S.&.P. to Pay Nearly $80 Million to Settle Fraud Cases


Posted by SEAH Hui Ting, Year 3 undergrad at the School of Accountancy, Singapore Management University

S&P to Pay Nearly $80 Million to Settle Fraud Cases

Standard & Poor’s, the credit rating agency blamed for helping inflate the subprime mortgage bubble, has settled accusations that it orchestrated a similar fraud years after the bubble burst.S.&P. has agreed to settle an array of government investigations stemming from 2011, paying nearly $80 million and admitting some misdeeds, federal and state authorities announced on Wednesday. As part of the deals, reached with the Securities and Exchange Commission and the state attorneys general in New York and Massachusetts, S.&P. also agreed to take a one-year “timeout” from rating certain commercial mortgage investments at the heart of the case, an embarrassing blow to the rating agency.

“This was egregious behavior with significant consequences,” Andrew J. Ceresney, the S.E.C.’s enforcement director, said on a conference call with reporters. He added that the problems pointed to a “deep cultural failure at S.&P.” and a “failure to learn the lessons of the financial crisis.”

The settlement, which coincided with the filing of an S.E.C. action against a former S.&P. ratings executive, is the S.E.C.’s first action against a top ratings firm. Despite the central role that rating agencies played in the crisis — awarding inflated credit ratings to mortgage investments that spurred the debacle — they faced no S.E.C. penalties.

Yet the Justice Department and several state attorneys general did take action in a separate case, suing S.&P. in connection with the crisis. After fighting that case for two years, S.&P. reached a tentative settlement that would require it to pay $1.37 billion, people briefed on the matter said this week, a penalty large enough to wipe out its operating profit for a year.

In addition to the commercial mortgage settlement, S.&P. also resolved accusations on Wednesday of internal control “failures” in its surveillance of rating investments backed by home mortgages. The breakdowns, which echo the rating agency’s problems during the crisis, came from October 2012 to June 2014.

The settle-at-all-costs mentality from S.&P., which is owned byMcGraw Hill, signifies an abrupt shift in its strategy. It also reflects a change atop McGraw Hill’s legal department, which recently installed a new general counsel, Lucy Fato, formerly a partner at the law firm Davis Polk.

In a statement on Wednesday about its settlement with the S.E.C. and the state attorneys general in New York and Massachusetts, S.&P. said it was “pleased to have concluded these matters.” It added that it “takes compliance with regulatory obligations very seriously and continues to make investments in people and technology to strengthen its controls and risk management throughout the organization.”

In settling, S.&P. agreed to pay more than $58 million to the S.E.C., $12 million to New York State’s attorney general, Eric T. Schneiderman, and $7 million to the office of the Massachusetts attorney general, Martha Coakley. S.&P. previously announced that it expected to pay about $60 million to settle the investigations.

The settlements largely center on S.&P.’s ratings of eight commercial mortgage-backed securities deals. Although S.&P. publicly claimed it used a conservative approach for rating certain commercial mortgage investments, it actually used a different methodology that lowered its standards.

To reinforce the impression that the new criteria were still relatively conservative, S.&P. “published a false and misleading article purporting to show that its new credit enhancement levels could withstand Great Depression-era levels of economic stress,” according to the S.E.C. That article “relied on flawed and inappropriate assumptions,” according to the S.E.C., which noted that the original author of the article complained that the S.&P. had turned the article into a “sales pitch” for the new criteria. The author said it could lead to his facing the “Department of Justice or the S.E.C.”

“Investors rely on credit rating agencies like Standard & Poor’s to play it straight when rating complex securities like C.M.B.S.,” Mr. Ceresney said, referring to commercial mortgage-backed securities. “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.”

The behavior detailed in the S.E.C.’s complaint seems ripped from the same playbook that led S.&P. to help enable the mortgage crisis of 2008. It lowered ratings criteria after losing market share. It ignored or stifled red flags, the S.E.C. said, including internal dissent and an anonymous email complaint. And it misled the public about the rigor of its methodology.

“In the wake of the housing crisis and the collapse of the global economy, credit agencies like S.&P. promised not to contribute to another bubble by inflating the ratings on products they were paid to evaluate,” Mr. Schneiderman said in a statement. “Unfortunately, S.&P. broke that promise in 2011, lying to investors to increase their profits and market share.”

The S.E.C. also filed an administrative proceeding against Barbara Duka, the former co-head of S.&P.’s commercial mortgage group, contending that she “fraudulently misrepresented the manner in which the firm calculated a critical aspect” of ratings. Ms. Duka, the S.E.C. said, “allegedly instituted the shift to more issuer-friendly ratings criteria, and the firm failed to properly disclose the less rigorous methodology.”

Ms. Duka jumped the gun on the S.E.C., filing a lawsuit in federal court last week that seeks to have any enforcement action against her heard before a federal judge as opposed to an administrative law judge. The S.E.C. has increasingly filed enforcement cases before administrative law judges, and some critics say this gives the S.E.C. an unfair home-court advantage.

In her federal lawsuit, Ms. Duka said she began cooperating with the S.E.C. investigation in August 2013, providing documents and testimony, and telling the S.E.C. throughout that she thought the change in the methodology used by S.&P. to analyze some commercial mortgage bond deals was appropriate and not done to further the rating agency’s commercial goals.

Ms. Duka’s lawyer, Guy Petrillo of Petrillo Klein & Boxer, released a statement on Wednesday, saying that “Barbara did not act wrongfully and always performed her duties at S.&P. in the utmost good faith.”


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