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S&P Lawsuit: Lessons From a Massive Screw-up

As it faces a $5 billion suit, Standard & Poor's is violating nearly every rule in the crisis communications handbook.

Every CEO will at some point face a crisis that forces a choice between doing what may be good for the short-term bottom line--or doing instead what builds a great reputation that attracts clients and employees in the long term, and an ethical culture that can immunize it from further trouble.

Standard and Poor's offers an object lesson in what not to do.

The Case Against S&P

This week, the U.S. Justice Department sued S&P, a unit of McGraw-Hill, for $5 billion--five times what S&P earned in 2011. The case against the company? Allegedly fudging its ratings of pools of subprime mortgages to make these ultimately toxic securities appear better than they were. The presumed motive is a familiar one to the 2008 financial meltdown: S&P got paid for providing ratings on securities, and apparently was afraid that if it did not give the bundles of risky assets high marks for safety, the issuers--large banks and other financial institutions--would take their business to a more compliant and helpful ratings source, thereby costing S&P money.

In announcing the suit, the government released numerous incriminating emails and other documents that make the case that, yes, S&P operated just like many businesses chasing revenues and profits at all costs. As a result, S&P created a culture of profits first--and ethical behavior a distant second.

Haven't We Seen This Before?

Unfortunately, S&P's response to the suit has been all too typical: Deny everything and blame the government for also failing to foresee the subprime mortgage disaster. (The careful reader will note that the government's ability to understand the depth of the junk being packaged as gold was hindered by the ratings agencies' own actions to rate garbage as safe).

In the recently released book Masters of Disaster, two experienced public relations executives, Christopher Lehane and Mark Fabiani, and an Oscar-winning filmmaker Bill Guttentag, outline the 10 commandments for companies facing an inevitable public relations catastrophe--something that virtually every company is going to encounter (think Apple with the problems with its maps and supply chain, Walmart with the fires in suppliers' factories and the fact that many of its employees are paid so poorly they are on public assistance). S&P has violated many of these recommendations, including the admonition to fully disclose everything it knows at the outset, don't accuse your accuser, and most importantly, don't do things to keep the story in the news.

In this instance, S&P, by denying culpability, is just begging the news media to focus even more on the juicy details of its ethical lapses apparent in the already-released and as yet unreleased emails and presentations. S&P has presumably decided that it can negotiate a better settlement by denying blame than by coming clean.

By denying blame for the undeniable, S&P's response will further damage its reputation. And its actions just set it up for more problems down the road. What companies do when they screw up sends a message not only to the public but also to the authorities. Most importantly, companies' responses to such crises send signals to their employees about their true values. In this instance, S&P has sent a pretty clear message: We put financial costs and profits ahead of admitting blame and telling the truth. Of course, that's precisely the attitude that got S&P into trouble in the first place.

S&P should have known about the problems in the mortgage markets because they were transparently evident to anyone who actually bothered to look. That's the most important lesson in Michael Lewis's best-selling book, The Big Short. People who made a fortune shorting the highly-rated mortgage securities couldn't believe the ratings when they actually read the prospectuses and looked into what was in the mortgage pools. That's the real lesson from the financial meltdown--numerous people, in banks and in the ratings agencies, were not only venal, many people simply did not do the job they were paid to do.

But the worst lesson of all? Few, if any, have suffered any real consequences.

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IMAGE: Getty
Last updated: Feb 6, 2013

JEFFREY PFEFFER | Columnist | Professor, Stanford's Graduate School of Business

Jeffrey Pfefferis the Thomas D. Dee II Professor of Organizational Behavior at Stanford University's Graduate School of Business, and a regular contributor to The Company Ethicist, a new blog about business ethics and leadership, published by Convercent.

The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.



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