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SEC Charges Ratings Agency With Internal Controls Failures in Connection With Ratings of CMBS and CLO Combo Notes


Washington D.C., Sept. 29, 2020 —

The Securities and Exchange Commission today announced that the credit ratings agency Kroll Bond Rating Agency Inc. (KBRA) has agreed to pay more than $2 million to settle separate charges relating to the rating of commercial mortgage-backed securities (CMBS) and of collateralized loan obligation combination notes (CLO Combo Notes).

According to the order pertaining to CMBS ratings, KBRA permitted analysts to make adjustments that had material effects on the final ratings but did not require any analytical method for determining when and how those adjustments should be made. Further, the order finds that there was no requirement for recording the rationale for those adjustments. The order finds that KBRA’s internal control structure failed to prevent or detect the ambiguity in KBRA’s record of its methodology for determining the CMBS ratings, such as a comparison of the methodology to the analysis used for specific transactions.

The SEC’s order relating to CLO Combo Notes finds that KBRA’s policies and procedures were not reasonably designed to ensure that it rated CLO Combo Notes in accordance with the terms of those securities. The CLO Combo Notes included a defined “Rated Balance” amount and also directed that noteholders were entitled to receive cash flows from the underlying components of the CLO Combo Note after the Rated Balance was reduced to zero. KBRA’s ratings of CLO Combo Notes were limited to repayment of the Rated Balance amount of each CLO Combo Note and did not reflect the risk associated with any cash flows payable to holders of the CLO Combo Note over and above the Rated Balance, even though such amounts could materialize, and would be payable to the holders of the CLO Combo Note.

“Ratings agencies play a crucial gatekeeping role in the securities market. With that responsibility comes the requirement that they establish and enforce policies and controls to ensure the consistency and integrity of credit ratings,” said Daniel Michael, Chief of the Enforcement Division’s Complex Financial Instruments Unit. “We will continue to hold rating agencies accountable for failing to ensure the integrity of the ratings process.”

The SEC’s orders find that, in connection with rating CMBS, KBRA violated Section 15E(c)(3)(A) of the Securities Exchange Act of 1934 and, in connection with rating CLO Combo Notes, KBRA violated Rule 17g-8(b)(1) of the Exchange Act. Without admitting or denying the SEC’s findings, KBRA agreed in the CMBS case to pay a civil penalty of $1.25 million, and in the CLO Combo Notes case to pay a $600,000 civil penalty and more than $160,000 in disgorgement and prejudgment interest, and to establish a Fair Fund for the benefit of victims. KBRA also agreed in both actions to review and correct its internal policies and procedures relating to the charged violations.

The KBRA investigations were conducted by Armita Cohen, Robert Leidenheimer, Brent Mitchell, Christopher Nee, and Lawrence Renbaum of the Complex Financial Instruments Unit and supervised by Deputy Chief Reid Muoio and Assistant Director Jeffrey Weiss. Thomas Bednar and Jim Connor of the Enforcement Division’s Trial Unit assisted with the CLO Combo Notes investigation and staff of the Office of Credit Ratings assisted with both investigations.


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