by T. GormanPosted on Posted in SECActions

Ratings from a nationally recognized statistical rating organization or NRSRO registered with the Commission can have a significant influence of the sale of products such as residential mortgage backed securities. It is for that reason that Congress in Dodd Frank, and the Commission in drafting certain rules regarding NRSROs, sought to ensure that the process was free of conflicts – those involved with the products being rated could not become participants in the sales and marketing process. See, e.g. Rule 17g-5(c)(8)(prohibiting ratings when there is conflict). Yet that is the situation in the Commission’s latest case in this area. In the Matter of S&P Global Ratings, Adm. Proceeding File No. 3-21240 (November 14, 2022).

Respondent is an NRSRO based in New York City. In August 2017 Respondent had not rated any transactions for the issuer since 2015. The client requested that the firm rate certain senior tranches of RMBS. Initially, Respondent informed the client that the RMBS transaction met the minimum credit enhancement floor under the applicable criteria to be assigned a “AAA” rating. Yet later Respondent notified the client that there had been a calculation error – the tranches being considered were actually 10 basis points under the minimum for the AAA rating criteria. A few days later Respondent informed the client that after further analysis and discussion the firm had reached a different conclusion – the tranches did meet the minimum requirements to secure the AAA rating.

The issuer repeatedly expressed disappointment with the process. During the communications between Respondent’s staff and that of the issuer, the latter threatened Respondent with a lawsuit. As Respondent’s employees re-evaluated the transaction over a five-day period in early August 2017 there were multiple discussions and emails along with meeting requests and telephone calls. There was an effort to pressure S&P analytical employees to find a way to rate the transaction AAA.

All of the communications between the S&P commercial and analytical employees during the period were chaperoned by staff from from S&Ps compliance department. Nevertheless, some emails reflected sales and marketing considerations. Those included the fact that a quick decision was required on if to move forward with S&P. Exclusion of the firm would impact its future business.

S&Ps analytical employees worked late the evening prior to a preliminary meeting of the rating committee. The group was considering a unique structural item as urged by the issuer. The analytical group concluded that the rating should be AAA based in part on an economic outlook that extended past the end point of the one prepared at the beginning for the transaction.

The Order concludes that as “a result of the content, urgent nature, high volume, and compressed timing of the communications between the S&P commercial employees and the S&P analytical team . . .” the S&P commercial employees became “participants” in the rating process for the RMBS transaction being influenced by sales and marketing considerations. This violates Rule 17g-5(c)(8).

In resolving the proceedings Respondent agreed to implement certain undertakings. Respondent consented to the entry of a cease-and-desist order based on Rules 17g-5(c)(8)(i) and 17g-5(c)(8)(ii) under Exchange Act Section 21F(g)(3). The firm agreed to pay a penalty of $2.5 million. See also In the Matter of Egan-Jones Rating Co., Adm. Proc. File No. 3-20902 (June 21, 2022)(same conclusion), available at secactions.com/this-week-in-securities-litigation-week-of-june-27-2022/

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by T. GormanPosted on Posted in SECActions

The Commission filed its annual tabulation of Enforcement statistics in a Release dated November 15, 2022 (here). The array of statistic compiled in FY 2022 provides insight into the work of the Enforcement Division over the past year. Key topics include: 1) the number of cases initiated; 2) the areas of concentration; 3) trials; and 4) cooperation.

The number of cases filed for the year is always a key focus. At the same time, it is well recognized that the number of cases is not true measure of the effectiveness of an enforcement program although it is important. In fiscal 2022 there were 462 new or “stand alone” cases filed.

The 462 stand alone cases filed in FY 2022 is the third largest number of actions in a fiscal year over the past six years, according to the Release: 1) FY 201 – 526 filed; 2) FY 2018 490 filed; 3) FY 2022 – 462 filed; 4) FY 2017 – 446 filed; 5) FY 2021 – 434 filed; and 6) FY 2020 – 405 filed.

A second important metric is the areas of concentration or focus. Stated differently, this metric looks at the type of cases being filed. Here a table lists the primary classification of the actions brought. The table lists 13 areas in which a total of 231 actions were initiated.

Most of the actions classified in the table fall into five areas: 1) Securities offerings, 87 cases; 2) insider trading, 36; 3) investment advisers, 34; 4) market manipulation, 30; and 5) issuer reporting/audit and accounting, 19. Together these five areas account for 206 of the 231 actions listed in the table.

The Release also discusses under the heading of “Substantive Breadth and Depth” areas in which cases were brought. Those included: 1) Financial fraud and disclosure; 2) gatekeepers; 3) auditors; 4) lawyers; 5) crypto; 6) cybersecurity and compliance; 7) ESG; 8) regulated entities and associated individuals; 9) market abuse; 10) complex products; 11) public finance; and 12) Foreign Corrupt Practices Act. Read together with the classifications listed above, it is apparent that the program cut a wide path.

A third area discussed in the Release tabulates the number of cases that actually went to trial during the year. As with most prosecutorial agencies, only a small number of Commission actions went to trial. Last year the agency tried 15 cases to verdict, prevailing in 12. This is the largest number of cases tried to verdict in a decade, according to the Release. The number does not include the nine actions resolved on summary in favor of the Commission.

