SEC Examinations Find Shortcomings in Credit Rating Agencies' Practices and Disclosure to Investors
On July 8, the Securities and Exchange Commission released findings from extensive 10-month examinations of three major credit rating agencies that uncovered significant weaknesses in ratings practices and the need for remedial action by the firms to provide meaningful ratings and the necessary levels of disclosure to investors.
Under new statutory authority from Congress that enabled the SEC to register and examine credit rating agencies, the agency's staff conducted examinations of Fitch Ratings Ltd., Moody's Investor Services Inc., and Standard & Poor's Ratings Services to evaluate whether they are adhering to their published methodologies for determining ratings and managing conflicts of interest. With the recent subprime market turmoil, the SEC has been particularly interested in the rating agencies' policies and practices in rating mortgage-backed securities and the impartiality of their ratings.
The SEC staff's examinations found that rating agencies struggled significantly with the increase in the number and complexity of subprime residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDO) deals since 2002. The examinations uncovered that none of the rating agencies examined had specific written comprehensive procedures for rating RMBS and CDOs. Furthermore, significant aspects of the rating process were not always disclosed or even documented by the firms, and conflicts of interest were not always managed appropriately.
"We've uncovered serious shortcomings at these firms, including a lack of disclosure to investors and the public, a lack of policies and procedures to manage the rating process, and insufficient attention to conflicts of interest," said SEC Chairman Christopher Cox. "When the firms didn't have enough staff to do the job right, they often cut corners. That's the bad news. There's also good news. And that's that the problems are being fixed in real time. The recent events affecting our economy and our markets have galvanized regulators around the world to re-examine the regulatory framework governing credit rating agencies, but ultimately the responsibility for providing meaningful ratings to investors begins with the credit rating firms themselves."
Lori Richards, Director of the SEC's Office of Compliance Inspections and Examinations, said, "These examinations found shortcomings in the ratings processes used by each of the firms examined. The firms have all agreed to implement broad reforms to address the letter and the spirit of the findings, to better ensure that investors can have confidence in their ratings."
The Summary Report of Issues Identified in the Commission Staff's Examinations of Select Credit Rating Agencies describes the significant weaknesses in the rating agencies' processes in rating subprime RMBS and CDOs linked to subprime residential mortgage-backed securities from January 2004 to the present.
Specifically, the examinations found:
The examinations were conducted by staff in the SEC's Office of Compliance Inspections and Examinations, Division of Trading and Markets, and Office of Economic Analysis. The report summarizes generally the remedial actions that credit rating agencies are expected to take as a result of the examinations, and includes observations by the SEC's Office of Economic Analysis about conflicts of interest that are unique to these products. A factual summary of the models and methodologies used by the rating agencies is provided in the report to provide transparency to the ratings process and the activities of the rating agencies in connection with the recent subprime mortgage turmoil.
The SEC last month proposed a three-fold set of comprehensive reforms to regulate the conflicts of interests, disclosures, internal policies, and business practices of credit rating agencies. The first portion of rulemaking would address conflicts of interest in the credit ratings industry and require new disclosures designed to increase the transparency and accountability of credit ratings agencies. The second portion would require credit rating agencies to differentiate the ratings they issue on structured products from those they issue on bonds through the use of different symbols or by issuing a report disclosing the differences. The third part of the SEC's proposed rulemaking would clarify for investors the limits and purposes of credit ratings and ensure that the role assigned to ratings in SEC rules is consistent with the objectives of having investors make an independent judgment of credit risks. (Press Rel. 2008-135)
Delinquent Filers' Stock Registrations Revoked
The registrations of the stock of Respondents Baroque Corp., Mother Lode Gold Mines Consolidated, and Solvis Group, Inc., have been revoked. Each had repeatedly failed to file annual and quarterly reports with the Securities and Exchange Commission in compliance with the requirements of the Securities Exchange Act of 1934. Thus, each violated a crucial provision of the federal securities laws that requires public corporations to publicly disclose current, accurate financial information so that investors may make informed decisions. The revocations were ordered in an administrative proceeding before an administrative law judge. (Rel. 34-58120; File No. 3-13077)
Commission Revokes Registration of Securities of Mother Lode Gold Mines Consolidated for Failure to Make Required Periodic Filings
On July 9, the Commission revoked the registration of each class of registered securities of Mother Lode Gold Mines Consolidated (Mother Lode) for failure to make required periodic filings with the Commission.
