Standard & Poors Receives SEC Wells Notice Over CDO Rating

Standard & Poor’s Ratings Services has received a Wells Notice from the Securities and Exchange Commission notifying the credit rating agency that it ma be subject to possible enforcement action over alleged violations of federal securities laws. The allegations involve S & P’s ratings for the Delphinus CDO 2007-1, a collateralized debt obligation.

The $1.6 billion hybrid CDO was downgraded just a few months after it received AAA ratings from both S & P and Moody’s Investor Services—the two biggest credit rating agencies in the country—by the end of 2008 its securities that were rated AAA had been downgraded to junk status. S & P’s parent company McGraw-Hill says that the credit rating agency is cooperating with the Commission’s examination into this matter. If the SEC were to file an enforcement action against S & P, it would be its first one against a credit rating agency for the rating of a mortgage-backed security.

Just today, the SEC staff expressed concern that despite changes that were implemented at credit rating agencies to better their operations, the Commission is still concerned about certain deficiencies. The SEC voiced its concerns in its first yearly report on Nationally Recognized Statistical Rating Organizations. Alleged deficiencies include:

• Not always following ratings procedures or methodologies.
• Failure to make accurate and timely disclosures.
• Improper management of conflict of interest.
• Lack of effective internal control structures for the rating process.

The new annual reports was mandated by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection, which is seeking better oversight and regulation of credit rating agencies. 10 credit rating agencies registered as NRSROs were examined. The names of the NRSROs weren’t published.

It was just earlier this year that the Senate Permanent Subcommittee on Investigations issued its bipartisan report noting that the most “immediate cause” of the financial crisis three years ago was the “mass ratings downgrades” of securities in 2007 that were made by Moody’s and S & P. Per the report, credit rating agencies were aware that their ratings wouldn’t “hold” and held back on putting up more strict ratings criteria. When they did modify their risk models that noted there were high-risk mortgages being issued, the revised models were not applied to existing securities. All of this allowed investment banks to push out high-risk investments before the tougher criteria were implemented.

Credit ratings changes can impact not just a company’s bond prices but also its stock price. The market can also be impacted.

For the time ever, S & P downgraded the US credit rating a notch lower than AAA. The credit agency expressed concern about the federal government’s ability to take care of its finances. S & P noted that the bipartisan agreement to look for at least $2.1 trillion in budget savings was not enough to quell the nation’s debt in the long run. Now, the SEC is looking into whether news of S & P’s downgrade of the country’s debt was leaked and the info used for trading before it was officially made known.

S&P downgrades U.S. credit rating for first time, Washington Post, August 5, 2011

S.E.C. Faults Credit Raters, but Doesn’t Name Them, NY Times, September 30, 2011

SEC Staff Issues Summary Report of Commission Staff’s Examinations of Each Nationally Recognized Statistical Rating Organization, SEC, September 30, 2011

More Blog Posts:

Moody’s, Fitch, and Standard and Poor’s Were Exercising Their 1st Amendment Rights When They Gave Inaccurate Subprime Ratings to SIVs, Says Court, Institutional Investment Fraud Blog, December 30, 2010

Standard and Poor’s Ratings Lawsuit to Go Forward, Says Judge, Institutional Investment Fraud Blog, September 16, 2010

SEC’s Handling of Credit Rating Agencies Oversight and Failure to Detect Madoff and Stanford Ponzi Scams Questioned at Senate Appropriations Financial Services Subcommittee, Stockbroker Fraud Blog, May 8, 2010

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