Standard & Poor’s Ratings Services today agreed to pay more than $77 million to the government for a series of federal securities law violations involving fraudulent misconduct in its ratings of certain commercial mortgage-backed securities.

As part of its settlement, S&P will pay more than $58 million to the Securities and Exchange Commission, plus an additional $12 million to the New York Attorney General’s office, and $7 million to the Massachusetts Attorney General’s office to settle parallel cases.

“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,” said Andrew Ceresney, Director of the SEC Enforcement Division. “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 SEC issued three orders instituting settled administrative proceedings against S&P.  One order addressed S&P’s practices in its conduit fusion commercial mortgage-backed securities (CMBS) ratings methodology.

S&P’s public disclosures affirmatively misrepresented that it was using one approach when it actually used a different methodology in 2011 to rate six conduit fusion CMBS transactions and issue preliminary ratings on two more transactions. As part of this settlement, S&P agreed to take a one-year timeout from rating conduit fusion CMBS.

Second Order

Another SEC order found that after being frozen out of the market for rating conduit fusion CMBS in late 2011, S&P sought to re-enter that market in mid-2012 by overhauling its ratings criteria. To illustrate the relative conservatism of its new criteria, 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. 

“S&P’s research relied on flawed and inappropriate assumptions and was based on data that was decades removed from the severe losses of the Great Depression,” the SEC stated. According to the SEC’s order, S&P failed to accurately describe certain aspects of its new criteria in the formal publication setting forth their operation. Without admitting or denying the findings in the order, S&P agreed to publicly retract the false and misleading Great Depression-related study and correct the inaccurate descriptions in the publication about its criteria.

“These CMBS-related enforcement actions against S&P demonstrate that ‘race to the bottom’ behavior by ratings firms will not be tolerated by the SEC and other regulators,” said Michael Osnato, Chief of the SEC Enforcement Division’s Complex Financial Instruments Unit. “When ratings standards are compromised in pursuit of market share, a firm’s disclosures cannot tell a different story.”

Third Order

A third SEC order issued in this case involved internal controls failures in S&P’s surveillance of residential mortgage-backed securities (RMBS) ratings.  The order found that S&P allowed breakdowns in the way it conducted ratings surveillance of previously-rated RMBS from 2012 to 2014. 

S&P changed an important assumption in a way that made S&P’s ratings less conservative, and was inconsistent with the specific assumptions set forth in S&P’s published criteria describing its ratings methodology. S&P did not follow its internal policies for making changes to its surveillance criteria and instead applied ad hoc workarounds that were not fully disclosed to investors. 

Without admitting or denying the findings in the order, S&P agreed to extensive undertakings to enhance and improve its internal controls environment.  S&P self-reported this particular misconduct to the SEC and cooperated with the investigation, enabling the Enforcement Division to resolve the case more quickly and efficiently and resulting in a reduced penalty for the firm.

The SEC’s orders find that S&P violated Section 17(a)(1) of the Securities Act (fraud), Section 15E(c)(3) of the Securities Exchange Act  (internal controls violations), Securities Exchange Rules 17g-2(a)(2)(iii) (books and records violations), Rule 17g-2(a)(6) (books and records violations), and 17g-2(a)(2)(iii) (failure to maintain records explaining differences between numerical model output and ratings).

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