Journalism in the Public Interest

SEC Keeps Ratings Game Rigged

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The Securities and Exchange Commission seems to think that it has done a much better job of investigating financial crisis wrongdoing than the Justice Department. And it's true.

But it's like being proud that you're the "Dumb" of "Dumb and Dumber."

A case the commission filed last week epitomizes a lot of what's wrong with the agency, even under the supposed overhaul by its chairwoman, Mary L. Schapiro.

The agency brought a civil case against a tiny, iconoclastic ratings agency called Egan-Jones, run by the outspoken Sean Egan, accusing it of, well, essentially filling out forms wrong.

Before the S.E.C. charges, Egan-Jones was best known for two things: having made some bold calls about shaky credit prospects and having a business model that was different than that of the big boys — Moody's Investors Service, Standard & Poor's and Fitch. Mr. Egan's outfit gets paid by the users of his ratings; the oligopoly gets paid by the issuers whose debt is going to be rated.

You don't need to be a hedge fund quant to see the conflict of interest: the more ratings, the more profits to the ratings agencies, so the temptation is to be extra lenient. And, boy, were they.

Mr. Egan wasn't shy about pointing this out, often through media appearances. To be honest, one wondered how much was showmanship and how much was deep research.

But the world needs his brand of punditry, especially on Wall Street, where the uncorrupted are too afraid to speak out. Mr. Egan has been prescient on some important calls about declining credit prospects, ahead of both the European financial crisis and the American mortgage and structured finance bubble before that.

The S.E.C.'s case against Mr. Egan and his firm concerns a filing made in 2008 seeking special designation to be a "nationally recognized statistical ratings organization." This status confers some rights and special privileges under securities laws, and it's one of the main competitive advantages the credit ratings trinity has.

The agency makes a variety of allegations. For one, Egan-Jones represented in its application that it had 150 ratings on asset-backed securities and 50 ratings on governments, when it hadn't issued any at the time, the S.E.C. says. To the guillotine! (Egan-Jones responds that it was using a different counting method.)

Some allegations are more serious, but only slightly. The agency contends that two Egan-Jones employees had a role in rating issuers while owning securities in those issuers. The firm says these employees had long-standing investments and that it actually brought these violations to the attention of the S.E.C.

All told, the allegations seem especially paltry when compared with the disastrous performance of the ratings agencies that matter — Moody's and S.&P. Egan-Jones's ratings didn't cripple the global economy. Mr. Egan's business model is far less prone to compromise and corruption. The inescapable conclusion is that the S.E.C. is letting Moody's and S.&P. officials walk free while pursuing Mr. Egan on minor technicalities.

This is your S.E.C., folks. It courageously assails tiny firms, and at the pace of a three-toed sloth. And when it goes after its prey, it's because it has found a box unchecked, rather than any kind of deep, systemic rot.

Unfortunately, there's an even worse problem here. The action against Mr. Egan gives the appearance, perhaps inadvertently, that the agency is persecuting a longstanding critic of the ratings agencies. That just solidifies the woeful ratings oligopoly we have today.

Now, the S.E.C. doesn't see it this way, naturally. The agency says that bringing one case doesn't preclude another. And it's true that there have been news reports of investigations into the ratings firms regarding actions that led to the financial crisis, including notices that it plans to bring charges over some ratings.

John Nester, a commission spokesman, said the agency stands up to the big boys. "Our record shows beyond dispute that no institution is immune from S.E.C. charges when we find violations of the securities laws," he said, pointing to, among others, Goldman Sachs, Citigroup, JPMorgan Chase and Bank of America.

Relative to Eric Holder's Justice Department, that record makes the S.E.C. look like the god Shiva, destroyer of worlds. But the S.E.C. has hardly been aggressive about the ratings agencies. It hasn't moved against any top executives of any major ratings firm for actions leading to the financial crisis.

In one of its timorous moments, the agency punted on a case involving Moody's and a questionable rating on a complicated European structured finance product. The S.E.C. determined that it was unclear whether it had jurisdiction because the securities were created and sold in Europe.

