Egan-Jones to Fight Potential SEC Charges

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Published April 19, 2012

| FOXBusiness

Egan-Jones plans to contest potential charges expected from the U.S. Securities and Exchange Commission today that the credit rating agency made material and intentional misstatements in its application to the SEC to rate securities in 2008.

Specifically, the SEC may vote on whether to charge Egan-Jones with misleading the market regulator over its rating experience, its finances, its internal procedures, as well as the adequacy of its books and records.

The SEC also may charge Egan-Jones over its conflict of interest policy. Egan-Jones gets paid by investors, whereas the larger credit-rating agencies get paid by Wall Street companies who issue securities. The SEC is not contesting the actual ratings offered by Egan-Jones. 

An earlier SEC inspector general report noted the market regulator had misgivings about Egan- Jones' application to be a credit rating agency. Reuters broke the news earlier that the SEC could vote possibly later today on whether or not to charge Egan-Jones, citing people familiar with the matter.

A person close to the matter says Egan-Jones denies any wrongdoing and will fight any charges. The SEC declined comment.

Jacob Frenkel, a lawyer representing Sean Egan, the firm's founder, tells FOX Business that he has filed a complaint about the leak of the Commission's deliberation.

Egan-Jones is the smallest of the credit-rating agencies, having just won approval from the SEC to be a "nationally recognized" rating agency, and rate securities like bonds and equities in 2008.

Sean Egan emailed FOX Business to say he will be holding a press conference on the matter at 4 p.m. today. The SEC would need a majority commission vote to act against Egan-Jones.

Egan-Jones lawyers Alan Futerfas and Frenkel also have sent memoranda to the SEC in the  firm’s defense. The documents, which FOX Business has obtained, note that the SEC had sent a Wells notice to Egan-Jones on November 11, 2011. An SEC Wells notice is often a prelude to a full blown agency investigation.

The Egan memo to the SEC notes “two newly available academic studies that analyze rigorously empirical ratings data relevant” to the ratings published by Egan-Jones. The studies come from the University of North Carolina at Chapel Hill and the University of Texas at Dallas, and compared Egan-Jones ratings with those from other rating agencies.

Egan-Jones also submitted to the SEC new information about its sovereign ratings and asset-backed securities ratings as well.

The financial collapse of 2008 put credit rating agencies, including Moody's Investors Services and Standard & Poor's, squarely in a harsh spotlight over severe conflict of interest allegations, as well as their failure to properly warn about the junk status of securities hiding behind the firms’ gold-plated triple-A ratings.

Congress held a string of hearings which revealed the lax procedures at the ratings agencies, which get paid by Wall Street investment banks to rate their securities, a conflict of interest believed to be behind the failure to stop an imminent housing and credit collapse. 

The firms were also found to be rubber stamping as triple-A asset backed securities collateralized with subprime junk loans, among other things.

Sean Egan has been a vocal advocate of more independent ratings, and subsequently, the Dodd Frank financial reform bill directed the SEC to implement regulation to encourage “non-issuer” pay models for ratings agencies. Egan Jones gets paid by investors, not issuers of securities.

Egan-Jones was first out of the box to downgrade Enron and WorldCom, as well as the U.S. credit rating last year.

Recently, Egan-Jones threatened to downgrade the U.S. to "AA" from "AA+" and also issued a controversial downgrade to the investment bank Jefferies due to its exposure to European debt. That downgrade, which came in the aftermath of the collapse of MF Global, was hotly contested by Jefferies, which said Egan-Jones failed to take into account its hedges against those bonds.

Egan-Jones' memo to the SEC today calls the issuer pays model used by Moody’s, Standard & Poor's and Fitch “corrupt,” as it leads to “ratings inflation.”

Specifically, the study suggests that issuers “with more short-term debt, a newly appointed CEO or CFO, or which have a lower percentage of past bond issues rated by S&P, are significantly more likely to receive an 'inflated rating' from S&P."

S&P and Fitch declined to comment, and Moody’s could not be immediately reached for comment.

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http://www.foxbusiness.com/investing/2012/04/19/egan-jones-to-fight-potential-sec-charges/