filed late Monday in Los Angeles federal court, the Justice Department said the credit rating agency gave high marks to mortgage-backed securities because it wanted to earn more business from the banks that issued the investments.
The case is the government's first major action against one of the credit rating agencies that stamped their approval on Wall Street's mortgage bundles. It marks a milestone for the Justice Department, which has been criticized for failing to make bigger cases against the companies involved in the crisis.
"Put simply, this alleged conduct is egregious — and it goes to the very heart of the recent financial crisis," Attorney General Eric Holder told a news conference yesterday. He called the case "an important step forward in our ongoing efforts to investigate and punish the conduct that is believed to have contributed to the worst economic crisis in recent history."
At the news conference, acting Associate Attorney General Tony West said "we think that at the very least," S&P is liable for more than $ 5 billion in civil penalties.
Joining the Justice Department in the announcement were attorneys general from California, Connecticut, Delaware, the District of Columbia, Illinois, Iowa and Mississippi, who have filed or will file separate, similar civil fraud lawsuits against S&P. More states are expected to file suits, the Justice Department said.
S&P, a unit of New York-based McGraw-Hill Cos., called the lawsuit "meritless" in a lengthy statement.
"Hindsight is no basis to take legal action against the good-faith opinions of professionals," the company said. "Claims that we deliberately kept ratings high when we knew they should be lower are simply not true," it said.
Rating agencies are widely blamed for contributing to the financial crisis that caused the deepest recession since the Great Depression. They gave high ratings to pools of mortgages and other debt assembled by big banks and hedge funds, suggesting there was little risk for investors. That gave even risk-averse investors the confidence to buy them.
Some investors, including pension funds, can only buy investments that carry high ratings. In effect, rating agencies like S&P greased the assembly line that allowed banks to push risky mortgages out the door.
When the housing market collapsed in 2007, the agencies acknowledged that mortgages issued during the bubble were far less safe than the ratings indicated. They lowered the ratings on nearly $ 2 trillion worth, spreading panic that spiraled into a crisis.
In its statement yesterday, S&P said its ratings "reflected our current best judgments" and noted that other rating agencies gave the same high ratings. It said the government also failed to predict the subprime mortgage crisis.
But the government contends in its lawsuit that S&P was more concerned with making money than issuing accurate ratings. It says the company delayed updating its ratings models, rushed through the ratings process and kept giving high ratings even after it was aware that the subprime market was flailing.
The complaint includes a trove of embarrassing emails and other evidence that S&P analysts saw the market's problems early:
— In 2007, an analyst who was reviewing mortgage bundles forwarded a video of himself singing and dancing to a song written to the tune of "Burning Down the House": "Going — all the way down, with/Subprime mortgages." The video colleagues laughing at his performance.
— A PowerPoint presentation that year said being "business friendly" was a core component of S&P's ratings model."
— In a 2004 document, executives said they would poll investors as part of the process for choosing a rating. One executive replied, asking, "Does this mean we are to review our proposed criteria changes with investors, issuers and investment bankers? ... (W)e never poll them as to content or acceptability!" The executive's concerns were ignored, the government said.
— Also that year, an analyst complained that S&P had lost a deal because its criteria for a rating was stricter than Moody's. "We need to address this now in preparation for the future deals," the analyst wrote.
Acting Associate Attorney General Tony West said the documents "make clear that the company regularly would 'tweak,' 'bend,' delay updating or otherwise adjust its ratings models to suit the company's business needs." He said that in 2007, S&P issued ratings that it "knew were inflated at the time they issued them."
S&P said the emails were "cherry picked," that they were "taken out of context, are contradicted by other evidence, and do not reflect our culture, integrity or how we do business."
It said the government left out important context. For example, an email that says deals "could be structured by cows" and then rated by S&P was unrelated to the types of mortgage investments at issue in the government's suit, S&P said. It said the analyst's concerns were addressed before a rating was issued.
Ratings agencies like S&P are a key part of the financial crisis narrative. When banks and other financial firms wanted to package mortgages and sell them to investors, they were required to seek a rating from a rating agency. Those investors suffered huge losses when housing prices plunged and many borrowers defaulted on their mortgage payments.
By 2006, S&P was well aware that the subprime mortgage market was collapsing, the government said, even though S&P didn't issue a mass downgrade of subprime-backed securities until halfway through 2007. The mortgages were performing so poorly "that analysts initially thought the data contained typographical errors," according to one document cited in the lawsuit.
In a 2007 email, another analyst said some at S&P wanted to downgrade mortgage investments earlier, "before this thing started blowing up. But the leadership was concerned of passing of too many clients and jumping the gun ahead of Fitch and Moody's."
The government's case sides with critics of rating agencies who have long argued that the agencies suffer from a fundamental conflict of interest. Because they are paid by the banks that create investments they are rating, the agencies had to compete for banks' business. If one agency appeared too strict, banks could shop around for a better rating.
The government's lawsuit says that "S&P's desire for increased revenue and market share ... led S&P to downplay and disregard the true extent of the credit risks" posed by the investments it was rating.
S&P typically charged $150,000 for rating a subprime mortgage-backed security and $ 750,000 for certain other securities. If S&P lost the business to Fitch or Moody's, its main competitors, the analyst who issued the rating would have to submit a "lost deal" memo explaining why he or she lost the business.
S&P analysts ended up trying to keep banks — its clients — happy, even if it meant approving sloppy ratings, the government said.
The government charged S&P under a law aimed at making sure banks invest safely, and said that S&P's alleged fraud made it possible to sell the investments to banks.
If S&P is eventually found to have committed civil violations, it could face fines and limits on how it does business. The government said in its filing that it's seeking financial penalties.
There are no criminal charges, which would require a higher burden of proof and carry the threat of jail time.
McGraw-Hill shares dropped $ 2.72, or 5.4 percent, to $47.58 in morning trading yesterday after plunging nearly 14 percent on Monday after the lawsuit was first reported.
Shares of Moody's Corp., the parent of Moody's Investors Service, another rating agency, lost $ 1.05, or 2.2 percent, to $ 48.40 in morning trading Tuesday after closing down nearly 11 percent on Monday.


