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SEC Puts Standard and Poor’s on Notice for Civil Charges on 2007 MBS

The SEC's eagle has it's eye on S&P. About time.

The SEC has told Standard and Poor’s that they may file civil charges over the rating agency’s role in a 2007 mortgage backed securities deal. The formal warning of potential imminent charges, known as a Wells notice, was delivered yesterday.

This warning, thought to be the first Wells notice against a rating agency related to the financial crisis, continues the fallout over Magnetar, the hedge fund which famously created bad securities and then bet against them to make money. The Wells notice specifically cites Delphinus, one of the many Magnetar deals. As Pro Publica notes, Delphinus came up in last year’s Senate Permanent Subcommittee on Investigations report about the financial crisis:

The report, which blamed inaccurate ratings as “a key cause” of the financial crisis, said agencies failed to do due diligence in grading securities and too often bent to the wishes of the banks that paid them. The report also flagged Delphinus as a “striking example” of the failures of ratings agencies, noting that the CDO was downgraded “a few months after its rating was issued.” Moody’s and Fitch, S&P’s main rivals in the United States, had also rated Delphinus and had to downgrade or withdraw those ratings after it went into default in 2008.

Senate investigators also released an internal S&P email chain in which analysts discussed whether to address the fact that about two-dozen “dummy assets” in the Delphinus portfolio were swapped out at the last minute for assets that “made the portfolio worse.” (Asked during congressional testimony about the use of dummy assets, two S&P execs told lawmakers they were unfamiliar with the practice in the CDO business.)

I imagine Moody’s and Fitch could be on the hook here as well, but in S&P’s case you have physical evidence in the form of the email chain, showing that they knew about Magnetar’s scam and rated the asset highly anyway.

Past SEC investigations on Magnetar-linked CDOs have all ended in settlements, and to be clear, this is a civil investigation. Still, it’s astounding that this is to date the only example of a rating agency even getting so much as a warning of a potential civil charge for their role in the financial crisis. By now we have many reports and investigations pegging the rating agencies as a key driver of the crisis. The regulators have lagged far behind.

More in the Financial Times.

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David Dayen

David Dayen