Man Bites Dog As SEC Causes Downgrade

NEW YORK ( TheStreet)--The Securities and Exchange Commission, that infamous wrist-slapper of financial crooks, has actually caused a major financial stock to be downgraded.

On Friday, analysts at Bank of America Merrill Lynch downgraded Federated Investors ( FII)to "Neutral" from "Buy" because of a widely expected rule proposal from the SEC that would tighten the rules for the money market fund industry. Federated, which is one of the largest money market managers in the U.S. and has 77% of its assets under management in money market funds, according to Merrill, is highly vulnerable.

"We had previously believed proposals were tolerable for Federated, but the possibility that the SEC will propose liquidity 'hold-backs' which limit the amount investors can redeem from money market funds would fundamentally alter the product in our view, potentially making it less widely used," the report states.

It is hard to think of many instances when anything the SEC has done or contemplated doing has roiled a major financial stock. It is true that the SEC's civil fraud charges against Goldman Sachs ( GS) had that effect in April 2010. But it is hard to say how much of that selloff came as a direct result of the SEC's toughness and how much of it came from what the charges implied: that government officials clearly had Goldman in their sights and wanted to do something--anything--to satisfy the public's desire to make Wall Street pay for the 2008 crisis.

Columbia University Securities law Professor John Coffee agrees that it is unusual for the SEC to have so direct an effect on the share price of a major company.

"The SEC actions against Enron and WorldCom may have had that effect; I cannot remember precisely, but you are correct that it is rare," he wrote via email.

After The Wall Street Journal reported on the proposed money market reforms on Tuesday morning, Federated shares opened more than 3.5% lower at $17.99. The shares were at $17.69 mid-Friday.

The SEC has a long-standing reputation for tameness, and some of its higher-profile settlements in the wake of the crisis have drawn criticism, most notably from Jed Rakoff, a United States District Judge for the Southern District of New York.

Rakoff rejected a proposed $33 million settlement between the SEC and Bank of America in 2009 after the regulator accused the bank of failing to adequately inform its shareholders of its increasing knowledge of what would ultimately amount to $15 billion in losses at Merrill Lynch prior to its acquisition of the securities dealer.

Bank of America officials also failed to tell shareholders about an agreement to let Merrill pay out nearly $6 billion in bonuses despite those losses while the merger was pending, according to the SEC.

Rakoff's court ultimately approved a larger $150 million settlement between the SEC and Bank of America, "while shaking its head," according to the judge's opinion.

Rakoff later rejected a proposed $285 million settlement between the SEC and Citigroup in November 2011. In that case, the SEC accused Citigroup of failing to tell investors it was betting against mortgage securities it sold them.

As part of that deal, Citigroup agreed it would never violate any of the main antifraud provisions of U.S. securities laws. However, according to The New York Times, Citigroup had already promised not to violate that same antifraud statute on at least four separate occasions.

Rakoff rejected the proposal, scheduling a hearing for July. However, Citigroup and the SEC appealed to the United States Court of Appeals for the Second Circuit. A motions panel of the appeals court was scheduled to "consider whether to further stay the proceedings beginning Jan. 17," according to a report in The New York Times in December, but whether the panel considered such an action and, if so, what it decided could not be determined. The court is still considering the SEC's appeal, according to an SEC spokesman.

The Citigroup and Bank of America episodes do not instill confidence that the SEC has changed its stripes. Neither, according to Columbia's Coffee, does a proposed settlement between the SEC and two former Bear Stearns hedge fund managers accused of misleading investors. (The SEC has not announced the settlement, though it has been reported by at least four major news organizations, all of which cite anonymous sources.)

Coffee called the proposed settlement "weak," adding it "suggests that they remain very risk averse about going to trial."

SEC spokesman responded that "no settlement has been announced, so I don't know how someone could intelligently evaluate its terms."

Typically, the SEC has argued it is too costly to try cases in court, but Coffee does not accept this rationale.

"Why did they sue if it is too costly to go to trial?" he wrote via email. "This was another slap on the wrist in a case where the defendants were prepared to defend themselves. If the defendants know that the SEC will cave on the steps of the courthouse (as they now do know) they will never settle for more than symbolic relief."

Still, if the SEC caused a stock to be downgraded, it must be doing something right. Whether it actually succeeds in reshaping the money market industry and making it safer for investors remains to be seen.

-- Written by Dan Freed in New York.

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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