Cooperation is another important area. The agency has long urged those involved in Commission investigations and litigations to cooperate with it. The Release cites four cases to illustrate the impact of cooperation: Headspin, Inc, a corporate fraud case; ProPetro Holding, an executive perks case; and Baxter International, an action centered on misstated revenue. In the first three cases no penalty was imposed; in the fourth a reduced penalty was imposed.

Comment

The task of SEC enforcement cannot be overtatated – attempting to effectively police the most significant securities markets in the world as it fosters confidence and trust in investors from Main Street to Wall Street. The Release paints a picture of a vibrant, successful enforcement program. It initiated a significant number of new enforcement cases, recovered significant amounts of ill-gotten gains, and imposed billions of dollars in penalties not just as punishment but a warning to others.

Perhaps the key point of the report is the breath, depth and reach of the program, illustrated by case cites scattered through the Release. Those cases include: the actions against JPMorgan Securities and others for failing to preserve important records; the case charging E& Y for egregious, repeated ethical lapses; the action against Boeing for misleading everyone on key safety issues regarding its airplanes; and the action against Deloitte for its significant audit failure with its China based affiliates which left investors at risk. Each of these cases and many others illustrate not just the complexity of the issues faced daily by the Division but the scope and reach of its work.

Finally, the fine work done by the Division of Enforcement also points to a need for additional improvement – cooperation. Despite repeated calls for cooperation over the years, the Release points only to four cases of hundreds where three firms were not penalized and another received a reduced fine. Surely there were other issuers who were rewarded for cooperation and perhaps even a few individuals. The point is, there should be more. A successful cooperation program could only add to the success of the Enforcement program. It is time to build that program. The Commission filed its annual tabulation of Enforcement statistics in a Release dated November 15, 2022 (here). The array of statistic compiled in FY 2022 provides insight into the work of the Enforcement Division over the past year. Key topics include: 1) the number of cases initiated; 2) the areas of concentration; 3) trials; and 4) cooperation.

The number of cases filed for the year is always a key focus. At the same time, it is well recognized that the number of cases is not true measure of the effectiveness of an enforcement program although it is important. In fiscal 2022 there were 462 new or “stand alone” cases filed.

The 462 stand alone cases filed in FY 2022 is the third largest number of actions in a fiscal year over the past six years, according to the Release: 1) FY 201 – 526 filed; 2) FY 2018 490 filed; 3) FY 2022 – 462 filed; 4) FY 2017 – 446 filed; 5) FY 2021 – 434 filed; and 6) FY 2020 – 405 filed.

A second important metric is the areas of concentration or focus. Stated differently, this metric looks at the type of cases being filed. Here a table lists the primary classification of the actions brought. The table lists 13 areas in which a total of 231 actions were initiated.

Most of the actions classified in the table fall into five areas: 1) Securities offerings, 87 cases; 2) insider trading, 36; 3) investment advisers, 34; 4) market manipulation, 30; and 5) issuer reporting/audit and accounting, 19. Together these five areas account for 206 of the 231 actions listed in the table.

The Release also discusses under the heading of “Substantive Breadth and Depth” areas in which cases were brought. Those included: 1) Financial fraud and disclosure; 2) gatekeepers; 3) auditors; 4) lawyers; 5) crypto; 6) cybersecurity and compliance; 7) ESG; 8) regulated entities and associated individuals; 9) market abuse; 10) complex products; 11) public finance; and 12) Foreign Corrupt Practices Act. Read together with the classifications listed above, it is apparent that the program cut a wide path.

A third area discussed in the Release tabulates the number of cases that actually went to trial during the year. As with most prosecutorial agencies, only a small number of Commission actions went to trial. Last year the agency tried 15 cases to verdict, prevailing in 12. This is the largest number of cases tried to verdict in a decade, according to the Release. The number does not include the nine actions resolved on summary in favor of the Commission.

Cooperation is another important area. The agency has long urged those involved in Commission investigations and litigations to cooperate with it. The Release cites four cases to illustrate the impact of cooperation: Headspin, Inc, a corporate fraud case; ProPetro Holding, an executive perks case; and Baxter International, an action centered on misstated revenue. In the first three cases no penalty was imposed; in the fourth a reduced penalty was imposed.

Comment

The task of SEC enforcement cannot be overstatated – attempting to effectively police the most significant securities markets in the world as it fosters confidence and trust in investors from Main Street to Wall Street. The Release paints a picture of a vibrant, successful enforcement program. It initiated a significant number of new enforcement cases, recovered significant amounts of ill-gotten gains, and imposed billions of dollars in penalties not just as punishment but a warning to others.

Perhaps the key point of the report is the breath, depth and reach of the program, illustrated by case cites scattered through the Release. Those cases include: the actions against JPMorgan Securities and others for failing to preserve important records; the case charging E& Y for egregious, repeated ethical lapses; the action against Boeing for misleading everyone on key safety issues regarding its airplanes; and the action against Deloitte for its significant audit failure with its China based affiliates which left investors at risk. Each of these cases and many others illustrate not just the complexity of the issues faced daily by the Division but the scope and reach of its work.

Finally, the fine work done by the Division of Enforcement also points to a need for additional improvement – cooperation. Despite repeated calls for cooperation over the years, the Release points only to four cases of hundreds where three firms were not penalized and another received a reduced fine. Surely there were other issuers who were rewarded for cooperation and perhaps even a few individuals. The point is, there should be more. A successful cooperation program could only add to the success of the Enforcement program. It is time to build that program.

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