In a victory for the Securities and Exchange Commission, the securities ratings firm Standard & Poor’s has agreed to settle claims it fraudulently certified certain mortgage-backed securities as good investments, as well as claims the firm used a certain methodology to calculate risk with regard to commercial mortgage-based securities when, in fact, a different and undisclosed method was used. The settlement addresses several claims of fraud by both federal regulators and several states, including Massachusetts and New York. What’s more, Standard and Poor’s is prohibited from engaging in certain commercial mortgage-backed securities transactions for one year.
Details of the case against Standard and Poor’s
As plainly stated by the SEC chief of enforcement:
“Investors rely on credit rating agencies like Standard & Poor’s to play it straight when rating complex securities like CMBS….But Standard & Poor’s elevated its own financial interests above investors by loosening its rating criteria to obtain business and then obscuring these changes from investors. These enforcement actions, our first-ever against a major ratings firm, reflect our commitment to aggressively policing the integrity and transparency of the credit ratings process.”
The details of the case involve several highly-complex CMBS transactions, which were evaluated by Standard & Poor’s for creditworthiness and riskiness to investors. Following a series of administrative orders issued by the SEC, the following issues were identified as actionable fraud by the firm:
- Falsely certifying to the SEC that it was using one method of evaluating these securities, when in fact it was relying on an undisclosed and less stringent method, thereby allowing certain transactions to carry through that may have been more risky and financially imprudent than originally communicated;
- Seeking to re-enter the CMBS market after being “frozen out” by initiating the new ratings methodology, presumably to “win over” investors eager to see completed transactions;
- Falsely describing the criteria it uses to evaluate these complex securities transactions, including the publication of a comparative article highlighting its new methodologies as capable of withstanding the financial stresses of even the Great Depression;
- Failure to maintain proper internal controls to ensure a “race to the bottom” mentality would not pervade the Standard & Poor’s methodologies and corporate culture.
The firm admitted a portion of the allegations and denied others. Nonetheless, it has agreed to a major overhaul of its internal compliance protocols and has attempted to explain its shift in methodology as an attempt to implement a “more issuer-friendly ratings criteria” system.
The SEC has been highly successful in combating fraud over the past few years, as a number of Recession-era issues have been settled involving residential mortgage-backed securities. Its false claims whistleblower program has also proven successful, resulting in yearly increases in reports and record-breaking whistleblower rewards.
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