Report: SEC Fretted About Egan-Jones Before 2007 Approval

Before giving Egan-Jones Ratings Co. the power to rate bonds and other securities in late 2007, the Securities and Exchange Commission reportedly held serious concerns about the small ratings company’s internal procedures and staffing levels.

According to The Wall Street Journal, an internal SEC watchdog said in a 2009 report there were “serious questions as to whether the approval of the application of one [credit-rating firm] was in the public interest given the significant issues that [the SEC] identified with the applications.”

While the report by then-inspector general David Kotz didn’t name the firm in question, the Journal said it was Egan-Jones.

Egan-Jones made waves late last year when the Haverford, Pa.-based firm downgraded midsize investment bank Jefferies (NYSE:JEF), citing its exposure to eurozone sovereign debt. The downgrade report, which Jefferies fiercely criticized as containing significant inaccuracies, came just days after the collapse of MF Global and helped send Jefferies’ shares spiraling lower.

In the 2009 report, Kotz said the SEC staff expressed “concerns about the adequacy of the [firm’s] managerial resources, suspicions regarding the accuracy of the financial information provided in its application and concerns about the authenticity of a number of certifications,” the Journal reported.

Still, the SEC signed off on the application, paving the way for Egan-Jones to rate corporate bonds, municipal debt, sovereign bonds and other securities.

With just over 1,000 ratings, Egan-Jones is a far smaller player than ratings leaders Standard & Poor’s and Moody’s (NYSE:MCO). S&P, which is owned by McGraw-Hill (NYSE:MHP), has almost 1.2 million ratings.

Sean Egan of Egan-Jones declined to comment on the report. His company’s lawyer, Alan Futerfas, declined to comment to the Journal on whether the unnamed firm in the SEC report was Egan-Jones.

“Assuming that Egan-Jones is one of the firms identified in the inspector general's report, obviously the SEC decided to grant [credit-rating firm] status, and it's extraordinarily in the public interest," Futerfas told the paper. "There's not a single rating by Egan-Jones that the SEC has ever said or even suggested was not of the highest quality or accuracy or integrity.”

In a report last year, the SEC detailed worries about unnamed credit raters’ weak compliance officers, who are responsible for adherence to regulations.

When Egan-Jones first registered with the SEC, it listed as its compliance officer Donna Blakely, who ran an arts-and-crafts store from 1999 to 2001 and attended, but didn’t graduate from, three universities, the Journal reported.

Ratings companies have been in the spotlight in recent years as lawmakers and academics say they deserve some of the blame for the financial crisis. S&P and Moody’s, which are paid by corporate bond issuers, have been heavily criticized for giving pristine AAA ratings on mortgage-related securities that subsequently imploded in 2007 and 2008 during the subprime crisis.

Unlike S&P and Moody's, Egan-Jones says it provides more accurate ratings because investors pay for its ratings research. Yet some believe this business model also creates conflicts of interest.

"Numerous independent studies have compared our ratings empirically to the issuer-pay model firms and have consistently found our ratings to be the most predictive in the industry to the benefit of our clients," Sean Egan told the Journal.

Egan pointed to his firm's decisions to downgrade infamous Enron and WorldCom before the major ratings firms did.