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SEC Puts S&P on Notice

""Standard & Poor's"":http://www.standardandpoors.com/home/en/us is coming under heavy scrutiny from the ""Securities and Exchange Commission"":http://www.sec.gov/ for it alleged misconduct in handling valuations for a $1.6 billion mortgage-bond deal. Regulators for the SEC are focusing on the company's possible exploitation of fictitious assets when rating the transaction in question.


The bond deal became a debacle during the financial crisis, and this week, S&P's parent company, ""McGraw-Hill Cos."":http://www.mcgraw-hill.com/, received notice from the SEC that it could be facing civil charges related to its potentially fraudulent actions. S&P is among many major financial institutions to recently be handed a so-called ""Wells"" notice by the SEC, and the information on possible civil proceedings contained in the SEC document targets ratings for a collateralized debt obligation known as Delphinus CDO 2007-1.

The SEC's alleged violations include a breach of federal securities laws, and the government says that S&P has been cooperating with those examining the Delphinus transaction. Robert Khuzami, who heads the SEC's enforcement division, is looking into S&P's triple-A credit rating of the Delphinus deal in an attempt to determine why the mortgage-bonds continued to carry such a high assignation even after strong assets were replaced with lower-quality versions.

While using ""dummy"" or hypothetical assets to value a CDO is common practice for deals that have auxiliary assets swapped in later, S&P's ratings appear to have ignored the fact that the ""dummy"" assets used for evaluation were much more stable than the risky assets traded into the mortgage-bond package. S&P's failure to alter the triple-A score following the addition of the lower value assets is the SEC's key concern.

""Moody's Corp.'s"":http://www.moodys.com/ Moody's Investor Service and ""Fimalac SA's"":http://www.fimalac.com/ Fitch Ratings also applied ratings to Delphinus, but neither company has been put on similar notice by the SEC. Both Moody's and Fitch also delivered their highest ratings available to the mortgage-bonds initially, and there is currently no information regarding the SEC's plans - or lack thereof - to examine related practices of Moody's or Fitch.

As for Moody's, the company did downgrade Delphinus to ""junk"" status as of January 2008, with S&P finally doing the same in February of that year. Japanese company ""Mizuho Financial Group, Inc."":http://www.mizuho-fg.co.jp/english/company/index.html was the underwriter of Delphinus, and the entity has declined to comment on the SEC's pursuit of S&P.

Last year, S&P's now-retired managing director Frank Raiter told regulators that, in his opinion, those behind the creation of Delphinus performed a classic ""bait and switch"" with the assets in question. However, Sen. Carl Levin (D-MI), countered Raiter during that Congressional hearing, calling the emails he had reviewed from within S&P ""devastating,"" in terms of the company culture displayed.

Though both S&P and the SEC have declined to comment publicly on this week's ""Wells"" notice, the _Wall Street Journal_ reports that S&P's August downgrade of U.S. debt has likely fueled the government's scrutiny of the organization. The S&P has defended its unprecedented and historic move to downgrade the nation's debt based on the rising debt burden taken on by the U.S. and the adjacent political risk. Sources from Capitol Hill also told the newspaper that Delphinus is just one of three deals listed in papers from the Congressional hearing, though no additional information is available.

About Author: Abby Gregory


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