New York-based credit rating agency Morningstar Credit Ratings has agreed to pay $3.5 million to settle charges with the SEC for failing to separate its analytical rating function from its sales and marketing efforts.
According to the SEC order, from mid-2015 through September 2016, credit rating analysts in Morningstar’s asset-backed securities (ABS) group engaged in sales and marketing to prospective clients. The order said in an effort to grow ABS rating business, Morningstar's business development director instructed ABS analysts to identify and initiate contacts with potential clients, set up marketing calls and marketing meetings with them, and offer them indications.
They were also instructed to solicit potential clients at industry conferences, follow up with potential clients and encourage potential clients to attend marketing meetings with Morningstar, the SEC order said, adding that the analysts were well aware that the goal of their contacts was to persuade potential clients to hire Morningstar to rate asset-backed securities. The order further pointed out that Morningstar senior management knew that the activities were being undertaken.
“Analysts solicited business from potential clients whom they knew, as well as potential clients whom they did not know but whom they identified through their own initiative, or who were identified to them by MCR’s ABS business development director,” the order said.
The order said a “contact log” that contained a comprehensive record of MCR’s efforts to establish and maintain relationships with potential ABS rating clients and persuade them to hire Morningstar was kept by the ABS business development director. The contact log was regularly circulated to the ABS analysts, stored in a shared drive that the ABS analysts could access and regularly updated based on the ABS analysts’ sales and marketing efforts, the order said.
The SEC order said Morningstar failed to establish, maintain and enforce written policies and procedures reasonably designed comply with rules that prohibit a rating agency from issuing or maintaining a credit rating where an analyst who participates in determining or monitoring credit ratings also participates in sales and marketing activity.
In addition, it said Morningstar also violated the Securities Exchange Act of 1934, which requires credit rating agencies to establish, maintain and enforce policies and procedures reasonably designed to address and manage conflicts of interest.
“Credit rating agencies must be vigilant to prevent potential conflicts of interest between their ratings functions and their sales and marketing activities,” Daniel Michael, chief of the SEC Enforcement Division’s Complex Financial Instruments Unit, sai in a prepared statement. “As the SEC’s order finds, Morningstar sometimes enlisted its analysts in business development efforts, introducing the exact conflict of interest that the rule is intended to eliminate.”
In a press release, Morningstar said it felt the settlement was in the best interest of the company. “There are no allegations that any credit ratings issued by the firm were affected by the conduct described in the settlement," the release stated. "MCR takes its regulatory obligations seriously, and the integrity of its credit ratings is of paramount importance.”
The SEC said Morningstar, without admitting or denying the findings, agreed to pay a $3.5 million penalty and committed to conduct training and the implementation of changes to its internal controls, policies, and procedures related to the charged provisions.