Without admitting or denying the findings in the order, except as to jurisdiction, which it admitted, Mother Lode consented to the entry of an Order Making Findings and Revoking Registration of Securities Pursuant to Section 12(j) of the Securities Exchange Act of 1934 as to Mother Lode Gold Mines Consolidated finding that it had failed to comply with Section 13(a) of the Securities Exchange Act of 1934 (Exchange Act) and Rules 13a-1 and 13a-13 thereunder and revoking the registration of each class of Mother Lode's securities pursuant to Section 12(j) of the Exchange Act. This order settled the charges brought against Mother Lode in In the Matter of Baroque Corp., et al., Administrative Proceeding File No. 3-13077.
Brokers and dealers should be alert to the fact that Exchange Act Section 12(j) provides, in pertinent part, as follows:
No member of a national securities exchange, broker, or dealer shall make use of the mails or any means or instrumentality of interstate commerce to effect any transaction in, or to induce the purchase or sale of, any security the registration of which has been and is suspended or revoked . . . .
For further information see Order Instituting Administrative Proceedings and Notice of Hearing Pursuant to Section 12(j) of the Securities Exchange Act of 1934, In the Matter of Baroque Corp., et al., Administrative Proceeding File No. 3-13077, Exchange Act Release No. 57995 (June 20, 2008). (Rel. 34-58121; File No. 3-13077)
SEC Charges Broker and Former Officer of VMT Scientific, Inc. in "Pump-And-Dump" Scheme and Suspends Trading in VMT Scientific Stock
The Securities and Exchange Commission filed a complaint today against a registered stockbroker, and the former Chief Technology Officer of VMT Scientific, Inc., a purported medical device manufacturer in Las Vegas, NV. The complaint alleges that the two defendants pumped VMT stock by issuing false press releases about VMT and then the stockbroker sold, or dumped, over 9.5 million shares for almost $1 million.
The Commission's complaint, filed in federal district court in Las Vegas, alleges that in mid-2005, Stephen H. Roebuck and Daniel Kaiser purportedly took control of VMT, a public shell company under court custodianship, and issued 120 million shares of VMT to Roebuck. Roebuck immediately transferred the shares to offshore brokerage accounts in the Cayman Islands, Turks and Caicos, and Panama.
The complaint further alleges that between November and December 2005, Roebuck and Kaiser created a website and issued a series of press releases that falsely touted the company's financial viability and its "breakthrough" product that would help patients with peripheral vascular disease. As alleged in the complaint, the website and press releases failed to state the company was under court custodianship, had no operations or revenues, and that Roebuck's stock sales were the company's only funding. After Roebuck and Kaiser issued the press releases, Roebuck sold 9,539,350 shares, resulting in proceeds over $990,000. Roebuck transferred approximately $300,000 to the company, and Kaiser took approximately $81,491 for himself.
The complaint charges the defendants with violating Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and that Roebuck violated Sections 5(a) and 5(c) of the Securities Act. Roebuck settled to a permanent injunction, disgorgement and a civil penalty to be determined by the court, and a permanent bar from participating in an offering of penny-stock. The Commission is seeking from Kaiser an injunction, disgorgement, civil penalty, a penny-stock bar, and a permanent officer and director bar. [SEC v. Daniel Kaiser and Stephen H. Roebuck, Civil Action No. 2:08-cv-00888-JCM-LRL (D. Nev.)] (LR-20639)
SEC Charges Sycamore Networks and Former Executives in Stock Options Backdating Case
On July 9, the Commission announced the filing of a settled civil injunctive action against Sycamore Networks, Inc., an optical networking company based in Chelmsford, Massachusetts, as well as its former Chief Financial Officer Frances M. Jewels, former Director of Financial Operations Cheryl E. Kalinen, and former Director of Human Resources Robin A. Friedman, in connection with the backdating of stock options to employees over several years.
