An SEC administrative law judge determined that Barbra Duka, a former S&P Global Ratings managing director for new issue ratings (later surveillance) of commercial mortgage-backed securities, was not liable for violations of the scienter-based antifraud provisions of the federal securities laws or for alleged violations of rules applicable to the procedures and methodologies of nationally recognized statistical rating organizations. But Duka was liable for the negligent violation of Securities Act Section 17(a)(3) and for causing S&P’s primary violation of Exchange Act Section 15E(c)(3). As a result, Duka was censured, ordered to stop violating the provisions for which she was found liable, and ordered to pay a civil money penalty of $7,500 (In the Matter of Barbara Duka, Initial Decision Release No. 1167, August 29, 2017).
The SEC charged Duka in 2015 with numerous violations related to her involvement in S&P’s alleged failure to disclose a change in ratings methodology in presale reports to investors. Much of the administrative hearing focused on the import of a "criteria article" S&P published and its Rating Analysis Methodology Profile (RAMP). With respect to the alleged failure to disclose, the focus was on a shift from what S&P referred to as "’Table 1’ constants" to a rating methodology based on blended constants. An addendum explains key figures in the matter. A separate case in a U.S. district court initially halted Duka’s administrative proceeding on constitutional grounds before an appeals court vacated the district court injunction and, thus, allowed the administrative case to proceed.
Scienter-based claims dismissed. The ALJ dismissed the SEC’s charges that Duka acted with the intent to deceive, manipulate, or defraud in violation of Securities Act Section 17(a)(1) (and Sections 17(a)(2) and (3) to the extent scienter was the basis for those charges) and Exchange Act Section 10(b) and Rule 10b-5. The ALJ likewise dismissed related aiding and abetting charges against Duka.
According to the initial decision, Duka appeared to have advocated a change to S&P’s rating methodology from Table 1 constants to blended constants based on her superior’s doubt about whether Table 1 constants accurately predicted defaults (some of which may have been unlikely given then-existing low interest rates). By contrast, the Enforcement Division had portrayed Duka as being motivated to generate business and to stanch the loss of significant ratings engagements due to S&P’s heightened credit enhancement levels (a footnote observed that issuers’ objections to S&P’s terms and conditions resulted in the loss of ratings engagements). The ALJ, after reviewing the same alleged meetings cited by the Enforcement Division, concluded that Duka had not acted with scienter.
Split decision on negligence claims. The Enforcement Division also brought negligence-based charges against Duka under Securities Act Sections 17(a)(2) and (3). The ALJ found the Enforcement Division’s evidence lacking with respect to Section 17(a)(2), but held that the Enforcement Division had succeeded in establishing Duka’s liability under Section 17(a)(3).
In addition to negligence, Section 17(a)(2) requires evidence that the person charged obtained money or property "by means of" an untrue statement or omission. The ALJ said the Enforcement Division failed to show that Duka received money or property despite arguing that the fees S&P received were sufficient to establish this element. The ALJ noted that courts are divided on this issue, but ultimately sided with a court decision finding that, at the time the Securities Act was enacted, "obtain" meant "acquiring possession" or "getting hold of something," which "suggests" a "personal act" not present in Duka’s matter. The ALJ also said the Enforcement Division failed to show that Duka obtained money or property "by means of" an untrue statement or omission because issuers decided pay S&P before statements or omissions impacted presales.
By contrast, the ALJ upheld the Enforcement Division’s charge that Duka negligently violated Securities Act Section 17(a)(3). Although the issue of whether there was misleading omission was "more complicated here than usual," the ALJ reviewed several items in evidence, including a "’literally true’" yet "incomplete" statement, and concluded that S&P omitted information from presales. The Enforcement Division argued successfully that the omission was material because S&P’s changed methodology resulted in higher credit enhancement levels; the ALJ found Duka’s assertion that CMBS investors conduct their own due diligence to be a less credible explanation.
Moreover, the ALJ concluded that Duka was negligent under Securities Act Section 17(a)(3). Specifically, the ALJ noted that Duka agreed to disclose the changed methodology, but failed to follow-up on this promise. The ALJ also concluded that Duka’s negligence impacted multiple presales and that this amounted to a "transaction, practice, or course of business" that "operates or would operate as a fraud or deceit upon the purchaser."
NRSRO rules charges. The ALJ found that Duka did not aid and abet or cause a violation of Exchange Act Rule 17g-2(a)(6), which requires NRSROs to keep records of established procedures and methods that are internally documented. The ALJ found that S&P’s RAMPs were transaction-specific, while the rule applied more generally to the determination of credit ratings. The criteria article also was beyond the rule’s reach.
Nor did Duka aid and abet or cause a violation of Exchange Act Rule 17g-6(a)(2), which bars an NRSRO from issuing or threatening to issue a rating that departs from established procedures and methods based on whether the rated person has or will purchase the rating or other services. The ALJ noted the Commission’s prior description of this rule as prohibiting an NRSRO from punishing or rewarding an issuer and the Enforcement Division’s briefing that said the rule prevents an NRSO from changing its methods to attract business. According to the ALJ, the Enforcement Division failed to show a primary violation because the evidence tended to show instead that S&P’s methods changed for analytical reasons, and not to attract business.
With respect to the SEC’s charges under Exchange Act Section 15E(c)(3), requiring each NRSO to maintain effective internal control structures for determining ratings, the ALJ rejected some of the Enforcement Division’s arguments before focusing on S&P’s code of conduct. S&P’s code stated that investors were entitled to "a brief statement of its analytic rationale" for initial ratings of structured finance products. The ALJ found that the failure to disclose the blended constants violated the code and that repeated violations of the code resulted in S&P’s primary violation of the statute.
Next, the ALJ found that Duka was negligently liable for causing S&P’s primary violation of Exchange Act Section 15E(c)(3) because she failed to include disclosure of the blended constants in presales. The ALJ also rejected Duka’s statutory construction argument: Duka posited that Exchange Act Section 15E(c)(3) is similar to Exchange Act Section 13(b), which contains a no circumvention provision (Section 15E(c)(3) does not), so she could not be liable under Section 15E(c)(3). The ALJ said the more than two-decades time difference between when Section 13(b) was enacted (1988) and when Section 15E(c)(3) was enacted (in 2010 as part of the Dodd-Frank Act) undermined her argument, although the ALJ said Duka’s argument would have a better chance if the two provisions had been enacted simultaneously.
The release is No. ID-1167.
Attorneys: Stephen C. McKenna for the SEC's Division of Enforcement. Guy Petrillo (Petrillo Klein & Boxer LLP) for Barbara Duka.
Companies: S&P Global Ratings f/k/a Standard & Poor’s Ratings Services
MainStory: TopStory CreditRatingAgencies DoddFrankAct Enforcement ExchangesMarketRegulation FinancialIntermediaries FraudManipulation RiskManagement SecuritiesOfferings
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