More than a year ago, Standard & Poor’s revealed that it was under investigation by the Securities and Exchange Commission for the high rating it granted to a 2007 mortgage bond deal known as Delphinus.
The nation’s large credit ratings agencies were being widely blasted for inflating the ratings of toxic investments at the heart of the financial crisis, and the SEC appeared poised to take the first major federal action against the largest of those firms.
But this week, the Justice Department leapfrogged ahead of the SEC when it slapped S&P with a civil lawsuit alleging that the firm defrauded investors by issuing stellar ratings on some shoddy securities between 2004 and 2007. Top law enforcement officials from more than a dozen states also filed suit.
The SEC has remained mum and may be running out of time to pursue monetary penalties.
“For the SEC to not be there at the table is somewhat surprising,” said Thomas A. Sporkin, a former SEC enforcement official who is now a lawyer at BuckleySandler. “Where were they?”
Many securities experts who track this issue have been asking the same question, said Thomas O. Gorman, who once worked for the SEC’s enforcement division and the general counsel’s office.
“It’s a mystery as to why the SEC wasn’t in on this,” said Gorman, a lawyer at Dorsey & Whitney. “They’ve clearly looked at this. They would have had the same evidence available to them as the Justice Department.”
The SEC declined to comment about the status of the Delphinus investigation, or any other related investigations it may be working on. But John Nester, an SEC spokesman, said in an e-mail that the agency has been “closely consulting with the Justice Department during its investigation and intends to continue working with the Department as the action proceeds.”
This arrangement is a departure from the norm.
Typically, the SEC and Justice Department pursue cases simultaneously, with the SEC focused on civil charges and the Justice Department on criminal ones, said Adam C. Pritchard, a law professor at the University of Michigan Law School.
Now that the Justice Department has lodged a civil complaint against S&P it would be highly unusual for the SEC to file another one, Pritchard said.
The SEC may have also run out of time to pursue fraud penalties, securities experts said. Some courts have ruled that the agency has to act within five years of the violation taking place. Unless S&P has agreed to waive the five-year limit, the SEC is past the deadline, although it could sue for other types of relief.
The SEC’s silence on the ratings agency may also reflect that it simply couldn’t make a case, Pritchard said. The SEC would have had to show that S&P knowingly or recklessly disregarded the truth about the quality of the mortgages it was assessing. Bad business decisions made in good faith would not be grounds to bring a securities fraud lawsuit.
By contrast, the Justice Department is relying on a 1989 law passed in the wake of the savings-and-loan crisis that requires it to meet less stringent standards for proving that S&P committed fraud against financial institutions.
“The answer as to why [the SEC] is not at the table may be that it’s too hard,” Pritchard said.
The fallout from the financial crisis continues to haunt the SEC, which has been derided for failing to police Wall Street leading up to the crisis and for missing multiple chances to stop the infamous Bernard Madoff Ponzi scheme. Since 2009, the agency has filed a record number of enforcement cases, including one in 2010 that led to a $550 million settlement with Goldman Sachs.