Promising leads on other potential wrongdoings by credit rating agencies seemingly go to the S.E.C. to die. A whistle-blower — Eric Kolchinsky, a former Moody's executive who oversaw the firm's collateralized debt obligation ratings — claimed that Moody's inflated ratings on a loan deal called Nine Grade Funding in January 2008 because it had already made a decision that it was going to downgrade the assets that were going into the deal.

Some three years after that allegation was dropped at the door of the S.E.C., there's been no action so far on the deal.

Moody's declined to comment. The S.E.C. does not confirm or deny investigations. Given that the regulator's bark is worse than its bite, Egan-Jones will probably be able to wriggle out of the agency's clutches with a settlement and a fine. Mr. Egan's business will be damaged, but he is likely to still have one.

The help that the S.E.C. has given the oligopoly will last, however. Any small company looking at filing for special status will think twice. While they ponder, Moody's, S.&P. and Fitch will continue to earn fat profits, and their executives walk free.

“The agency says that bringing one case doesn’t preclude another.”

This has been what our government has been about, with respect to big companies, for decades.  We’re NOT prosecuting, but we COULD, so just hang tight.  And don’t worry about that bluish color in your cheeks.

But, it’s what you expect when you draw from the financial industry to monitor the financial industry.

Another problem (which, alas, brings us to the void at the Department of Justice) is that we “regulate” these industries, rather than making them follow actual law.  I get the sense that they could literally get away with murder, because the SEC doesn’t have an anti-murder rule.  Haul these idiots into court, not closed meetings with their buddies.

But, as pointed out, that would require someone like Eric Holder to actually prosecute (or even investigate) wrongdoing, and I think he’s made it abundantly clear that it’s simply not about to happen.

They HAVE gotten away with murder. The rise in suicides, domestic violence, drug related deaths in the misery these bastards have made, is nothing short of murder by proxy. People ARE dying over this compost.

I recently read an article in The Economist about government corruption in Tajikistan.  The gov’t agency purportedly policing drug trafficking from Afghanistan through Tajikistan is actually protecting the officials in Tajikistan who are on the make, and preventing smaller criminals from entering the “market.”  This sounds familiar.

As a country our government does let companies get away with murder. Just look at all the veterans where thousands of deaths, related cancers and sickness is tied to Agent Orange and our chemical companies. Keep in mind, the S.E.C. is responsible to regulate the industry. Not slap hands after the United States banking industry melts down. And not after they find the industry built a house of cards!  And how many regulators have been removed?

The question of negligence or corruption, as opposed to mere incompetence, is actually a sideshow. The SEC may or may not figure out a way to punish the rating agencies, though their First Amendment defense is very strong. This article, however, misses the critical problem, which is the persistence of Rule 2a-7. This SEC rule is a gift to rating agencies that keeps on giving: it requires money-market funds, a.k.a. the heart of the “shadow banking system,” to use agency ratings in picking securities. This is a money machine for the agencies, a guaranteed payday; and it disproportionately rewards the larger ones, because they have more coverage which means more investment choices for the money-fund operators.

Not only does 2a-7 enfranchise the agencies, it gives the money-fund operators a convenient excuse for not doing their own homework. It replaces their prudential judgment on a critical question (“will I get my money back?”) with a compliance process (“did I only buy eligible securities?”) This allows them to outsource what should be their essential function of investor capital protection—so they compete on yield, and not on security of principal.

Make no mistake: as long as there is Rule 2a-7, rating agencies won’t reform, and investors won’t get the competitive market in credit opinions that they need (and are forced to pay for, even though they don’t get it). Our shadow banking system will continue to have a big hole in the middle, too, a hole where credit analysis and investor protection should be. There are other regulations with similar effect in other markets but 2a-7 is by a long shot the most potent and therefore toxic.

