Articles Posted in Credit Rating Agencies

Barbara Duka, the ex-head of Standard & Poor’s commercial mortgage-backed securities, is on trial before a Securities and Exchange Commission administrative law judge. Duka is accused of inflating the ratings of commercial mortgage-backed securities and not telling investors that she and her team had changed the way they formulated ratings for the securities in 2011.

The SEC contends that Duka implemented the change after the credit rating agency lost market shares for rating commercial-backed securities using “more conservative criteria” in the wake of the 2008 economic collapse. The regulator believes that Duka began to rate the securities in a way that favored the issuers so S & P could bring in more business.

Meantime, investors  continued to believe that the ratings were conservatively-based.  Now, the Commission wants to bar Duka from associating with ratings organizations. It also wants her to pay financial penalties.

The SEC brought its case against Duka last year around the time that the Commission and two state attorneys general announced that they had reached a $77M settlement with S &P. The regulator’s case was brought after Citigroup Inc.(C) and Goldman Sachs Group(GS) had to withdraw a $1.5B commercial mortgage-backed securities offering because S & P told them about an internal review of the securities ratings. Duka, meantime, sued the SEC, questioning whether it had the right to pursue cases in-house before its own judge instead of in court.  Although a district court judge ruled that the SEC could not move forward with its case against Duka, a federal appeals court decided otherwise.

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According to a letter written by prosecutors to Moody’s (MCO), the U.S. Department of Justice intends to sue the credit rating agency and its Moody’s Investors Services unit over valuations that the latter assigned to mortgage-backed securities leading up to the 2008 financial crisis. The MBS fraud case is expected to make claims about the way the agency rated collateralized debt obligations and residential mortgage-backed securities, as well as allege violations of the Financial Institutions Reform, Recovery, and Enforcement Act as it pertains to rating RMBSs and CDOs. Moody’s disclosed the expected case in an update that also included third quarter earning results.

Aside from the DOJ case, several states’ Attorney Generals are expected to pursue their own claims against Moody’s, except that their cases would be brought under state law.

A number of ratings companies have come under fire over their alleged failure to provide accurate warnings about the risks involved in investing in MBSs and CDOs leading up to the economic crisis. In 2013, the DOJ sued Standard & Poor’s over similar allegations, along with the claim that the agency misled investors for its own profit while misrepresenting the actual risks involved in the securities. Last year, S & P settled with the DOJ, the District of Columbia, and 19 states for almost $1.4B. The government and the states took issue with the way S & P rated the CDOs and RMBSs that it issued from ’04 to ’07.

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1st Circuit Reinstates Lawsuit Against Moody’s
The First Circuit Court of Appeals has reinstated the $5.9 billion residential mortgage-backed securities fraud case brought by the Federal Home Loan Bank of Boston against Moody’s Investor’s Service, Inc. and Moody’s Corp. The bank claims that the credit rating agency knowingly issued false ratings on certain RMBSs that it had purchased.

A district court judge in Massachusetts had dismissed the lawsuit citing lack of personal jurisdiction. The judge also held that the court could not move the lawsuit to a different court where jurisdiction would be proper because cases dismissed for lack of jurisdiction could only be transferred if the dismissal was for lack of subject matter jurisdiction, not personal jurisdiction.

Now the First Circuit has vacated that ruling and found that transferring a case that has dismissed for lack of personal jurisdiction is also allowed. It is moving the RMBS case to the district court, which will decide whether to move the case to New York.

Former Barclays Trader Pleaded Guilty to Libor Rigging
According to prosecutors in the U.K., ex-Barclays Plc. (BARC) trader Peter Johnson pleaded guilty to conspiracy to manipulate the London interbank offered rated in 2014. The government announced the guilty plea this week after lifting a court order that had prevented the plea from being reported until now. The disclosure comes as the criminal trial against five of Johnson’s former Barclays co-workers into related allegations is underway.

