April 19, 2012 / 5:45 PM / 8 years ago

UPDATE 3-U.S. SEC takes action against rater Egan-Jones

* 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 (Reuters) - 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 on Thursday.

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.

“I think this does a significant disservice to the investment community,” Futerfas said. “I think it is grossly disproportional to any possible error in any four-year-old application. And we intend to vigorously contest these allegations.”

Egan-Jones is among the smallest U.S.-recognized credit rating firms in an industry dominated by three major agencies — Moody’s, 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.

Futerfas added 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 person said.

Egan-Jones is one of the few ratings agencies whose services are paid for by subscribers, rather than the issuers of the securities it rates.

In its defense to the agency, Egan-Jones previously warned the SEC 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 firm 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.

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.”

An SEC spokesman declined to comment.


The 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 subscriber-paid model, Sean Egan has said, eliminates a key source of conflict that policymakers have since flagged as a root of the U.S. housing crisis of 2008, when subprime-related securities received top ratings from the nation’s three leading credit-rating firms.

There are also critics of the subscriber-paid model, who say large customers such as fund managers could try to ensure that their investments do not get downgraded.

The SEC first got authority from Congress to regulate credit-rating firms in 2006. Under that regime, firms file applications with the SEC to be dubbed as “nationally recognized” rating agencies.

SEC regulations require credit-rating firms to maintain certain books and records, furnish financial reports, disclose and manage conflicts of interest and establish procedures to manage the handling of material, non-public information, among other things.

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.

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