Why would the SEC would go after tiny Egan-Jones when it’s clear that there were bigger and worse conflicts at other ratings firms?  The model of selling ratings to those your rating is conflict enough.  It makes me question the priorities of the SEC—and who is setting those priorities. 

Whether it’s lazy, inept or worse the agency has been problematic for some time.  Can the SEC be an effective regulatory agency?  Or, have they become so intertwined with Wall Street and the revolving door that they fail to check corporate hubris?

I posted a piece on the SEC and pressure to regulate proxy advisory firms recently at HuffPost… would be grateful to hear what you think.


May 2, 2012, 4:30 p.m.


Odd that it’s 2012 and the SEC/DOJ still wants folks to rest patiently knowing how they’re still on the case like a houndog…  some houndog, because somebody could wonder if all that dogged unrelenting investigating wouldn’t feel exhausting by say, year 3 or 4…
  the fact that nothing of substance has been launched at Moodys/SP/Fitch eventually starts to feel the same as there actually being nothing there to prosecute anyway.  The latter has made good sense to me because I know that these RA’s are private, profitmaking concerns, with customers that pay for a product/svc rendered.  But unlike typical claims of fraud against a company, the claimant isn’t the paying customer.  It’s the universe of randoms that actually never will have paid a penny to these RA’s.  They’ve chosen to use the ratings out of choice, and btw: The RA’s have simply no contractual relationship with any of them, have made no unfulfilled promises, no failure of product quality, etc.  i bet not a peep coming from any actual paying client of these RA’s. 
not a great business to be in if parties you never heard of can complain about what you’ve delivered for a fee.

Egan Jones downgraded the US government from AA+ to AA on April 5, 2012. 

Exactly two weeks later, the SEC suddenly had concerns about some paperwork filed four years ago by Egan Jones…

As the only government approved ratings agency that is paid by investors rather than issuers, Egan Jones has the proper incentives to advise investors.

I’m very glad to see that this act of intimidation is getting some attention.  It is another step along the road to becoming a banana republic. Thanks for your work on this.

This action is very similar to the fact them after S&P showed their first shred of integrity and downraded the US last year, two weeks later their board was intimidated into firing their CEO.

Top executives at the big banks, wall street firms, most of the 500 fortune company official media and government all are in bed.

A day will come in USA, where there will be only two classes left.
(1) Super Rich and (2) Poor and Super Poor.
Middle class will be wiped out.

Well done Mr.Eisinger, but you’d expect exactly what from the SEC?
The revolving door there spins faster than a whirling dervish.
But I shouldn’t be so critical, they’re probably still brimming with pride for taking out the systemic symptom that was Bernie Madoff, while leaving the disease without check.

E. Henry Schoenberger

May 3, 2012, 1:59 p.m.

From 4 decades of successful experience in the securities business and a the former owner of an NASD Member Firm - trust me this article is not close to how bad the SEC has been, nor the Fed.

And anyone with a shred of securities background knows that it is usual and customary for the SEC to not go after the biggest and the guiltiest of fish!  Never have.  For the SEC to have sued the banks was like a member of the Manson family going after Charlie.

All of this including the significant regulations that the SEC and the Fed did not enforce are in my new book.  So if you want the whole truth and want to know that the factual root cause of our economic crises and vast chasm of income inequality is the return of Social Darwinism that has metastasized into Financial Darwinism - then read the only book about this - How We Got Swindled by Wall Street Godfathers, Greed & Financial Darwinism ~ The 30-Year War Against the American Dream—with a foreword from David Satterfield, the former business editor of the Miami Herald and 2 times Pulitzer winner.

Satterfield’s endorsement from the back cover:

“With keen intellect and searing wit, Henry Schoenberger’s How We Got Swindled exposes the myriad of financial hijinks and colossal leadership failures that have turned the first decade of the new century into an economic disaster.  Schoenberger not only identifies the causes, rationales and human failings that led to this mess; he provides some ready answers for how we must go about fixing it.  This should be must-reading for every policy maker in Washington and every student of economics and finance.”