The defendants on trial are Jay Merchant, Stylianos Contogoulas, Alex Pabon, Ryan Reich, and Jonathan Matthew. They have pleaded not guilty to the charge of conspiracy to commit fraud. The U.K.’s serious fraud office claims that the men acted dishonestly when they turned in or asked others to submit rates for Libor.

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The State of California is suing Morgan Stanley (MS) for allegedly selling bad residential mortgaged backed securities. According to lawmakers, the firm sold residential mortgage-backed securities as risky loans to subprime lenders while downplaying or hiding the risks and at times encouraging credit raters to bestow the securities with high ratings that were not warranted. Because of these RMBS sales, contends the state, the California Public Employees’ Retirement System (CALPERS) and California State Teachers Retirement System (CalSTRS) sustained devastating losses.

California claims that the firm violated the state’s False Claims Act and securities laws. A significant part of the case challenges Morgan Stanley’s behavior when marketing the Cheyne SIV, which was a structured investment vehicle that failed nine years ago. State Attorney General Kamala Harris is seeking $700M from the firm, as well as over $600M in damages.

Meantime, Morgan Stanley has argued that the case is meritless. It contends that the RMBSs were sold and marketed to institutional investors who were sophisticated enough to understand the investments. They claim that the RBMBs performed in a manner that was in line with the sector to which it belonged.

It was just recently that Moody’s Corp. reached an agreement with CalPERS to pay the California pension fund $130M to resolve allegations that the credit rating agency may have acted negligently by giving high ratings to toxic investments. CalPERS contended that its purchase of the investments cost it hundreds of millions of dollars.

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UBS to Pay $33M to NCUA Related to MBS Sold to Credit Unions
UBS AG (UBS) will pay $33 million to resolve a lawsuit filed by the National Credit Union Administration accusing the bank of selling toxic mortgage-backed securities to credit unions. The case revolves around MBS that were underwritten and sold by UBS. The securities were purchased by Members United Corporate Federal Credit Union and Southwest Corporate Federal Credit Union for almost $432.4M from ’06 to ’07.

NCUA alleged that offering documents for the securities sold included untrue statements claiming that the loans were originated in a manner that abided by underwriting guidelines when, in fact, the loans’ originators had “systematically abandoned” said guidelines. The false statements made the securities riskier than what was represented to the credit unions. Eventually, the MBS failed, resulting in substantial losses.

To date, NUCA has recovered almost $2.46B from banks over MBS sales that occurred prior to the 2008 financial crisis.

US, UK Regulators May Pursue More Banks Over Libor
According to the The Wall Street Journal, the US Commodity Futures Trading Commission and the UK Financial Conduct Authority are working on pressing the last civil charges against a number of banks for alleged rigging of the London interbank offered rate. LIBOR is the benchmark that underpins interest rates on trillions of dollars of financial contracts around the globe.

Sources tell WSJ that the firms under scrutiny include Citigroup (C), J.P. Morgan Chase & Co (JPM)., and HSBC Holdings (HSBC)—although the FCA has already dismissed its probe into J.P. Morgan.

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Credit Rater Accused of Misrepresenting Surveillance Approach for Complex Securities
Credit rating agency DBSR Inc. will pay nearly $6 million to settle Securities and Exchange Commission charges. The regulator is accusing the credit rater of misrepresenting the surveillance method it used for rating certain kinds of complex financial instruments over a three-year period.

In its yearly examination of DBSR, The agency’s Office of Credit Ratings found that the credit rating agency misrepresented that it would each month monitor its current ratings of re-securitized real estate mortgage investment conduits and residential mortgage-backed securities. DBSR said it did this via a three-step quantitative analysis and a surveillance committee review of each rating.

However, said the SEC, the firm failed to perform this monthly scrutiny and did not have its committee look at each rating every month. Instead, when the committee would get together it would only examine a limited subset of outstanding Re-REMIC and RMBS ratings. The credit rater lacked the sufficient technological resources and staffing for performing surveillance for all outstanding Re-REMIC ratings and RMBS each month. The SEC also said that DBRS failed to disclose modifications to specific surveillance assumptions even though its methodology said that is what it would do.

