It was big news last September when Standard & Poor’s disclosed that it had received a Wells Notice in connection with the Securities and Exchange Commission’s investigation of the $1.6 billion Delphinus collateralized debt obligation. The SEC sends Wells Notices to potential targets, not mere witnesses, so there was a lot of speculation that the Delphinus investigation might be the government’s long-awaited attempt to hold a rating agency accountable for colluding with a bank to misrepresent the quality of a mortgage-backed instrument.
But based on the complaint the SEC filed Wednesday against the Delphinus sponsor, Mizuho Bank, it looks to me like S&P is off the hook.
Mizuho, which earned $10 million in fees on the Delphinus deal, agreed to pay $127.5 million to settle the SEC’s case, which claimed investors were deceived by the ratings S&P, Fitch and Moody’s gave to the CDO. Four Mizuho executives involved in Delphinus structuring and marketing also settled, via administrative proceedings that imposed sanctions and fines. The settlement documents make it clear that Delphinus investors were misled about the quality of the mortgage-backed securities that served as collateral for the CDO.
So, however, were the rating agencies, according to the narrative the SEC laid out in its complaint against Mizuho, which was filed in federal court in Manhattan. In the SEC’s telling, the Delphinus offering materials required particular ratings from S&P. The agency could issue a preliminary rating on the CDO even before the portfolio of referenced securities was finalized, but the indenture documents said that if the CDO didn’t obtain final ratings based on the actual collateral in the referenced portfolio within 30 days of the closing, Delphinus would go into a form of default known as “effective date” failure.
All of the referenced securities for the CDO were actually selected by July 17, 2007, two days before the deal closing. That’s not what Mizuho told S&P and the other rating agencies, though. According to the SEC, Mizuho knew the CDO wouldn’t receive the ratings it needed if the bank showed the actual portfolio of underlying securities to S&P, which had just toughened its CDO rating standards. So instead, on July 18, 2007, the bank sent various “dummy portfolios” containing imaginary assets to S&P, promising that it intended to back the CDO with securities of similar quality.