To know what Congress and Wall St do not want you to know, and what the media does not fully understand:

This is just a symptom we see all over the country where large rich corporations are showered with perks and protected from being held accountable.
Where I live the city of Austin which just awarded Apple corporation a set of inducements to move more business here. Nobody asked why does one of the most successful US companies with billions is cash assets need public help from a city cutting back services in other areas. Why do they help the big successful company will a welfare program ? I am sure there are many small businesses like mine who have been here decades could make more jobs in the area than Apple and we local people won’t ever ship American jobs over seas.

Agriculture subsidies go only to the biggest producers, Tax loop holes go to those need them the least. Our government haven been overthrown and democracy has been replaced with a Fascist Oligarchy. I would not be surprised if Egan-Jones was slowly squeezed out of business. The big three could just refuse to work with anyone who did business with Egan-Jones and he’s gone.  This is why free market, supply side, libertarians like Milton Friedman"s ilk are naive and the markets need heavy regulation.

When you run a large enterprise, such a bank, an investment bank, a mutual funds company or a hedge fund, when you want to be free of adverse (to you) regulation, just give a lot of money to people who will win elections. Another way is to send a lot of your employees into high ranking government jobs, where conflicts of interest are ignored. Regulate campaign funding in ways the Supreme Court says is unconstitutional requires a constitutional amendment. I would support a constitutional amendment limited to an effective limit on campaign contributions especially the holding of Buckley v Valeo (1976) which said a campaign contribution, that’s right, the giving of money to a committee, is an exercise in free speech. It’s a ridiculous idea, but it’s the law and can only be overturned with a new Court or a Constitutional Amendment.

Let the DOJ investigate the SEC.

E. Henry Schoenberger

May 4, 2012, 5:13 p.m.

Let the DOJ indict the heads of the SEC - i have called for this in my book.  Certainly the SEC goes after anyone who goes against them. Remember Cox (the Harvard Lawyer Goldman guy when he was head of the SEC- could not vacate the Merrill “contracts” for billions of bonuses for fraud - the fraud that killed Merrill and was absorbed by Bank of Am.

What the SEC and the Fed have not done is protect the economy - only Wall St Trojan Mega Banks.

The fraud of which the SEC has been complicit is of RICO magnitude.

Cox and Shapiro should be prosecuted to the full extend of the law.

Then, Goldman and others should be cahrged.

The US market and its criminals is universally distrusted and reviled.

What are we waiting for?

Do we need to assemble a Star chamber?

E. Henry Schoenberger

May 5, 2012, 11:27 a.m.

Jim - you are exactly right.  Schapiro and Cox could be worse than you think.  And the leaders of Goldman et al should be indicted, and after recent conversations with officers of the Cleveland Fed Bank - it might just be Fed policy to have not enforced SIGNIFICANT REGS AGAINST—SECURITIES THAT CANNOT BE EXPLAINED WELL ENOUGH TO BE UNDERSTOOD, an implied conclusion not inferred.

Not so good.  And that is why i wrote my new book.  So I hope if Americans care about the war against those of us who are not filthy rich the 99% (or whateverrr the %) care enough learn what Congress and Wall Street do not want us to know.  And after so many decades licensed by the SEC and my first book, which the chairman of the Finance Dept of Miami U (Oxford,Oh) when i spoke there in 1990, said was the equilavant of a PhD thesis published as a trade book - plus the research and the additional 20 years of experience from the 1st book, i don’t need sources to determine what has actually happened. Jesse, unlike so many “journalists” is a real investigative reporter and wrote an entire book about one or two of my chapters, which was execellent but does not reveal the sum of the parts which combined to form the whole truth.

Read How We Got Swindled to know about all the culprits and controlling issues and what we need to do. And spread the word because we must identify the root cause of the return of Social Darwinism metastasized into Financial Darwinism and use this as a unifying cause to overturn the lack of concern for the common good stemming from unfettered rapacious sociopathic greed.

