Last Wednesday, January 21, 2015, the Securities and Exchange Commission suspended Standard & Poor's Ratings Services (S&P) for one year from rating certain mortgage-backed securities as part of a combined $77 million settlement with McGraw-Hill Financial Inc. The settlement is part of a resolution of three separate administrative actions brought by the SEC and state attorneys general in New York and Massachusetts. Additionally, S&P disgorged $6.2 million in profits earned on six transactions in which S&P allegedly used diluted ratings criteria.
In connection with resolving one of the actions, the SEC extracted an agreement from S&P that it would not, for a period of one-year, rate conduit commercial mortgage-backed securities. The settlement arises from allegations that S&P misrepresented its rating methodology for this product, allegedly applying more relaxed criteria and resulting in potentially inflated ratings.
As part of its resolution of another of the administrative actions, S&P agreed to retract an allegedly misleading 2012 study suggesting that, under S&P's new ratings criteria, bonds rated AAA could withstand Great Depression-era levels of economic stress. In retracting this study, S&P essentially conceded that the study was false or at least misleading because it was based on flawed assumptions and some data that preceded the Great Depression by decades.
Finally, in resolving the third action, without admitting or denying wrongdoing, S&P consented to a finding that its surveillance of previously rated mortgage-backed securities from October 2012 to June 2014 was lacking.
Against the backdrop of these administrative settlements, S&P reiterated its intent to strengthen its surveillance controls and risk management in an effort to restore integrity to the ratings system.
Separate from the administrative actions brought against S&P, the SEC charged individually Barbara Duka, the former head of S&P’s CMBS Group. In its charging document, the SEC alleges that Ms. Duka fraudulently misrepresented the way in which S&P calculated a critical aspect of its CMBS ratings in 2011 as part of a push for more issuer-friendly ratings criteria.
This series of settlements and the Duka action are significant because they reflect the SEC's first substantive attack on a major ratings agency, which some contend should bear responsibility for a significant portion of the 2008 financial collapse. Moreover, these actions reflect the SEC flexing its new-found powers over ratings agencies conferred by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act.
As the SEC takes a tougher stance on the rating agencies, we anticipate that conflicts of interest will be among the primary allegations leveled by the SEC. This potential for conflicts of interest underpins a February 2013 action brought by the Department of Justice, in conjunction with 17 states, who accuse S&P of inflating ratings of collateralized debt obligations and mortgage-backed securities in the months and years preceding the 2008 financial in response to pressure from product issuers who were paying for the ratings.
The cases are In the Matter of Standard & Poor’s Ratings Services, administrative proceeding numbers 3-16346, 3-16347 and 3-16348, and In the Matter of Barbara Duka, administrative proceeding number 3-16349, before the U.S. Securities and Exchange Commission.