Telegram Russia ban spurs privacy debate

Updated 21 April 2018
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Telegram Russia ban spurs privacy debate

  • Telegram has always attracted a mix of criticism and respect for its use of encryption to ensure its messages between users remain confidential.
  • A Moscow court decided last week to block the app in Russia because it refused to hand over encryption keys to authorities.

LONDON: Telegram, the messaging app that re-located from Russia to Dubai, has again fallen foul of the authorities in its mother country. So what is it about the social media platform that simultaneously has governments worldwide so concerned and freedom of speech advocates so agitated?
Telegram has always attracted a mix of criticism and respect for its use of encryption to ensure its messages between users remain confidential.
A Moscow court decided last week to block the app in Russia because it refused to hand over encryption keys to authorities — sparking fresh controversy around the app, which has previously been banned in countries such as Iran, Afghanistan and Indonesia.
Telegram has been under close scrutiny in Russia since legislation was passed in mid-2016 that required communication companies to hand over encryption keys to the Federal Security Service (FSB), if requested.
There was also a move to place companies on a “register of information distributors,” which requires firms to store user online communications for a set period of time and hand over data to the authorities when needed.

 


Some of Russia’s large social networks are reportedly on the register and Telegram was pressurized to register in mid-2017. Other Western social media companies such as WhatsApp are not listed. WhatsApp did not immediately respond to a request for comment.
Weeks after joining the register, Telegram refused to agree to FSB requests for encryption keys, resulting in the Russian media watchdog Roskomnadzor seeking court approval this month to block the app.
On the day of the court decision, Telegram’s founder Pavel Durov tweeted: “Privacy is not for sale, and human rights should not be compromised out of fear or greed.” The company has also said it is technically impossible to transfer encryption keys.
It was not the Russian entrepreneur Durov’s first run-in with Russian authorities. Telegram — which was launched in 2013 — originally had its development team based in St. Petersburg, but had to leave the country due to local IT regulations. It is currently based in Dubai.
The messaging app prides itself in being the most secure and independent form of instant messaging that respects the need for privacy. Its “secret chats” option makes use of end-to-end encryption that ensures only users can read them. Messages cannot be forwarded and you can order messages to “self-destruct” within a set amount of time. It can also alert users if the recipient of the message takes a screenshot of the correspondence. So-called Telegram “Channels” can be used to broadcast public messages to a large audiences.
While WhatsApp — which is owned by Facebook — also provides end-to-end encryption, Telegram differentiates itself with claims it is faster and more secure.
Damir Gainutdinov is a legal analyst at Russian human rights group Agora, which represented Telegram in court. He has headed up its project on the defense of online freedom in Russia since 2010.
He told Arab News that the block placed on Russia was more of a power-play by the authorities.
“I think that Russian authorities believe that Telegram is a threat because they cannot control it.
“But I wouldn’t say that it is really the biggest threat. The attack on Telegram is more about showing that they can block any global service if they want,” he said.
Russia’s government has argued that the app helps to enable terrorist attacks in the country, saying that access to encrypted messages is a national security issue.
The FSB said a suicide bomber who killed 15 people on a St. Petersburg subway in April last year had used Telegram to plan the attack.
Voices from outside Russia have also criticized Telegram for not doing enough to clamp down on terrorists using the app. “Terrorists and extremist groups such as ISIS (Daesh) use encrypted applications like Telegram because it allows them to recruit new members, fundraise, incite to violence, and even coordinate terrorist activity without the threat of being discovered,” said executive director David Ibsen at the US-based non-government organization Counter-Extremism Project.
“ISIS also created public channels on Telegram to broadcast pro-ISIS news updates and disseminate other propaganda materials,” he told Arab News. Durov has been quoted as saying at a conference in 2015 that the right to privacy is more important to the company than “our fear of bad things happening, like terrorism.” Following the Paris attacks in 2015, Telegram did revise its policy on its public channels, but it has refused to take down private Daesh chats, according to Ibsen.
