Credit Rating Agencies

SEC is working on issues related to asset-backed securities, credit ratings, and money market mutual funds, says Schapiro

Published on: January 31, 2010 | by Shepherd Smith Edwards & Kantas, LLP

According to Securities and Exchange Commission Chairman Mary Schapiro, the agency is dealing with a number of credit crisis-related issues associated with money market mutual funds, asset-backed securities, and credit ratings. She also said that the SEC is working on ABS rule proposals that would allow the interests of investors and sellers to align.

The proposals, and other measures, would seek to give investors easier access to loan level data, allow them more time to review products before they invest, create a mechanism to allow for continuous disclosure, and modify “shelf” offerings eligibility standards. Schapiro says that the proposals are meant to be preemptive and would tackle certain areas where issues similar to the ones that surfaced during the current financial crisis might arise in the future.

American and European regulators have been closely examining collateralized debt obligations, mortgage-backed securities, and other ABS because of the large parts they played during the financial collapse. The SEC is reviewing ABS regulations and ABS-related disclosures and reporting. The agency is also seeking to impose more stringent credit quality and maturity requirements for market mutual funds, as well as put into place substantial liquidity standards. Members will be voting on proposed rule amendments meant to strengthen the money market mutual funds’ framework. The SEC is in the process of taking out credit rating references in a number of its regulations and rules.

Make Credit Rating Agencies Collectively Liable for Inaccuracies, Proposes Lawmaker

Published on: October 7, 2009 | by Shepherd Smith Edwards & Kantas, LLP

House Financial Services subcommittee chair Paul Kanjorski introduced a new draft bill that proposes making credit ratings agencies collectively liable for inaccuracies. The agencies received a lot of heat when they failed to properly warn investors about the risks associated with subprime mortgage securities before the market fell.

One problem with the current system is that the firms issuing the securities are the ones paying the credit ratings agencies for rating the securities. Kanjorski’s draft bill lets investors pursue lawsuits against credit rating agencies that recklessly or intentionally did not examine key data to determine the ratings. He says that collective liability could compel the ratings agencies to provide reliable, quality ratings while providing the proper incentive for them to monitor each other.

Critics of the plan, including Republicans and industry executives, warned that collective liability could result in a slew of expensive complaints while decreasing competition even more in an industry that Fitch Ratings, Moody’s Investors Services, and Standard and Poor’s already dominate.

Securities Fraud Lawsuit Against UBS AG Gets Added Steam with Employee Email Calling Collateralized Debt Obligations “Vomit”

Published on: September 16, 2009 | by Shepherd Smith Edwards & Kantas, LLP

UBS AG must post a $35.6 million bond, says Superior Court Judge John Blawie. Blawie says that hedge fund Pursuit Partners, LLC has sufficient evidence to pursue its securities fraud case claiming that the investment bank knew it was selling collateralized debt obligations that were toxic to institutional investors but did nothing to inform clients about the risks.

Blawie cited an e-mail written by a UBS employee that called the asset-backed securities “vomit.” Another e-mail noted that UBS was selling Pursuit CDOs that were “crap.”

The judge is letting the securities fraud complaint go forward without ruling on the case’s merits. Between July and October 2007, UBS sold the hedge fund CDOs valued at $40.5 million. Following the global credit crisis, there has been $1.7 trillion in losses and writedowns.

Moody’s Investors Can Pursue Securities Fraud Class Action Lawsuit Accusing the Credit Rating Agency of Falsely Claiming Independence

Published on: March 11, 2009 | by Shepherd Smith Edwards & Kantas, LLP

A US District Court judge says Moody’s Corp. investors can go ahead in part with a lawsuit accusing the credit rating agency of securities fraud. The class action lawsuit accuses Moody’s of claiming it was an independent body that impartially published accurate financial instrument ratings when such misrepresentations artificially inflated its stock price (until media reports about its compromised objectivity caused the value of its stocks to drop).

In the U.S. District Court for the Southern District of New York, Judge Shirley Wohl Kram said the plaintiffs sufficiently alleged that the credit rating agency’s statements over its independence were false. She did find deficiencies with other pleadings, however, including a failure to properly plead scienter against Michael Kanef, the group managing director of Moody’s US asset finance group, and Brian Clarkson, Moody’s chief operating officer. The court also approved the plaintiffs’ request that they be allowed to cure the pleading deficiencies.

The court also said that it did not consider Moody’s statements about its independence to be inactionable puffery. Moody had declared independence and made a list of verifiable actions it executed to make sure it continued to stay independent. However, other specifics, the court said, were not actionable, including statements about the meaning of structured finance securities or that its structured finance revenues came from legitimate business practices.

The court said that the plaintiffs’ class action case survives the defendants’ motion to dismiss the lawsuit.

Credit Rating Agencies
It is the job of credit rating agencies to help manage financial market risk. CRA’s are responsible for publishing creditworthiness evaluations about their clients. These evaluations not only help in the assessment of credit risk but they are important for regulation.

