In a First, SEC Warns Rating Agency It May Bring Financial Crisis Lawsuit

by Marian Wang ProPublica

Though they2019ve been faulted for their central role in the financial crisis, the major credit ratings agencies have thus far weathered the fallout of the crisis with no sanctions [1] from federal regulators and little more than a bruise to the reputation.

But that could soon be changing.

In a formal warning known as a Wells notice, the Securities and Exchange Commission informed credit rating firm Standard & Poor2019s that it2019s considering filing civil charges [2] tied to the firm2019s ratings of a 2007 mortgage-backed securities deal. It2019s the first such warning to be dealt to a credit rating agency over matters directly related to the financial crisis.

The deal 2014 known as Delphinus 2014 was one of more than two dozen collateralized debt obligations [3] linked to the hedge fund Magnetar, whose role in creating and betting against risky CDOs was detailed in a ProPublica investigation [4] last year. Completed in July 2007, Delphinus was one of the last deals done by Magnetar and was underwritten by Japanese bank Mizuho.Details on the specifics of S&P2019s potential violations are still unclear. But last year2019s Senate investigation of the financial crisis may contain some hints.

The report 2014 which blamed inaccurate ratings as 201Ca key cause [5]201D of the financial crisis 2014 said agencies failed to do due diligence in grading securities and too often bent to the wishes of the banks that paid them. It also specifically flagged Delphinius as a 201Cstriking example [6]201D of the failures of ratings agencies, noting that the CDO was downgraded 201Ca few months after its rating was issued.201D Moody2019s and Fitch, S&P2019s main rival firms in the U.S., had also [7] rated [8] Delphinus and had to downgrade or withdraw those ratings after it went into default in 2008.

Senate investigators also released an internal S&P e-mail chain [9] in which analysts discussed whether or not to address the fact that about two dozen 201Cdummy assets201D in Delphinus portfolio were swapped out at the last minute for assets that 201Cmade the portfolio worse.201D (Asked during Congressional testimony about the use of dummy assets, two S&P execs told lawmakers they were unfamiliar with the practice [10] in the CDO business.)

In a statement [11] disclosing the SEC2019s Wells notice, S&P2019s parent company, McGraw-Hill, noted that letter was 201Cneither a formal allegation nor a finding of wrongdoing,201D and said that 201CS&P has been cooperating with the Commission in this matter and intends to continue to do so.201D A S&P spokeswoman declined further comment.

The SEC also declined comment on the deal.

Several big banks 2014 namely, Goldman Sachs [12], JPMorgan Chase [13], and Wells Fargo [14] 2014 have already settled fraud charges related to specific CDO dealings, and more are under investigation. Mizuho, which marketed and sold Delphinus to investors, is also under investigation [15] for a separate CDO deal involving Magnetar, as we noted last week.