Is the SEC Finally Dealing with Corruption in Ratings Agencies?

Once all-powerful ratings agencies Moody’s (NYSE:MCO) and S&P (NYSE:MHP) may be slated for a fall from Olympus as word is making its way around town today that the SEC has a “strong civil fraud case” against the two companies. The ratings agencies, which continue to drive trading momentum with warnings of reviews, upgrades, and downgrades for debt holdings in private banks and federal securities alike, are being investigated by the SEC for a sort of grade inflation it gave to banks leading up to the financial crisis. Federal Investigators believe that Moody’s and others knowingly continued to issue strong ratings on debt packages sold by Wall Street’s top banks, Citigroup (NYSE:C), Goldman-Sachs (NYSE:GS), Morgan Stanley (NYSE:MS), Bank of America (NYSE:BAC), and others, without doing its homework, which can be prosecuted as fraud.

From, “The SEC is looking at ‘whether the ratings companies committed fraud by failing to do enough research to be able to rate adequately the pools of subprime mortgages and other loans.'” The column in the Street also cites the opinion of highly respected Columbia University Securities Law Professor John Coffee, who argues, “That kind of adjustment does sound like fraud, whereas passivity can be defended as simply non actionable negligence. Thus, the strength of such a suit will likely depend on what is alleged…It is important to go beyond charges of inactivity and assert (as the economic evidence seems to show) that they deviated from their own models to inflate their ratings.”

Coffee continues, saying the ratings’ agencies may have caught a break in being targeted by the SEC rather than the Justice Dept., “I think that there may have been some jurisdictional rivalry and probably a compromise in the SEC pursuing the case because it would not make sense to have everyone piling on and suing the rating agencies. If I were the defendants, I would prefer to be sued by the SEC than the Department of Justice–even civilly.”

Perhaps investors and international organizations have increased reason to take threats from ratings’ agencies and revisions on outlooks with a grain of salt.