The Commission's complaint, filed in federal court in Boston, alleges that Sycamore's unreported options-related expenses totaled nearly $250 million during the period from 2000 through 2005. According to the complaint, Jewels and Kalinen repeatedly backdated options grants between October 1999 and July 2002 to prices at or near monthly or quarterly low points for the company's stock, and they falsified or caused others to falsify various company documents concerning these grants. The Commission further alleges that Jewels and Kalinen personally benefited from backdated options grants. The complaint also alleges that Friedman was aware of a plan by Jewels and Kalinen to backdate options to five company employees without informing the company's auditors, and that, in connection with the plan, Friedman altered or created, or caused others to alter or create, company personnel and payroll records so that they would reflect incorrect information.
All parties have agreed to settle the Commission's charges without admitting or denying the allegations in the complaint. The company and the former executives will be subject to permanent injunctions prohibiting them from future violations of various provisions of the federal securities laws, and the former executives have agreed to pay more than $650,000 combined in disgorgement, interest, and penalties. Jewels also will be barred from serving as an officer or director of a public company for five years.
[SEC v. Sycamore Networks, Inc. et al., Civil Action No. 1:08-CV-11166 (D. Mass.)] (LR-20638; AAE Rel. 2843)
Proposed Rule Changes
The NASDAQ Stock Market LLC has filed a proposed rule change and Amendment No. 1 thereto (SR-NASDAQ-2008-019) pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 to remove from the Nasdaq rules fee provisions relating to Nasdaq's Mutual Fund Quotation Service. Publication is expected in the Federal Register during the week of July 7. (Rel. 34-58102)
Financial Industry Regulatory Authority has filed a proposed rule change (SR-FINRA-2008-036) pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 relating to the Incorporated NYSE Rules. Publication is expected in the Federal Register during the week of July 7. (Rel. 34-58103)
NYSE Arca has filed a proposed rule change (SR-NYSEArca-2008-47) pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 to waive retroactively as of June 24, 2008, certain initial listing fees for companies transferring the listing of their securities from any other national securities exchange. Publication is expected in the Federal Register during the week of July 7. (Rel. 34-58109)
Accelerated Approval to Proposed Rule Change
The Commission noticed and granted accelerated approval to a proposed rule change (SR-NYSE-2007-64), as modified by Amendment No. 1, submitted by the New York Stock Exchange relating to Section 31 accumulated funds. Publication is expected to be made in the Federal Register during the week of July 7. (Rel. 34-58108)
Immediate Effectiveness of Proposed Rule Changes
A proposed rule change filed by the Boston Stock Exchange to permit the listing and trading of options on Foreign Currency ETFs and Commodity Pool ETFs (SR-BSE-2008-34) has become effective pursuant to Section 19(b)(3)(A) of the Securities Exchange Act of 1934. Publication is expected in the Federal Register during the week of July 7. (Rel. 34-58110)
A proposed rule change and Amendment Nos. 1, 2 and 3 filed by the National Stock Exchange (SR-NSX-2008-11) eliminating references to the Intermarket Trading System plan from NSX's rules and a technical change to Rule 8.15 have become effective under Section 19(b)(3)(A) of the Securities Exchange Act of 1934. Publication is expected in the Federal Register during the week of July 7. (Rel. 34-58112)
Approval of Proposed Rule Changes
The Commission approved a proposed rule change (SR-NYSEArca-2008-40) submitted by NYSE Arca through its wholly owned subsidiary, NYSE Arca Equities, Inc., pursuant to Rule 19b-4 under the Securities Exchange Act of 1934 relating to the listing and trading of shares of the NETS Tokyo Stock Exchange REIT Index Fund. Publication is expected in the Federal Register during the week of July 7. (Rel. 34-58113)
The Commission approved a proposed rule change, as modified by Amendment No. 1 thereto, submitted by the Financial Industry Regulatory Authority under Rule 19b-4 of the Securities Exchange Act of 1934 (SR-FINRA-2007-026) for TRACE to Disseminate Additional Data Elements Relating to Each Transaction. Publication is expected to be made in the Federal Register during the week of July 7. (Rel. 34-58115).
Amendment No. 2 to a Proposed Rule Change
The Financial Industry Regulatory Authority has filed Amendment No. 2 to a proposed rule change (SR-NASD-2007-041) to amend the minimum price-improvement standards set forth in NASD Interpretive Material (IM) 2110-2. Publication is expected in the Federal Register during the week of July 7. (Rel. 34-58114).
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