Related Web Resources:
Moody’s Must Defend Investor Suit Over Independence, Bloomberg.com, February 23, 2009
Shareholder lawsuit vs Moody’s allowed to proceed, CNBC.com, February 23, 2009
Moody’s
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Wells Fargo, Goldman Sachs, JP Morgan Chase, Citigroup, UBS Securities, Bank of America, Moody’s Investment Services, and Fitch Ratings are Among Defendants Sued On Behalf of Wells Fargo Certificate Investors for Alleged Securities Fraud Violations

Published on: March 5, 2009 | by Shepherd Smith Edwards & Kantas, LLP

The Boilermaker-Blacksmith National Pension Trust is suing a number of investment banks, credit rating agencies, and underwriters, including Wells Fargo, WFASC, Morgan Stanley & Co., Credit Suisse Securities (USA) LLC, Barclays Capital Inc., Bear Stearns & Co., Countrywide Securities Corp., Deutsche Bank Securities Inc., JPMorgan Chase Inc., Bank of America Corp., Citigroup Global Markets Inc., McGraw-Hill Cos., Moody’s Investor Services Inc., and Fitch Ratings Inc., over allegations that they made false statements in the prospectus and registration statement for certificates that were collateralized by Wells Fargo Bank, NA. The lawsuit, filed on behalf of thousands of investors that bought the certificates from Wells Fargo Asset Securities Corp., accuses the defendants of violating the 1933 Securities Act by engaging in these alleged actions.

According to the securities fraud lawsuit, the defendants concealed from investors that Wells Fargo revised its underwriting practices in 2005 and became involved in high risk subprime mortgage lending. The complaint contends that WFASC and a number of defendants submitted to the Securities and Exchange Commision prospectus and registration statements representing that the mortgages were backed by certificates that were subject to specific underwriting guidelines for evaluating a borrower’s creditworthiness. The plaintiffs contend that these prospectuses and registration statements were false because they neglected to reveal that the Wells Fargo-originated certificates were not in accordance with the credit, underwriting, and appraisal standards that Wells Fargo, per the companies, had supposedly used to approve mortgages.

The lawsuit also claims that because Wells Fargo decided to enter the subprime mortgage mortgage market in 2005, the investment bank had to take significant write-downs in 2008 because of its massive exposure to the subprime market and the WFASC certificates that these mortgages backed dropped significantly in value. The Boiler-Blaksmith fund reports that it lost about $5 million, which is more than half of what it invested.

Related Web Resources:
Read the Complaint

The Boilermakers National Funds
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SEC Adopts Rules to Streamline Mutual Funds Disclosures But Delays Making Decision on Credit Ratings’ Final Rules

Published on: November 26, 2008 | by Shepherd Smith Edwards & Kantas, LLP

In a unanimous vote, the Securities and Exchange Commission agreed to adopt rule amendments to improve mutual fund disclosures. This includes letting investors receive a summary prospectus written in simple English. The SEC also adopted revisions to the mutual funds’ registration form known as form N-1A, including amendments that let exchange-traded funds use summary prospectuses.

Summary Prospectus

The summary prospectuses, which are voluntary, may include important information about investment strategies and goals, past fund performance, risks, and fees. As long as the statutory prospectus, summary prospectus, and other essential data can be accessed online, mutual funds that send investors a summary prospectus will be fulfilling their prospectus delivery requirements. Key data, such as selling and buying procedures, financial intermediary compensation, and tax consequences must also be included. The SEC expects approximately 75% of all mutual funds to use summary prospectuses.

Moody’s, Standard & Poor’s, and Fitch’s Assignment of High Credit Ratings to Mortgage-Backed Securities Contributed to the Financial Meltdown

Published on: November 6, 2008 | by Shepherd Smith Edwards & Kantas, LLP

At a hearing presided over by the House Oversight and Government Reform Committee in Washington DC, the executives of Moody’s, Standard & Poor’s, and Fitch Ratings, the three top credit rating agencies in the country, were grilled about how their assignment of high ratings to mortgage-backed securities, while drastically underestimating their risks, contributed to the current financial crisis.

While the heads of the country’s three leading credit agencies-Standard and Poor’s Deven Sherman, Fitch Ratings’s Stephen W. Joynt, and Moody’s Raymond W. McDaniel-have called the mortgage-backed securities collapse “unprecedented” and “unanticipated and said that any errors the agencies’ made were unintentional, internal documents reveal that the credit rating agencies knew that the ratings they were giving the securities were overvalued. It wasn’t until this past year, when homeowners began defaulting on subprime mortgages, that the credit ratings agencies began downgrading thousands of the securities.

Lawmakers are trying to determine whether the firms’ business model contributed to the conflicts of interests. Issuers pay the credit ratings agencies for evaluating securities. While the credit ratings agencies were giving mortgage-backed securities high ratings, the heads of the three leading credit agencies were earning $80 million in compensation.

