* Relates to alleged misstatements in 2008 application
* Involves record-keeping, past rating experience
* Charges also involve conflicts policy issues
* Egan-Jones lawyer says firm to fight the charges
By Sarah N. Lynch and Karen Freifeld
WASHINGTON, April 19 U.S. securities regulators
have decided to bring an enforcement case against credit-rating
agency Egan-Jones, alleging the firm made material misstatements
in a 2008 regulatory application, the company's lawyer confirmed
Alan Futerfas, an attorney for Egan-Jones, said the company
plans to vigorously contest the Securities and Exchange
Commission's administrative charges, which are expected to be
formally filed sometime next week.
Egan-Jones is among the smallest U.S.-recognized credit
rating firms in an industry dominated by three major agencies:
Moody's Corp, McGraw-Hill Cos Inc's Standard &
Poor's, and Fimalac SA's Fitch.
The firm and its outspoken founder, Sean Egan, have been
scrambling for market share, and have been faster than the other
agencies in downgrading the debt of some developed countries,
including the United States, and certain companies in the wake
of the global financial crisis.
Egan-Jones issued a statement on Thursday accusing the SEC
of targeting the firm and sparing the ratings giants which it
said played a damaging role in the 2007-2009 financial crisis.
"Egan-Jones believes that the SEC's action is inexplicable
except as an effort to silence Egan-Jones and maintain the
status quo of a conflicted, issuer-paid ratings agency
monopoly," the statement said.
Futerfas said that the SEC will not say in its filings what
specific relief it is seeking. An SEC administrative law judge
will eventually hear evidence and arguments in the case.
The SEC's decision to file charges came after commissioners
voted in a closed-door meeting on Thursday.
The charges are linked to issues in the firm's 2008
application to rate asset-backed and government securities.
The issues include allegedly misrepresenting the firm's
rating experience, conflict-of-interest policy issues, and a
failure to keep certain books and records, people familiar with
the matter said.
The company learned last October about possible SEC charges
after it received a "Wells notice", or a document the SEC issues
to possible defendants when it plans to recommend charges, one
An SEC spokesman declined to comment.
Sean Egan said in an interview on CNBC television on
Thursday that the 2008 application submitted to regulators was
"accurate to the best of my ability."
DAVID VS. GOLIATH
Egan-Jones is one of nine credit raters recognized by the
SEC, and is one of the few ratings agencies whose services are
paid for by subscribers, rather than the issuers of the
securities it rates.
The SEC's oversight of credit raters is relatively new. A
law passed in 2006 gave the SEC the authority to regulate them
and tasked the SEC with trying to create more competition in the
The oversight regime is also shifting after the financial
crisis, during which the top three raters assigned overly
positive ratings to toxic mortgage-backed securities and then
downgraded the products en masse, helping trigger the crisis.
Lawmakers said the issuer-paid model motivated the inflated
ratings, and ordered the SEC in the 2010 Dodd-Frank financial
reform law to study whether there was a way to reduce conflicts
The SEC has taken no public enforcement action so far
against raters for their role in the financial crisis, and
Egan-Jones marks only the second rater to face enforcement
action by the agency.
Egan-Jones has argued that it brings necessary competition
to the ratings agency marketplace, and Sean Egan has lashed out
at the business models of its competitors, saying the
issuer-paid model is like restaurants paying reviewers.
In its defense to the SEC during the Wells notice process,
Egan-Jones warned the agency that enforcement action could
"effectively put out of business the leading independent,
non-conflicted David to the issuer-paid Goliath," according to
documents reviewed by Reuters.
A 2011 SEC report said that Egan-Jones only has five
analysts and analyst supervisors on staff, compared with ratings
giant Standard & Poor's, which had 1,345 analysts on staff.
The filings to the SEC in response to the investigation were
signed by Futerfas, who runs his own law office, and Jacob
Frenkel, a former SEC attorney who is now with Shulman Rogers
Gandal Pordy & Ecker.
Ratings from Egan-Jones, which is based in Haverford,
Pennsylvania, usually have little market impact. But in November
it made headlines when it downgraded Jefferies Group
over concerns about euro-zone debt exposure, contributing to a
sell-off in the shares of the midsize investment bank.
The SEC has been scrutinizing Egan-Jones for years.
A report by the SEC's inspector general in 2009 cited
problems with a credit-rating firm funded by subscriber fees,
but did not name Egan-Jones by name. People familiar with the
matter, however, confirmed it was referring to Egan-Jones.
The watchdog's report cited suspicions regarding the
accuracy of financial information provided in the
subscriber-model firm's application. The report criticized the
SEC for approving the application and delaying in starting an
inspection of the firm.