Egan Jones Charged by SEC

NEW YORK ( TheStreet) -- Egan-Jones, a competitor ratings agency to Moody's and Standard & Poor's, has been charged by the Securities and Exchange commission for "material misrepresentations and omissions" in its July 2008 application to register as a certified agency with securities regulators.

In its charge, the SEC says that when applying to be what's called a "Nationally Recognized Statistical Rating Organization," Egan-Jones claimed it had rated asset-backed securities and government debt obligations; however, the firm had no proof of such ratings. The SEC also said that it found weaknesses in Egan-Jones analyst compliance policies and its disclosures relating to conflicts of interest in rating securities.
Sean Egan of Egan Jones

The firm and its co-founder Sean Egan were recognized for prescient calls about weaknesses in the U.S. banking system ahead of the 2008 financial crisis, and have since made headlines for controversial downgrades to the debt of issuers ranging from the U.S. government to investment bank Jefferies ( JEF).

"The SEC's Division of Enforcement alleges that in its 2008 application, EJR falsely stated that as of the date of the application it had 150 outstanding ABS issuer ratings and 50 outstanding government issuer ratings... In fact, at the time of its July 2008 application, EJR had not issued -- that is, made available on the Internet or through another readily accessible means -- any ABS or government issuer ratings, and therefore did not meet the requirements for registration as an NRSRO in these categories," the SEC said in its charge.

In its charge, the SEC went on to say that Egan-Jones continued to misstate the scope of its ratings in subsequent annual certifications to the SEC. Meanwhile, the regulator also said that Egan-Jones failed to properly manage conflicts of interest by barring analysts from owning securities that it rates and misstated whether it knew subscribers were long or short some of those securities.

"The SEC's Division of Enforcement alleges that Egan provided inaccurate information that was included in EJR's applications and annual certifications. He signed the submissions and certified that the information provided in them was "accurate in all significant respects," when he knew that it was not. Egan also failed to ensure EJR's compliance with the recordkeeping requirements and conflict-of-interest provisions."

In a press release responding to the SEC's allegations, Egan-Jones said on April 19 that the "SEC's action has nothing to do with the quality, integrity or excellence of any rating EJR has ever issued."

"Rather, the SEC's claims relate to a four year old application process. EJR intends to vigorously defend itself in this proceeding."

The firm also stressed the unique role that it plays in rating corporate and government debt. Instead of getting paid fees by the issuers of the debt that it rates, Egan-Jones earns money through subscription fees by investors.

"EJR is the only independent NRSRO and is a small business with fewer than 20 employees. It is paid by subscribers - not by the issuer. Multiple academic studies, including some issued just this past year, have shown that EJR issues the most timely, accurate and predictive ratings in the industry," said the firm in a statement. Egan-Jones also highlighted what it called a "near monopoly" held by larger agencies like Moody's and Standard & Poor's, while stressing their faulty ratings of debt securities tied to the real estate market.

Earlier in April, the firm downgraded the debt of the U.S. government one notch to AA, citing the nation's debt burden. In November 2011, Egan-Jones downgraded its rating of investment bank Jefferies a notch to BBB- with a "negative" outlook just days after the collapse of brokerage MF Global, citing the company's exposure to the debt of peripheral European nations. That downgrade caused Jefferies stock to fall nearly 20%; however shares have since gained by over 50% to $16.23.

In response, Jefferies strongly criticized Egan-Jones' ratings methodology and the accuracy of calculations on its European debt exposure contained within multiple reports. Shortly thereafter, Jefferies disclosed that it had minimal net exposure to European government debt.

Sean Egan, a co-founder of Egan Jones named in the SEC's complaint was called the number one person who saw the financial crisis coming by Fortune Magazine - ahead of economist Nouriel Roubini and hedge fund managers David Einhorn and John Paulson. Egan-Jones won that honor for its harsher than average ratings assessments of firms like Ambac Financial, MBIA and Lehman Brothers prior to their troubles.

For more on Egan-Jones and its spat with Jefferies, read about their credibility title bout in November.

-- Written by Antoine Gara in New York.

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