SEC Considering Legal Action Against S&P for Rating of Mortgage Debt

The nation's foremost financial securities regulator is considering bringing a civil injunction against ""Standard & Poor's"":http://www.standardandpoors.com (S&P) for its rating of a ""collateralized debt obligation"":http://en.wikipedia.org/wiki/Collateralized_debt_obligation (CDO) linked to high-risk mortgages.

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S&P's parent company, New York-based ""McGraw-Hill Cos."":http://www.mcgraw-hill.com/, told investors Monday that it has received a ""Wells Notice"" from the ""Securities and Exchange Commission"":http://www.sec.gov (SEC) stating that the federal agency may recommend instituting a civil injunctive action against S&P along with civil money penalties and disgorgement of fees.

A Wells Notice from the SEC signals the recipient is the subject of a formal investigation and the federal agency is planning to proceed with some form of enforcement action.

The case centers around S&P's rating of a $1.6 billion CDO in 2007 known as Delphinus CDO 2007-1. In a report issued last spring, the U.S. Senate’s Permanent Subcom-

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mittee on Investigations cited this hybrid CDO as a “striking example” of “how inflated credit ratings contributed to the financial crisis by masking the true risk of many mortgage related securities.”

According to ""the senators’ report"":http://hsgac.senate.gov/public/_files/Financial_Crisis/FinancialCrisisReport.pdf, S&P rated six Delphinus tranches AAA in July and August 2007. By the end of that year, S&P began downgrading its securities, and by the end of 2008, had fully downgraded the AAA-rated securities to junk status.

""Moody’s"":http://www.moodys.com gave AAA ratings to seven Delphinus tranches and eventually downgraded those to junk status as well, along the same timelines as S&P.

The Senate subcommittee uncovered evidence, including internal emails, showing that analysts at both ratings agencies were aware of the increasing risks in the mortgage market in the years leading up to the financial crisis, but failed to adjust their ratings to accurately reflect the higher risk associated with lax lending standards, poor quality loans, and unsustainable housing prices.

Investigators attributed a number of factors to the agencies assignments of inaccurate credit ratings to RMBS and CEO securities, including pressure from investment banks to inflate ratings and the inherent business drive to increase market share.

Commenting on the latest action in the saga by the SEC, McGraw-Hill said in a statement that S&P has been cooperating with the federal agency and intends to continue to work with the SEC towards a resolution.