SEC pursuing new enforcement cases against rating firms

WASHINGTON Wed Apr 30, 2014 6:29pm EDT

A general exterior view of the U.S. Securities and Exchange Commission (SEC) headquarters in Washington, June 24, 2011. REUTERS/Jonathan Ernst

A general exterior view of the U.S. Securities and Exchange Commission (SEC) headquarters in Washington, June 24, 2011.

Credit: Reuters/Jonathan Ernst

WASHINGTON (Reuters) - The U.S. Securities and Exchange Commission is pursuing potential enforcement actions against credit-rating agencies over disclosure violations as the regulator turns to new targets now that few cases remain from the financial crisis, the SEC's top enforcement chief said Wednesday.

"There are a lot of new rules for credit rating agencies," SEC Enforcement Director Andrew Ceresney said at the Reuters Financial Regulation Summit. "That's an area we're very focused on, and trying to make sure that we're enforcing those, and I think you'll see some activity there."

Ratings firms are some of several potential targets for enforcement action, Ceresney said. He also highlighted some other initiatives by the SEC, including an increased effort to police accounting violations and to pursue possible charges against exchanges, dark pools and high-speed traders for market structure rule violations.

"We have a bit of luxury in the sense that we don't have something that is so all-consuming like the financial crisis that takes our attention away from all of the other things we have going on," Ceresney said. "The absence of a specific crisis allows us to spread our resources around those areas and really make an impact in lots of different areas."

Since Congress in 2006 gave the SEC broad authority to police credit-rating firms, the agency adopted a series of new requirements, but has rarely taken actions against the firms.

Ceresney cited a handful of SEC regulations governing credit-rating agencies that are being explored by his division.

One rule, for instance, prohibits firms from engaging in "unfair, coercive or abusive practices" that could be used to unduly win more business. For instance, the rule bans firms from threatening to change or withdraw a rating if a company won't purchase other services or products offered by the credit-rater.

Other areas the SEC is exploring, Ceresney said, involve looking at whether raters are complying with rules surrounding how conflicts of interest are disclosed and managed. The SEC's regulations, for example, restrict the amount of business a rating firm can provide if it generates more than 10 percent of its revenue from that client in the most recent fiscal year.

The rules also require firms to disclose certain conflicts, such as whether a firm is paid by an issuer to rate a product, and outright ban other conflict-ridden business arrangements. In addition, Ceresney also cited rules governing the kinds of books and records that a credit-rating firm must maintain.

"If there are violations of those rules, which I think ... are a pretty robust set of rules, that would be something we'd look at," Ceresney said.

DIVISION CRITICIZED

The SEC enforcement division was criticized for failing to file charges against Standard & Poor's (MHFI.N), Moody's Corp (MCO.N) and Fitch Ratings (LBCP.PA) for the rosy ratings they assigned subprime mortgage products that ultimately soured during the 2007-2009 financial crisis.

S&P had previously disclosed it was under SEC investigation for its role in rating a failed subprime mortgage product. Ultimately the U.S. Justice Department, not the SEC, filed civil charges over the flawed rating that are now being litigated in court.

Ceresney declined to comment specifically on the S&P matter.

He differentiated the agency's pending probes from financial crisis-era issues, saying that compliance with rules adopted in recent years is being reviewed.

A 2012 case against Egan-Jones and its president Sean Egan marks one rare example where the SEC has taken some enforcement action. In that case, the regulator alleged a series of violations including a failure to maintain certain books and records and failing to follow rules governing conflicts of interest.

Egan-Jones later settled the matter and agreed to be barred for 18 months from rating asset-backed and government securities.

'MORE COMING DOWN THE PIKE'

Since SEC Chair Mary Jo White took the helm of the agency a year ago, she and Ceresney have refocused the SEC's attention on traditional accounting fraud.

Last year, the SEC launched a task force on financial reporting and auditing that routinely reviews restatements and other accounting matters for potential violations.

While the task force still focuses on trading accounting matters - such as revenue recognition, expense booking and off-balance sheet issues - Ceresney said the group is also singling out less scrutinized areas.

Those include internal controls over financial reporting required by the 2002 Sarbanes-Oxley Act and goodwill - a reference to how companies value intangible assets listed on their balance sheet, such as the reputation and name brand of a recently acquired company.

"We've had a bunch of recent...good-sized accounting fraud cases, and there will be more coming down the pike," Ceresney said, noting that the SEC has already brought a handful of cases such as accounting fraud charges against executives at the bankrupt law firm Dewey & LeBoeuf as well as accounting-related fraud charges against Diamond Foods and AgFeed Industries Inc.

He added that the regulations requiring internal controls over financial reporting have "not received the kinds of attention that may be deserved."

MARKET STRUCTURE FOCUS

Ceresney also said cases related to exchanges, dark pools and high-speed trading are ripening.

Questions about high-speed trading and whether some investors are at a disadvantage have been reignited in recent weeks after author Michael Lewis published a book alleging that the markets are rigged in favor of automated traders.

The SEC was already probing market-structure matters, and has brought a number of high-profile cases against exchanges including the New York Stock Exchange (ICE.N), Nasdaq OMX (NDAQ.O) and the Chicago Board Options Exchange (CBOE.O).

In regard to exchange-related cases, Ceresney said, "I think you'll see some additional activity on that front very soon."

He also said the SEC is exploring potential violations by alternative trading venues and dark pools, such as whether they are providing accurate disclosures to the SEC about their operations, the use of sub-penny orders, inappropriate trading on confidential information that is meant to be walled off, and compliance with "market access" rules.

Finally, he said, the SEC is looking into high-speed and automated trading, including "abuses of order types," manipulative trading practices and how they deal with exchanges.

"Obviously a lot of attention is there right now, but we have had investigations ongoing for a significant period of time," he said.

(Reporting by Sarah N. Lynch; additional reporting by Emily Stephenson; Editing by Karey Van Hall and John Pickering)