U.S. SEC charges credit rater Egan-Jones

WASHINGTON (Reuters)—U.S. securities regulators on Tuesday charged credit-rating firm Egan-Jones Ratings Co. and its president, Sean Egan, with making false statements in a 2008 application to the agency to rate certain securities.

The Securities and Exchange Commission's administrative charges also include allegations that Egan-Jones allowed two analysts to participate in ratings for issuers whose securities they owned.

A lawyer for Egan-Jones said his clients will fight the charges.

"Egan-Jones and Mr. Egan dispute the allegations and will litigate vigorously. Not one word in the administrative proceeding questions the quality, integrity and timeliness of the Egan-Jones ratings," said Jacob Frenkel, an attorney for Egan-Jones.

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 S.A.'s Fitch.

It has aggressively pursued more market share, and Sean Egan has slammed the big three rating firms for their business model in which issuers pay for the ratings they receive, saying it is a glaring conflict of interest.

Egan-Jones first registered with the SEC in 2007 as a "nationally recognized" credit rating agency for financial institutions, insurance companies, and corporate issuers.

It submitted another application in 2008 to rate issuers of asset-backed securities and government securities.

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The SEC alleges that in its July 2008 application, Egan-Jones falsely stated it had 150 asset-backed issuer ratings and 50 outstanding government issuer ratings.

Months later, the SEC says, Egan-Jones amended those figures in its 2008 annual certification, from 150 to 14 and from 50 to nine.

The SEC contends that at the time of its application, Egan-Jones had not issued any asset-backed or government issuer ratings that were made available on the Internet or through any other readily accessible means.

It was only in January 2010, the SEC said, that Sean Egan finally directed an employee to post those ratings on the company website.

In addition, the SEC alleges that Sean Egan and his firm claimed they had been issuing continuous ABS and government securities ratings since 1995. The company was inconsistent in subsequent filings, however, claiming it had only been issuing ratings in this field since 2005, the SEC said.

This lack of rating experience, the SEC said, should have made Egan-Jones ineligible for the SEC to recognize the firm as a "nationally recognized" credit-rating agency in those categories.

Aside from the SEC's accusations of misleading the regulator, the SEC also alleges that Egan-Jones failed to enforce its conflict-of-interest policies.

One analyst participated in 17 different ratings despite owning securities in those companies, the SEC said.

Tuesday's action marks only the second time the SEC has filed charges against a credit rating agency.

Independence

Ratings from Egan-Jones, which is based in Haverford, Penn., usually have little market impact. But in November it made headlines when it downgraded Jefferies Group Inc. over concerns about euro-zone debt exposure, contributing to a sell-off in the shares of the midsize investment bank.

Tuesday's action marks only the second time the SEC has filed charges against a credit rating agency.

Ratings from Egan-Jones, which is based in Haverford, Penn., usually have little market impact. But in November it made headlines when it downgraded Jefferies Group Inc. over concerns about euro-zone debt exposure, contributing to a sell-off in the shares of the midsize investment bank.

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Egan-Jones has also been faster than the other agencies in downgrading the debt of some developed countries, including the United States.

The firm 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 industry.

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 of interest.

The SEC has taken no enforcement action so far against raters for their role in the financial crisis.

Alan Futerfas, another attorney for Egan-Jones, called the alleged violations "hyper-technical" and "de minimis," and accused the SEC of failing to direct its resources toward much more troubling conduct by Egan-Jones' competitors.

"To me, this is indicative of the SEC's desire not to have an independent" credit-rating agency, Mr. Futerfas said.