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Morningstar settles with SEC over conflict of interest charges

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Inside the Beltway
Tuesday, May 19, 2020

The Securities and Exchange Commission (SEC) settled with credit rating agency Morningstar Credit Ratings LLC for violating a conflict of interest rule designed to separate credit ratings and analysis from sales and marketing efforts. Morningstar agreed to pay $3.5 million to settle the charges. 

The SEC’s order found that 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. According to the order, Morningstar’s head of business development instructed analysts to identify business targets and pursue them through marketing calls, meetings, and offers to provide indicative ratings. 

“Credit rating agencies must be vigilant to prevent potential conflicts of interest between their ratings functions and their sales and marketing activities,” said Daniel Michael, chief of the SEC Enforcement Division’s Complex Financial Instruments Unit.  “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 cooperated with the SEC’s investigation, neither admitted nor denied the charges, and believed the settlement is in the best interest of the company.

“MCR takes its regulatory obligations seriously, and the integrity of its credit ratings is of paramount importance,” the company said. “As part of its integration with DBRS, which Morningstar acquired last year and well after the investigated activity took place, the combined DBRS Morningstar has enhanced and will further strengthen policies, procedures, and internal controls. It will also conduct additional training to reinforce compliance with regulations.”

In the SEC order, one example it gave of violations was that one ABS analyst at Morningstar wrote a commentary specifically aimed at a potential client issuer and sent it to the issuer for the purpose of obtaining the business of the issuer, which eventually became a Morningstar client. It found that Morningstar issued and maintained ABS ratings for certain entities where an analyst who participated in determining or monitoring the credit rating also participated in the sales or marketing of a Morningstar product or service.

In addition, the SEC said, it found that between at least June 2015 and November 2016, Morningstar failed to maintain written policies and procedures reasonably designed to sufficiently separate the firm’s analytical and business development functions. 

“MCR’s written policies and procedures failed sufficiently to address and manage the conflict of interest relating to sales and marketing prohibited by Rule 17g-5(c)(8)(i). Specifically, MCR’s Analytical Firewall Policy and Code of Conduct only prohibited analysts from discussing fees for ratings services or negotiating engagement terms. Those policies did not prohibit analysts from engaging in other sales and marketing activity,” the order stated.

The order also detailed another alleged violation from the ABS segment.

“In an effort to grow MCR’s ABS rating business, MCR’s ABS business development director instructed ABS analysts to identify and initiate contacts with potential clients (referred to as “targets”), set up marketing calls and marketing meetings with them, and offer them indications,” the order stated. “MCR’s ABS business development director also instructed ABS analysts to (i) solicit potential clients at industry conferences, (ii) repeatedly follow up with those potential clients, and (iii) encourage potential clients to attend marketing meetings with MCR. Analysts understood that the goal of their contacts was to persuade potential clients to hire MCR to rate ABS. These activities were undertaken with the knowledge of senior MCR managers.”

The SEC’s investigation was conducted by Robert Leidenheimer of the Complex Financial Instruments Unit and Colin Forbes of the Boston Regional Office with the assistance of Senior Trial Counsel Al Day, and was supervised by Assistant Director Celia Moore.

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