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S&P to pay $77 million in settling fraud probes

Standard & Poor’s, the credit rating agency blamed with helping inflate the subprime mortgage bubble, has now settled accusations that it orchestrated a similar fraud years after the bubble burst.

S&P, which is owned by McGraw Hill, has agreed to settle an array of government investigations stemming from 2011 by paying about $77 million, federal and state authorities announced Wednesday. As part of the deals, reached with the Securities and Exchange Commission and the attorneys general in New York and Massachusetts, S&P agreed to take a one-year “timeout” from rating certain commercial mortgage investments at the heart of the case, an embarrassing blow to the rating agency.

“Investors rely on credit rating agencies like Standard & Poor’s to play it straight when rating complex securities like CMBS,” Andrew J. Ceresney, the SEC’s enforcement director, said in a statement, referring to commercial mortgage-backed securities. “But Standard & Poor’s elevated its own financial interests above investors by loosening its rating criteria to obtain business and then obscuring these changes from investors.”

The settlement, which came on top of an action filed against a former S&P ratings executive, is the SEC’s first action against a top ratings firm. Despite the central role that rating agencies played in the crisis – awarding inflated credit ratings to mortgage investments that spurred the meltdown – they faced no SEC penalties.

Yet the Justice Department and several state attorneys general did take action, suing S&P in connection with the crisis. After fighting that case for two years, S&P has now reached a tentative settlement that would require it to pay $1.37 billion, a penalty large enough to wipe out its operating profit for a year.

On Wednesday, in addition to the commercial mortgage settlement, S&P also resolved accusations of internal control “failures” in its surveillance of rating investments backed by home mortgages. The breakdowns, which echo the rating agency’s problems during the crisis, came between October 2012 and June 2014.

S&P’s settle-at-all costs mentality signifies an abrupt shift in its strategy. It also reflects a change atop McGraw Hill’s legal department, which recently installed a new general counsel, Lucy Fato, formerly a partner at the law firm Davis Polk.

In a statement Wednesday about its settlement with the SEC and the attorneys general in New York and Massachusetts, S&P said it was “pleased to have concluded these matters.” It added that it “takes compliance with regulatory obligations very seriously and continues to make investments in people and technology to strengthen its controls and risk management throughout the organization.”

In settling, S&P agreed to pay more than $58 million to the SEC, $12 million to Eric T. Schneiderman, New York’s attorney general, and $7 million to Martha M. Coakley, Massachusetts’ attorney general. S&P had previously announced that it expected to pay about $60 million to settle the investigations.

The settlements largely center on S&P’s ratings of eight commercial mortgage-backed securities deals. While S&P publicly claimed it used one approach for rating certain commercial mortgage investments, it actually used a different methodology.

“In the wake of the housing crisis and the collapse of the global economy, credit agencies like S&P promised not to contribute to another bubble by inflating the ratings on products they were paid to evaluate,” Schneiderman said in a statement. “Unfortunately, S&P broke that promise in 2011, lying to investors to increase their profits and market share.”

The SEC also filed an administrative proceeding against Barbara Duka, formerly co-director of S&P’s commercial mortgage group, contending that she “fraudulently misrepresented the manner in which the firm calculated a critical aspect” of ratings. Duka, according to the SEC, “allegedly instituted the shift to more issuer-friendly ratings criteria, and the firm failed to properly disclose the less rigorous methodology.”

Duka jumped the gun on the SEC, filing a lawsuit in U.S. Distrct Court last week seeking to have any enforcement action against her be heard before a federal judge as opposed to an administrative law judge. The SEC has increasingly filed enforcement cases before administrative law judges, and some critics say that this gives the SEC an unfair home-court advantage.

In her federal court lawsuit, Duka said she began cooperating with the SEC investigation in August 2013, providing documents and testimony, and telling the SEC throughout that she thought the change in the methodology used by S&P to analyze some commercial mortgage bond deals was appropriate and not done to further to the rating agency’s commercial goals.

On Nov. 18, Duka said the SEC notified her that the agency’s staff intended to recommend filing an enforcement action against her for “aiding and abetting” S&P’s violations.