by T. GormanPosted on Posted in SECActions

Rating agencies, officially known as nationally recognized statistical rating organizations or NRSROs, played a key role in the evolution of the market crisis. Accordingly, the Dodd-Frank Wall Street Reform and Consumer Protection Act included a series of provisions bolstering their reporting obligations and restructuring their activities. The SEC’s authority over the organizations was enhanced as discussed here. That authority began with the Credit Rating Agency Reform Act of 2006.

The SEC staff has published its most recent report regarding on the latest examinations of these agencies. It is titled: “2011 Summary Report of Commission Staff’s Examinations of Each Nationally Recognized Statistical Rating Organization” (here). The Report identifies ten NRSROs.

Key findings in the report include:

  • Fees: The NRSROs are trending toward an issuer pay business model in contrast to the subscribers pay model. This trend is occurring with respect to asset-backed securities. Three of the smaller agencies using this payment model “appear to have some weakness” in their policies and procedures for managing the potential conflicts arising from it.
  • Reform: Each of the three large NRSROs have devoted what the report calls “notable resources” toward responding to staff comments from the July 2008 examinations. Those exams focused on the rating of subprime residential mortgage-backed securities and collateralized debt obligations.
  • Following procedures: All of the agencies failed to follow their ratings procedures in some instances. One of the larger NRSRO’s self-reported a failure to comply with its procedures regarding its ratings methodology for certain asset backed securities. Two of the smaller agencies had “notable” instances of apparent failures to adhere to the policies and procedures for committee review of rating actions.
  • Adopting procedures: Two of the larger agencies did not have specific policies and procedures for managing the potential conflict of rating issuers that may be significant shareholders of the firm.
  • Separation of functions: One of the smaller NRSROs had “weak barriers” between its rating analysts and those employed in an ancillary service that presents a potential conflict of interest.
  • Supervision: Three of the smaller agencies have weak internal supervisory controls.
  • Selective dissemination: At one of the larger agencies the policies for the publication of a rating allowed for early, selective disclosure. At three of the smaller organizations there appeared to be unnecessary delay in publication.

Program: The Impact of the Supreme Court’s Decision in Morrison v. National Bank of Australia on securities litigation and SEC enforcement actions. Presented by Celequ Legal Education in conjunction with West Thomson. Webcast on October 12, 2011 from 12:00 to 1:00 EST. For furtrher information please click here

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by T. GormanPosted on Posted in SECActions

The Inspector General for the SEC issued another report on a pending enforcement action. This time the report concerned allegations of staff misconduct relating to the hotly contested enforcement action against Dallas Maverick’s owner Mark Cuban. SEC v. Cuban, Civil Action No. 08-CV-2050 (N.D. Tx.). The report, which was initially discussed in press reports quoting unnamed sources, was made available by the IG’s office late last week.

This is not the first report issued by the SEC IG on a pending investigation or enforcement action. Previously, for example, the SEC IG investigated questions raised by lawmakers and the press regarding the institution of the enforcement action against Goldman Sachs. Another investigation probed the circumstances surrounding the settlement of that case. Those investigations differ significantly from inquiries such as the one probing the failure of the Commission to uncover the Madoff Ponzi scheme at an earlier date. That inquiry centered on past issues with the intent of improving future performance. In contrast, the inquiries into the Goldman and Cuban cases focused on active law enforcement investigations and court proceedings where there were forums in which to raise any questions of improper conduct.

Inquiries into pending enforcement proceedings raise questions about the proper role of the IG, the actions of that Office and its impact on the important work being done by the Commission and its staff. The website for the SEC IG defines its role as follows: “The mission of the OIG is to detect fraud, waste and abuse, to promote integrity, economy, efficiency and effectiveness, in the Commission’s programs and operations.”

Squaring its stated mission with probing active Enforcement Division investigations and court actions is problematic at best. If the goal of the SEC IG is to promote the efficiency and effectiveness of the Commission and facilitate its overall mission, the Office should avoid steps which might undermine the Enforcement program absent the most exigent circumstances. By injecting its self into pending enforcement investigations and actions however the SEC IG risks acting in a manner which is directly contrary to its stated mission.

Enforcement investigations and actions are vital to the implementation of the Commission’s mission. Every enforcement official understands those investigations and actions are conducted in a virtual fishbowl. Whether serving as an investigator during an on-going inquiry or as counsel to the Commission in a federal district court enforcement action, staff members and the Commission are open to being second guessed by everyone. Lawmakers, the press, the public, those involved in an investigation and defendants in enforcement actions all challenge the proceedings at every turn. Those challenges are part of the job. Unfortunately in some instances those challenges become personal attacks on those conducting the proceeding. Some practitioners use this approach as a tactic which is more than inappropriate, it is unethical. Regardless, there are forums in which they can be litigated. Indeed, in Cuban allegations of misconduct were raised as a defense. No doubt if Goldman Sachs was aggrieved by some form of misconduct its very able counsel would obtain an appropriate remedy.

Not only is there no need for an IG inquiry into a pending matter in the first instance, but it may seriously interfere with the proceeding and undercut the important work of the Enforcement Division. The mere opening of the IG inquiry can bolster defense claims which may otherwise lack merit. Conducting the inquiry can delay the Enforcement investigation or litigation, diverting the scarce resources of the Division to defending itself rather than conducting the case. When repeated over time it creates a kind of hostile work environment where enforcement attorneys will be required to spend more time consulting with their personal counsel than their colleagues on how to effectively handle the matter.

This is clearly not beneficial to the Commission and is inconsistent with the stated mission of the SEC IG.

There is no doubt that the SEC IG has done commendable work in the past. Equallly apparent is the fact that improper conduct has no place in an enforcement investigation or litigation. Not only is it wrong, it diminishes and undercuts the important work of the SEC. When it occurs it must be halted and those responsible should be dealt with in an appropriate manner. At least in the first instance there are adequate remedies in the courts without the interference of the SEC IG which should confine its activities to the defined mission.

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