At the hearing, former Moody’s credit policy managing director Jerome S. Fons testified that the agencies’ business model prevents analysts from placing investor interests before the firms’ interests. In one confidential document obtained by investigators, Moody’s CEO McDaniels is quoted as saying that bankers, investors and creditors regularly “pitched” the credit ratings agency. According to Frank L. Raiter, the former head of residential mortgage-backed securities ratings at Standard and Poor’s, “Profits were running the show.”

Investors depend on the credit rating agencies for independent evaluations. According to Congressman Waxman, the ratings agencies “broke this bond of trust,” while federal regulators failed to heed the red flags and protect investors.

Related Web Resources:

Credit Rating Agency Heads Grilled by Lawmakers, New York Times, October 22, 2008
Oversight Committee Hearing on Credit Rating Agencies and the Financial Crisis, Polfeeds.com, October 22, 2008
Committee on Oversight and Government Reform
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Connecticut Attorney General Sues Moody’s, McGraw Hill, & Fitch Over Municipal Bond Issues

Published on: August 10, 2008 | by Shepherd Smith Edwards & Kantas, LLP

Connecticut Attorney General Richard Blumenthal has filed a lawsuit against Fitch Inc., Moody’s Corp., and McGraw-Hill Companies. He is charging them with deliberately giving lower credit ratings to bonds issued by public entities, such as municipalities, in comparison to corporate and other kinds of debt.

Blumenthal says that by purposely giving artificially low credit ratings to municipalities, taxpayers have been forced to unnecessarily incur millions of dollars in higher interest rates and bond insurance. The lawsuit is part of a probe into bond insurers, credit rating agencies, and related entities and their potential violations, including those involving consumer protection and antitrust.

The Connecticut AG says that the state is holding the defendants responsible for “millions of dollars that have been illegally exacted from the state’s taxpayers.” The lawsuit, filed in coordination with Department of Consumer Protection (DCP) Commissioner Jerry Farrell, Jr., accuses the agencies of violating the Connecticut Unfair Trade Practices when they purposely left out or misrepresented material facts that lead bond issuers to buy bonds at higher interest rate.

Moody’s, Fitch, and McGraw Hill say they will combat the charges against them. McGraw-Hill, Standard & Poor’s parent company, claims that the state of Connecticut is using the lawsuit to dictate the kind of bond rate it gets. Moody says it will push to get the case dismissed.

The way that credit rating agencies deal with municipal bonds was addressed earlier this year in a letter sent to executives at Standard and Poor’s, Fitch, and Moody’s. Sent by the state treasurers of 11 US states, including Connecticut and California, and a number of municipal officials, the letter called on the firms to change their municipal bond rating system so it better reflects the bonds’ default risks. The treasurers say this would save municipalities billions of dollars in interest costs.

Read the Complaint (PDF)

Department of Consumer Protection, Ct.gov
Ct Ag Richard Blumenthal
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The Association For Financial Professionals Wants SEC Chairman Cox To Push Harder For Reform Of Credit Rating Agencies

Published on: April 4, 2008 | by Shepherd Smith Edwards & Kantas, LLP

The Association for Financial Professionals is calling on Securities and Exchange Commission head Christopher Cox to use the SEC’s authority to push for the reform of the credit rating agencies.

In a letter from the AFP, CEO Jim Kaitz urged Cox to use the authority that Congress granted the SEC with the Credit Rating Agency Reform Act of 2006, which gives the SEC permission to hold the agencies accountable for providing timely and accurate ratings.

SEC Director of Trading and Markets Erik Sirri has said, however, that although the SEC can hold credit rating systems accountable for their ratings, it does not have the authority to interfere with the way that agencies assign ratings, which is a key issue that is impacting the current subprime mortgage market crisis.

Merrill Lynch, Morgan Stanley and Bear Stearns Suffer Losses as Ratings Agencies Are Grilled over Sub-prime’s

Published on: October 11, 2007 | by Shepherd Smith Edwards & Kantas, LLP

Merrill Lynch will soon report third quarter earnings which analysts have revised downward. An analyst at competitor Goldman Sachs says that Merrill’s earnings for the third quarter will be about $1.80 per share, down from $1.95 and lowered Merrill’s stock price target to $94 from $108. The Goldman analyst predicted that Merrill will have $4 billion in write-downs, primarily from the fixed income division, resulting in a net loss of $1.5 billion for the quarter.

Other analysts’ expectations were even even lower: Fox Pitt Kelton’s analyst lowered earnings per share estimate for Merrill to $1.20, from a previous estimate of $1.91, “while noting that forecasting confidence is low in periods such as these.” He also expected the firm to experience $3.5 billion “in gross negative marks and realized losses” on leveraged loans, CDOs, and mortgages resulting in $2.2 billion in net losses and attributes the more positive net loss estimate to “$700 million in hedging gains; $500 million in loan fees; and $100 million in gains on liability marks.”

Morgan Stanley reported last week that it suffered a 17 percent drop in profit compared to the third quarter last year, earning $1.44, about ten cents below analysts’ estimates, with loan losses of $1 billion the culprit.