WASHINGTON — Federal regulators are accusing a prominent corporate and government credit rating agency and its president of making false statements in their application for an official designation to rate securities.
The Securities and Exchange Commission on Tuesday filed civil charges against Egan-Jones Ratings Co. and its owner and president, Sean Egan, for making "material misrepresentations" in its July 2008 application to the SEC.
Egan-Jones, based in Haverford, Pa., is a much smaller but well-known competitor to the big three rating agencies that dominate the industry: Moody's Investors Service, Fitch Ratings and Standard & Poor's, which is owned by The McGraw Hill Cos.
The SEC approved its application to rate asset-backed and government securities in December 2008.
Egan and the firm disputed the allegations through their attorney and said they will contest the charges before an administrative law judge at the SEC.
"Not one word in the (SEC's order) questions the quality, integrity and timeliness of the Egan-Jones ratings," the attorney, Jacob Frenkel, said in a statement.
"The SEC took three years of investigation and four years of inspections, threw everything it learned against the wall, and is hoping that something will stick," Frenkel said. AThe allegations grossly overstate the facts."
The SEC said Egan-Jones falsely stated in its application that it had issued 150 ratings on asset-backed securities and 50 on government securities. In fact, at the time of the application, the firm hadn't issued any such ratings. That meant it didn't meet the requirements to be registered, the agency said.
Egan signed the application and annual filings made after the firm was registered, and he certified that the information in them was accurate when he knew it wasn't, the SEC claims.
Rating agencies are crucial financial gatekeepers. They evaluate the creditworthiness of public companies and securities. And those ratings can be key factors in determining a company's ability to raise or borrow money. The ratings also affect the prices of securities purchased by banks, mutual funds, state pension funds or local governments.
For example, Egan-Jones in January cut its rating on Germany's debt to AA- from AA, with a negative outlook, citing the fact that "Germany will be footing a significant portion of the bill for the (European Union's) problems."
The three big agencies have been blamed for helping fuel the 2008 financial crisis by giving unrealistically high ratings to risky mortgage securities, a type of asset-backed security. Those investments later soured when the housing market went bust.
Spurred by a widely perceived lack of competition in the ratings industry that critics said lowered the quality of ratings, inflated the price of securities, stifled innovation and allowed conflicts of interest to thrive, Congress enacted the Credit Rating Agency Reform Act in 2006. It required rating agencies to apply to the SEC to be nationally recognized statistical rating organizations, or NRSROs.
Once officially approved, ratings companies must provide the SEC detailed information – some of which remains confidential – including lists of their largest customers, audited financial statements, the qualifications of their credit analysts and their procedures for preventing conflicts of interest or misuse of confidential company information.
The SEC approved Egan-Jones's initial application to register as an NRSRO for companies, financial institutions and insurers in December 2007. The firm applied in July 2008 to gain the NRSRO designation for rating asset-backed securities as well as securities issued by governments, including foreign governments and U.S. municipalities.
Egan-Jones, a small firm with only about 20 employees, says it is the only NRSRO that is independent because it's paid by subscribers – not the companies and governments issuing securities. That arrangement prevents the sort of conflicts of interest that the big rating agencies are susceptible to, the firm says.
Frenkel, the attorney representing Egan and the firm, said "It is clear that the SEC does not want independent firms as NRSROs, even though Congress does."