As part of the settlement, DBRS consented to disgorge over $2.7M in rating surveillance fees that it received from ’09 to ’11 in addition to prejudgment interest. It consented to paying a $2.925M penalty and will hire an independent consultant to look at its internal controls, make recommendations for how to improve them, and other matters.

NFP Advisor Services to Pay $500K to FINRA Over Inadequate Supervision
The Financial Industry Regulatory Authority has censured NFP Advisor Services for failing to properly supervise its registered representatives when they conducted private securities transactions. These representatives were registered not just with the firm but also with a registered investment advisor.

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SEC to Propose Reforms to Improve Liquidity Management for Open-End Funds
The Securities and Exchange Commission voted to propose a package of rule reforms to improve effective liquidity risk management for open-end funds, including exchange-traded funds and mutual funds. If approved, both would have to put into place liquidity risk management programs and improve disclosure about liquidity and redemption practices. The hope is that investors will be more able to redeem shares and get assets back in a timely fashion.

The liquidity risk management program of a fund would have to include a number of elements, including classification of the fund portfolio assets liquidity according to how much time an asset could be converted to cash without affecting the market, the review, management, and evaluation of the liquidity risk of a fund, the set up of a fund’s liquidity asset minimum over three days, as well as board review and approval. The proposal also seeks to codify the 15% limit on illiquid assets that are found in SEC guidelines.

Commission Looks for Comment on Regulation S-X
The SEC announced last month that it is looking for public comment regarding the financial disclosure requirements in Regulation S-X and their effectiveness. The comments are to focus on form requirements and the content contained in financial disclosure that companies have to submit to the regulator about affiliated entities, businesses acquired, and issuers and guarantors of guaranteed securities.

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Credit rating agency Moody’s Investor Service has downgraded the credit rating for the city of Chicago, Illinois to junk, reducing the rating of its $8.1 billion of general obligation by two to Ba1, along with a negative outlook. That’s right under investment grade.

The reduction lets banks demand that the Illinois city pay back the debt it owes them early. It also makes Chicago vulnerable to fees to terminate swap contracts.

Aside from the Michigan city of Detroit, Chicago is the lowest-rated of any large city in the U.S. Moody’s downgrade comes after the Illinois Supreme Court decision over retirement benefits last week. The court unanimously decided that a state pension law to reduce government worker benefits, which would get rid of $105 billion in retirement system debt, was unconstitutional. Now, there is skepticism over whether Chicago can keep its $20 billion pension fund short fall under control.

Credit rating agency Standard & Poor’s will pay $1.5 billion to settle a number of lawsuits accusing the company of inflating the ratings of mortgage securities in the lead up to the 2008 economic crisis. As part of the deal, S & P’s parent company McGraw Hill will pay $687.5 million to the U.S. Justice Department and $687.5 million to the District Columbia and 19 states over their inflated ratings cases.

The U.S. sued the credit rater in 2013, asking for $5 billion and claiming that S & P had bilked investors. The company fought the claims, arguing that the First Amendment protected its ratings and contending that the mortgage ratings case was the government’s way of retaliating after S & P downgraded the United States’ own credit rating. As part of the settlement, the credit rating agency said it found no evidence that retaliation was a factor.

S & P is not admitting to violating any law. It noted that its mission is to give the marketplace information that is independent and objective and employees are not allowed to influence analyst opinions because of commercial relationships.

According to the Wall Street Journal, the U.S. Department of Justice has been meeting with ex-Moody’s Investor Service (MCO) executives to talk about the way the credit ratings agency rated complex securities prior to the 2008 financial crisis. Sources say that the probe is still in its early stages and it is not certain at the moment whether the government will end up filing a bond case against the credit rater.

DOJ officials are trying to find out whether the company compromised its standards in order to garner business. The government’s focus is on residential mortgage deals that took place between 2004 and 2007.

Moody’s and credit rating agency Standard and Poor’s gave triple A ratings to the deals so that even conservative investors were buying the subprime loan-backed securities. The investments later proved high risk. When the housing market failed, the bond losses cost investors billions of dollars.