Bloomberg News

SEC Says Egan-Jones Made False Claims in Regulatory Filings

April 24, 2012

The U.S. Securities and Exchange Commission accused Egan-Jones Ratings Co. and founder Sean Egan of making misrepresentations about the firm’s experience rating asset-backed and government securities in a 2008 application to become a nationally recognized statistical ratings organization.

Egan-Jones falsely claimed in the application that it had about 150 outstanding ABS issuer ratings and 50 government ratings, the SEC said today in an administrative proceeding authorized by commissioners last week. At the time of the July 2008 application, the Haverford, Pennsylvania-based firm hadn’t issued any such ratings and therefore didn’t meet requirements for registration as a NRSRO, the SEC said.

Egan-Jones, which is paid by investors, is one of about 10 firms registered with the SEC as an NRSRO, meaning companies can use their credit ratings to meet regulatory requirements. The biggest NRSROs, Moody’s Corp. (MCO:US) and McGraw-Hill Cos.’ Standard & Poor’s unit, are paid by debt issuers.

Jacob Frenkel, an attorney for the firm and Egan, said they will fight the claims.

“There is no allegation that any ratings were corrupted or unduly influenced, and not one word in the administrative proceeding questions the quality, integrity and timeliness of the Egan-Jones ratings,” Frenkel said in an e-mail.

Conflicts of Interest

The SEC also accused Egan-Jones of failing to enforce its own policies to address conflicts of interest. Two analysts were allowed to participate in determining credit ratings for issuers whose securities they owned, according to the SEC.

Egan-Jones falsely stated that it was unaware of whether its subscribers held certain positions in particular securities, the SEC said. In fact, the firm’s salespeople were aware of certain clients’ holdings, and in some instances knew whether clients had long or short positions, according to the administrative proceeding.

In at least three instances, information about whether a client had a long or short position was communicated to Egan, the firm’s primary analyst, the SEC said.

“At no time did nominal holdings by two analysts influence in the slightest the firm’s independent ratings actions,” Frenkel said. “When the SEC raised a concern during its annual examination of the firm, Egan-Jones implemented a conflicts of interest policy that went well beyond what the rules require.”

Converted House

Egan joined Bruce Jones, a former credit analyst at Moody’s, to form Egan-Jones in 1995. The firm, which operates out of a converted house in Pennsylvania and has two full-time senior analysts, submitted its first application to become an NRSRO in 2000 and was first granted that status for three classes of securities in 2007. The 2008 application sought approval to grade ABS and government securities.

While Egan-Jones says it has 1,136 outstanding credit grades, the firm employs a total of five analysts, including Egan and Bill Hassiepen, according to a March regulatory filing. Jones and senior analyst Art Burke both work part time. The filing lists a fifth analyst, NG Subramanian, in India.

“We are well-staffed to not only service our existing clients, but to grow and to continue issuing timely, accurate ratings,” Egan wrote April 23 in an e-mailed statement. “Our ratings have been reviewed by independent academics and compared to the other firms and have consistently been found to be the most accurate, predictive ratings in the industry.”

Egan-Jones became an NRSRO in December 2007 after seven years of being denied the status, following passage of the Credit Agency Reform Act of 2006.

The legislation, which sought to increase competition among credit-rating firms, pushed the SEC to authorize companies to assign debt grades that banks use for determining capital withholding requirements.

Adequate Resources

Under the law, an SEC committee has 90 days to grant a company NRSRO status after receiving its application. It must give approval unless the document is incomplete or out of compliance, or the company lacks “adequate financial and managerial resources to consistently produce credit ratings with integrity and to materially comply” with requirements.

When the SEC’s internal watchdog raised concerns in 2009 about a certain credit-rating company’s application, the panel that approved it said it “only had suspicions and concerns but lacked evidence,” according to a report issued that year.

“Instead of resolving the issues they just simply approved the companies to be credit agencies,” said H. David Kotz, the former SEC inspector general who identified several unnamed companies with problematic applications and declined to comment specifically about Egan-Jones.

“The process was not worthwhile in that respect because they weren’t doing a thorough review,” Kotz, now a managing director at investigation firm Gryphon Strategies, said in a telephone interview.

Jefferies Group

Egan-Jones downgraded New York-based Jefferies Group (JEF:US) Inc.’s debt in November and said it should raise $1 billion in equity and reduce leverage. Without “major de-leveraging,” Egan-Jones said it might cut Jefferies’s credit grade.

Jefferies’s $800 million of 5.125 percent notes due in April 2018 dropped to as low as 76.1 cents on the dollar on Nov. 18 from 90 cents at the end of October, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

On Nov. 28, Oppenheimer & Co. analyst Chris Kotowski said the rating company’s analysis of Jefferies contained “epic errors of fact.” The debt traded at 98 cents on at 2:14 p.m. in New York today, Trace data show.

To contact the reporters on this story: Joshua Gallu in Washington at jgallu@bloomberg.net; Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editors responsible for this story: Maura Reynolds at mreynolds34@bloomberg.net; Alan Goldstein at agoldstein5@bloomberg.net


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