U.S. securities regulators have decided to bring an enforcement case against credit-rating agency Egan-Jones, alleging the firm made material misstatements in a 2008 regulatory application, the company's lawyer confirmed on Thursday.
Alan Futerfas, an attorney for Egan-Jones, said the company plans to vigorously contest the Securities and Exchange Commission's administrative charges, which are expected to be formally filed sometime next week.
Egan-Jones is among the smallest U.S.-recognized credit rating firms in an industry dominated by three major agencies: Moody's Corp, McGraw-Hill Cos Inc's Standard & Poor's, and Fimalac SA's Fitch.
The firm and its outspoken founder, Sean Egan, have been scrambling for market share, and have been faster than the other agencies in downgrading the debt of some developed countries, including the United States, and certain companies in the wake of the global financial crisis.
Egan-Jones issued a statement on Thursday accusing the SEC of targeting the firm and sparing the ratings giants which it said played a damaging role in the 2007-2009 financial crisis.
"Egan-Jones believes that the SEC's action is inexplicable except as an effort to silence Egan-Jones and maintain the status quo of a conflicted, issuer-paid ratings agency monopoly," the statement said.
Futerfas said that the SEC will not say in its filings what specific relief it is seeking. An SEC administrative law judge will eventually hear evidence and arguments in the case.
The SEC's decision to file charges came after commissioners voted in a closed-door meeting on Thursday.
The charges are linked to issues in the firm's 2008 application to rate asset-backed and government securities.
The issues include allegedly misrepresenting the firm's rating experience, conflict-of-interest policy issues, and a failure to keep certain books and records, people familiar with the matter said.
The company learned last October about possible SEC charges after it received a "Wells notice", or a document the SEC issues to possible defendants when it plans to recommend charges, one person said.
An SEC spokesman declined to comment.
Sean Egan said in an interview on CNBC television on Thursday that the 2008 application submitted to regulators was "accurate to the best of my ability."
DAVID VS. GOLIATH
Egan-Jones is one of nine credit raters recognized by the SEC, and is one of the few ratings agencies whose services are paid for by subscribers, rather than the issuers of the securities it rates.
The SEC's oversight of credit raters is relatively new. A law passed in 2006 gave the SEC the authority to regulate them and tasked the SEC with trying to create more competition in the industry.
The oversight regime is also shifting after the financial crisis, during which the top three raters assigned overly positive ratings to toxic mortgage-backed securities and then downgraded the products en masse, helping trigger the crisis.
Lawmakers said the issuer-paid model motivated the inflated ratings, and ordered the SEC in the 2010 Dodd-Frank financial reform law to study whether there was a way to reduce conflicts of interest.
The SEC has taken no public enforcement action so far against raters for their role in the financial crisis, and Egan-Jones marks only the second rater to face enforcement action by the agency.
Egan-Jones has argued that it brings necessary competition to the ratings agency marketplace, and Sean Egan has lashed out at the business models of its competitors, saying the issuer-paid model is like restaurants paying reviewers.
In its defense to the SEC during the Wells notice process, Egan-Jones warned the agency that enforcement action could "effectively put out of business the leading independent, non-conflicted David to the issuer-paid Goliath," according to documents reviewed by Reuters.
A 2011 SEC report said that Egan-Jones only has five analysts and analyst supervisors on staff, compared with ratings giant Standard & Poor's, which had 1,345 analysts on staff.
The filings to the SEC in response to the investigation were signed by Futerfas, who runs his own law office, and Jacob Frenkel, a former SEC attorney who is now with Shulman Rogers Gandal Pordy & Ecker.
Ratings from Egan-Jones, which is based in Haverford, Pennsylvania, usually have little market impact. But in November it made headlines when it downgraded Jefferies Group over concerns about euro-zone debt exposure, contributing to a sell-off in the shares of the midsize investment bank.
The SEC has been scrutinizing Egan-Jones for years.
A report by the SEC's inspector general in 2009 cited problems with a credit-rating firm funded by subscriber fees, but did not name Egan-Jones by name. People familiar with the matter, however, confirmed it was referring to Egan-Jones.
The watchdog's report cited suspicions regarding the accuracy of financial information provided in the subscriber-model firm's application. The report criticized the SEC for approving the application and delaying in starting an inspection of the firm.
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