Social media sites are coming under increasing pressure from authorities worldwide to do more to limit the promotion of extremism online.
In a statement to Arab News, Twitter said it had permanently suspended 274,460 sites in the second half of last year — down more than 8 percent on the previous reporting period.
While Telegram is far from the only social media app to be criticized for its counter-terrorism policies, it is seen by some as the more reluctant player in the battle against online extremism. “Social media companies remove content regularly that violates their stated terms of service, and some of this includes extremist and terrorist videos, images and other propaganda,” said Ibsen. “However, despite the availability of technology that can identify and permanently prevent prohibited materials from being re-uploaded, the biggest social media platforms are not taking this vitally important step,” he said.
“Telegram has become a refuge app from the moment the preferred apps (Twitter in particular) started to clamp down on extremist content,” said Rik Coolsaet, a professor of international relations at Ghent University in Belgium who has written extensively on counter-terrorism efforts. “Its encryption offered a secure environment for terrorist recruiters and groomers, but at the same time limited their propaganda outreach, since it is more difficult to access. For that reason, Twitter remains their preferred app,” he added.
Russia is not the only country clamping down on Telegram. Iran restricted certain channels in December last year during the protests and there have been recent threats that restrictions could be reimposed. A estimated 40 million Iranians use Telegram’s channels and messaging services.
“In the case of Russia and Iran, the Telegram crackdown has much more to do with controlling the lives of its citizens than it does with preventing terrorist activity,” said Ibsen.
Telegram did not respond to Arab News’ request for comment.

 

Q&A
We talk to leading world cyber terrorism expert Chris Sampson, co-author of “Hacking ISIS: How to Destroy the Cyber Jihad” and an analyst with the Terror Asymmetrics Project

Why are governments so worried about Telegram?
Telegram was launched as an encrypted messaging app. This meant that government agencies were less likely to be able to intercept messages passing across the Internet and read private conversations. However, in September 2015, Telegram also created an option for channels, which act like chat groups. This allowed like-minded individuals to essentially host a chat room. Unless the channel was set to public you couldn’t read what was discussed without being given an invitation link. Groups like ISIS began using these channels to share propaganda and information. Other groups use Telegram in much the same manner. Non-violent resistance groups around the world would also use the messaging app and channels to communicate so authorities in the countries they fear would be less likely to intercept their discussions.

Will clamping down on social media apps be effective?
As governments crack down and ban apps, others will rise and replace them with new features and focus on security from outside eyes. They will operate either within the legal construct or outside of it depending on the countries they seek to circumvent. Since laws around the world differ dramatically, what is legal in one country could be illegal in another. We’ve seen this already happen as countries sought to ban use of Telegram, WhatsApp or even Twitter. Inevitably the access to the technology remains the same and users find a way to use both encrypted messaging and social media platforms.

Does Russia’s action set a precedent?
Countries such as Indonesia, Iran, Afghanistan and others have banned Telegram. Brazil banned WhatsApp around the timing of the World Cup only to lift the ban. Such bans are largely ineffective because the majority of users are engaged in lawful communications yet want their privacy, those engaged in illegal and potentially violent activities make up a fraction of the userbase. The better solution is to know where nefarious users are lurking on the web and keep track of them in observable spaces. Banning the public’s access to messaging apps will always fail. Telegram and similar companies should deny government agencies the keys to encryption unless there is a reason given that would justify unlocking communications. If the governments are able to seize a phone and unlock it, they’ll already have access to a suspect’s communication if they haven’t erased the data.

Decoder

Telegram

Telegram, founded by Russian entrepreneur Pavel Durov in 2013, is an app that enables encrypted messaging, together with “self-destruct” messages. It is used by 200 million people worldwide. Authorities in a number of countries criticized it for providing secure communications channels for terrorists and criminals.