Errr…really, the DoJ?  The guys who outright refuse to investigate war crimes (remember those?), Fast and Furious (their own screwup), the rampant fraud on Wall Street, the destructive speculation in the commodities market (the “demand” for oil on paper is 33x the consumption rate, food is climbing), and…well, you get the idea.  That Department of Justice?

Sorry, they’re much too busy prosecuting whistleblowers and helping the big media companies bully grandmothers and college kids out of their savings for alleged copyright infringement.

They’re just as complicit as the SEC.  Remember, a lot of what Wall Street has done is provably unfair monopolistic business practice, violation of contract law, interstate fraud, and so forth.  They don’t need the SEC, and yet they stand by, just like they do with everything else.

E. Henry Schoenberger

May 7, 2012, 10:26 a.m.

John - you’re right.  However, the DOJ should be the place - because clearly the SEC will not and has not stepped up to the line.

Americans just need to know more and then become involved with reasoned outrage to demand that zealot born again Social Darwinism metastasized into Financial Darwinism with the ethic of - survival of the richest - be stopped and that our Democracy should be for the people and the survival of the richest.

Hopefully if enough people read How We Got a new dialogue of understanding will emerge from all the propaganda, sound bites and media parsing.

The return to the robber baron economic theories of laissez faire and maximize profits no matter what from the robber baron era of Social Darwinist caused our last depression and this one. Until we recognize and acknowledge that the ethic of Financial Darwinism is the root cause of our economic tsunami and vast chasm of income inequality we will not have an effective march to fight back against the war against the American Dream.

And, it goes without saying, as a country, we simply can’t afford the likes of Mittens…

Actually, the entire complicit SEC should be frog-marched into Gitmo.

E. Henry Schoenberger

May 7, 2012, 10:39 a.m.

Yes!  If you are not sick yet - when you read my book you will be.

Your important and valid perspective risks getting set aside too early   if anybody finds the selfpromotion unsettling…  need not be like that though

E. Henry Schoenberger

May 14, 2012, 7:09 a.m.

Wm - if anyone finds how and where to get the information that is missing from our public discourse or lack thereof unsettling - let them consider that it is difficult to get the real truth out in the face of so many superficial pronouncements and media hubris.  All the members of the 4th estate with books push them relentlessly on the shows and on eachothers shows.  So when a book appears that is more to the point, spot on reality and based on 4 decades of inside experience, and research - by an author who has no need to rely on “sources” (often conflicted with guilt, slanted and without the integrity to not participate - this makes the other books or “so-called prominent experts look not so good.
a function of their own greed and lack of concern for if it was right

E Henry Schoenberger

May 14, 2012, 7:21 a.m.

sorry i hit the wrong thing on my wife’s laptop.  regretably, when you see what others either do not or choose to not see, and know you are furnishing truth that is not available anywhere else - at least not under one cover - there must be a way to communicate this is conversations like this - or on Huffington or Cape Cod Today where I blog or on my own blog -

I have been writing about my insights since my first book in 1989. And shared my outline on Financial Darwinism with Jonathan Katz, Secretary of the SEC, in a 3 page letter in 1989 when I was a broker-dealer.  This letter is in the appendix of How We Got Swindled.

Anyway - thanks for noticing my perspective - and if you read my book you will know the synthetic derivatives are all illegal, the regulations that control this thought are cited.  Finally - i did not write a whole book about what could be one chapter - i wrote 19 chapters about what could have been 19 - maybe 16, books.

agree w the egan jones wrongful demonization
but the most ridiculous part is
they are said by SEC to not issue the recommendations
just how is a buyer paid ratings agency supposed to work?
why pay anything if they muct be public to get a recognised rater tag
and have SEC plessed funds use them?

Jesse Eisinger

About The Trade

In this column, co-published with New York Times' DealBook, I monitor the financial markets to hold companies, executives and government officials accountable for their actions. Tips? Praise? Contact me at .(JavaScript must be enabled to view this email address)