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Summary
- The Securities Exchange Commission has sued Morningstar Credit Ratings for violations in laws for rating commercial mortgage-backed securities.
- SEC has accused Morningstar of allowing analysts to make changes in the methodology behind the ratings without disclosure.
- SEC had earlier pulled up Kroll Bond Rating Agency Inc on similar charges.
The Securities Exchange Commission (SEC) has filed a lawsuit against Morningstar Credit Ratings LLC for allegedly violating provisions of laws for rating commercial mortgage-backed securities. The Morningstar has been accused of allowing its analysts to make hidden adjustments to mortgage-backed securities which gave them higher ratings. The SEC said that these ratings help investors and other market players in their investment decisions; hence transparency in methodologies need to be accurately disclosed.
Also read: Fitch Ratings dominates The Asset’s Rating Agency Awards 2020, wins five honours
In its lawsuit, the SEC has said that between 2015 and 2016, Morningstar allowed analysts to adjust key stresses in the methods used to fix the ratings in 30 CMBS transactions with a total worth of US $30 billion. It has also accused that the company has failed to enforce strong internal jurisdiction over the adjustments made in as many as 31 transactions.
The SEC has filed the suit in a federal court in Manhattan. The suit said that the analysts often, by easing stresses in models, lowered the credit enhancement necessary for several ratings which have benefited issuers, as they had to pay lower interest to investors.
The company spokesperson said that the complaint was against methodology that the company had stopped using in 2018 and that the SEC did not allege investors were harmed in any way.
Others under the scanner
Morningstar is not the only company that has been pulled up by the SEC. In September, the SEC had indicted Kroll Bond Rating Agency (KBRA) Inc for letting analysts make adjustments that influenced final ratings, but there was no method or analysis followed to regulate those adjustments.
It also accused the agency of not recording the theory behind those adjustments and said that KBRA did not have an effective internal system of control to detect ambiguity in the company’s methodology used for arriving at CMBS ratings.
Also read: Superloans warned by the Commerce Commission over possible lending infringements
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SEC had noted that KBRA did not rate collateralised loan obligation combination notes (CLO Combo Notes) in keeping with the terms of that security. CLO Combo Notes had defined that the holders of the security would receive cash flow from the underlying components of the note after the rated balance – defined by the note – came down to zero. The SEC accused KBRA that its rating did not clarify the risks relating to cash flows payable to holders in addition to rated balance. The rating only considered the repayment of the rated balance.
KBRA had to pay more than US $2 million to settle the accusations against the rating of CMBS relating to the rating of commercial mortgage-backed securities and of CLO Combo Notes.
Also read: October Financial Stability Review: Banks Performing Better Than 2008 GFC
Rating agencies were pulled up for their role in the US financial crisis of 2008. It has been widely reported that the 2008 meltdown happened partially because of the faulty ratings given to housing mortgage-backed securities (MBS). Rating agencies were accused of giving an AAA rating to housing MBS that did not deserve such high ratings.
A large number of institutional investors lost out on their money as they had invested in these securities based on the ratings. In the aftermath of the financial crisis of 2008, Congress gave the SEC the authority to oversee rating agencies.
