S&P faces first action by US government against a major credit rating agency

Tuesday, September 27th 2011 - 04:56 UTC

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S&P gave top grades to a package of securitized mortgages in 2007 that quickly soured

United States regulators disclosed they may take action against Standard & Poor's for securities law violations after the ratings agency gave top grades to a package of securitized mortgages in 2007 that quickly soured.

The possible action could be the first by the United States against one of the major credit rating agencies, which have been accused of enabling the lending excesses that led to the sub-prime mortgage crisis in 2008.

The disclosure follows S&P downgrade of the debt of the US government in August, an unrelated move that was not followed by other rating agencies and that drew darts from the Obama administration and a bipartisan group of politicians.

The disclosure came in a statement Monday from McGraw-Hill Cos Inc, parent company to Standard & Poor's, which said it had received a Wells notice from the US Securities and Exchange Commission on September 22.

Wells notices give potential defendants an opportunity to explain why civil charges should not be brought. The company said SEC staff is considering recommending that commissioners take action against S&P for violating securities laws in its ratings of a 2007 collaterized debt obligation known as “Delphinus CDO 2007-1.”

While Wells notices are not always followed by lawsuits from the SEC, they represent a serious threat. “A Wells notice ups the ante,” said Alan Palmiter, professor, Wake Forest University School of Law, Winston-Salem, North Carolina. “It is clear the SEC has identified something it sees as a problem with ratings issued during the sub-prime mortgage heyday.”

If the SEC presses charges, McGraw-Hill would likely try to settle them, and may have to change its ratings practices, Palmiter added. S&P warned it might have to pay civil penalties in the case.

McGraw-Hill earlier this month announced plans to split into two publicly traded companies to satisfy activist investors unhappy with its depressed value.

S&P is the flagship business of the ratings and market information services company that will be spun off. The other business is being structured around McGraw-Hill's textbook publishing business.