SEC queries S&P downgrade methodology

THE Securities and Exchange Commission (SEC) is reviewing the method Standard & Poor's used to cut the US's credit rating and if the firm properly protected the confidential decision, a person with direct knowledge of the matter has said.

By InvestSMART · 15 Aug 2011

By InvestSMART ·
15 Aug 2011

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SEC inspectors are examining S&P's policies for conducting such analyses and whether those procedures were followed when the ratings agency firm downgraded the US's credit rating this month, said the person, who declined to be identified.

The downgrade of the US for the first time triggered an equity rout that wiped about $US6.8 trillion ($6.56 trillion) off the value of global stocks. US officials have said the downgrade was based on a flawed analysis that overstated US debt by about $US2 trillion S&P said the discrepancy did not change projections that the US debt-to-gross domestic product ratio will probably continue to rise in the next decade.

S&P lowered the US's AAA grade to AA after warning on July 14 that it would reduce the ranking in the absence of a credible plan to decrease deficits, even if the country's $US14.3 trillion debt limit was raised.

The decision was at odds with the other two main ratings firms, Moody's Investors Service and Fitch, both of which said the US continued to deserve the top credit rating.

SEC staff are also looking into whether certain market participants learned of the downgrade before its announcement. The inquiry, which is in the preliminary stages, may not result in a referral to the SEC's enforcement division, the source said.

An S&P spokesman said the firm does not discuss specific interactions it has with regulators.

The rating downgrade added to concern about prospects for the global economy as Europe's debt crisis deepened. US stocks fell for a third straight week, with the S&P500 losing 1.7 per cent to 1178.81 in the five days to Friday, capping a week of record swings.

The downgrade followed an agreement by US lawmakers on August 2 to raise the debt ceiling and put in place a plan to enforce $US2.4 trillion in spending cuts in the next 10 years, less than the $US4 trillion that S&P had said it preferred. The political wrangling that preceded the debt pact was also a concern, S&P said. The SEC inquiry was reported in the weekend's Financial Times.

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Frequently Asked Questions about this Article…

What is the SEC investigation into S&P about the US credit rating downgrade?

The SEC is reviewing the methodology Standard & Poor's used to cut the US credit rating and whether the firm properly protected the confidentiality of that decision. SEC inspectors are examining S&P’s policies for conducting such analyses and whether those procedures were followed when the agency downgraded the US.

Why did S&P downgrade the US from AAA to AA+?

S&P said it lowered the US rating to AA+ after warning on July 14 that it would reduce the ranking if there was no credible plan to reduce deficits. The agency cited concerns about the adequacy of deficit-reduction plans and the political wrangling that preceded the debt agreement, even though the debt limit was raised.

How large was the market impact of the S&P downgrade?

The downgrade triggered an equity rout that wiped about $US6.8 trillion (about $6.56 trillion) off the value of global stocks. US markets were hit too: US stocks fell for a third straight week and the S&P 500 lost 1.7% to 1,178.81 in the five trading days covered by the article.

Did other ratings agencies agree with S&P’s decision to downgrade the US?

No. The two other main ratings firms mentioned—Moody’s Investors Service and Fitch—said the US continued to deserve the top credit rating, so they did not follow S&P’s downgrade.

What disagreement arose over S&P’s analysis of US debt levels?

US officials said S&P’s analysis was flawed and overstated US debt by about $US2 trillion. S&P responded that the discrepancy did not change its projection that the US debt-to-GDP ratio will probably continue to rise over the next decade.

Is the SEC probing whether anyone had advance knowledge of the downgrade?

Yes. SEC staff are looking into whether certain market participants learned of the downgrade before its public announcement. The inquiry is in preliminary stages and may not result in a referral to the SEC’s enforcement division.

What is the current status of the SEC inquiry and S&P’s comment on it?

The inquiry is described as preliminary and may not be referred to enforcement. An S&P spokesman said the firm does not discuss specific interactions it has with regulators.

What key facts should everyday investors take from the S&P downgrade and the SEC review?

From the article: the downgrade amplified concerns about global economic prospects and added to market volatility; it followed a US debt-ceiling agreement on August 2 that raised the limit and included a plan for $US2.4 trillion in spending cuts over 10 years (less than the $US4 trillion S&P had preferred). Investors should note the market reaction and that sovereign ratings can hinge on deficit plans, political developments and debt-to-GDP projections.