In an unprecedented move, the SEC warned S&P that it might be suing it over its rating of a mortgage-backed bond. It’s the first warning a credit rating firm has gotten over its behavior leading up to the financial crisis.
WSJ reports that the warning came in the form of what is known as a “Wells notice,” a letter the SEC sends to companies and individuals that it may bring civil action against.
The potential lawsuit centers around S&P’s 2007 rating of a mortgage-backed securities deal called “Delphinus.” It was one of several collateralized debt obligations (CDOs) linked to the Magnetar hedge fund. Magentar is under scrutiny by the Senate, being accused of repackaging risky asset-backed securities that it sold to investors and then “shorted.” If it loses money, the fund wins. This conflict of interest gives a strong financial incentive to a firm to try to sell the worst dung they could and then bet against their own Frankensteinian creations.
In 2007, S&P rated the deal at AAA. They then downgraded it six months later.
A Senate report found that the Magnetar deal was a “striking example” of the failures of rating agencies leading up to the financial crisis. Moody’s and Fitch, the two other big ratings agencies, also rated the deal in 2007. They haven’t received Wells notices.
Back in August, S&P took the earth-shattering move of downgrading US debt a notch, setting off a political firestorm and a stock market plunge. Maybe it’s payback time.