SEC Scrutinizes S&P Downgrade

The Securities and Exchange Commission is scrutinizing the method Standard & Poor's used to cut the U.S.'s credit rating and whether the firm properly protected the confidential decision, according to a person with direct knowledge of the matter.

SEC inspectors are examining S&P's policies for conducting such analyses and whether those procedures were followed when the New York-based firm downgraded the U.S.'s credit rating Aug. 5, said the person, who declined to be identified because the inquiry isn't public.

S&P's downgrade of the U.S. contributed to an equity rout that erased about $6.8 trillion from global stocks since late July. U.S. officials have said the downgrade was based on a flawed analysis that overstated the nation's debt by about $2 trillion, while S&P said the discrepancy doesn't change projections that the U.S. debt-to-gross domestic product ratio will probably continue to rise in the next decade.

The rating company lowered the nation'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 nation's $14.3 trillion debt limit were lifted.

The decision was at odds with the other two main ratings companies, Moody's Investors Service and Fitch Ratings, which both said the U.S. continues to deserve the top credit rating.

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

Ed Sweeney, an S&P spokesman, said the firm doesn't discuss specific interactions it has with regulators.

“S&P takes its confidential information and securities trading policies, and the related securities regulation, very seriously,” Sweeney said in a statement. “Our policies prohibit analysts or rating committee members from trading and holding securities or options of the companies or governments they rate.”

Sweeney said the firm has “long-standing policies and procedures in place” to protect confidential information. Sweeney also said the firm had previously indicated in a July statement that there was a chance of a downgrade.

S&P “published several reports and broadly communicated our views regarding the potential impact on other fixed-income securities,” the statement said.

'Market Turmoil'
The rating downgrade added to concern that the economy is weakening as Europe's debt crisis deepened. U.S. stocks fell for a third straight week, with the S&P 500 losing 1.7 percent to 1,178.81 in the five days ended Aug. 12, capping a week of record swings.

Treasuries rose, with 10-year yields falling as much as 52 basis points this week, the most since December 2008, and signaling the lower rating hasn't reduced confidence in the nation's creditworthiness. The yield declined nine basis points to 2.26 percent as of 5:02 p.m. on Aug. 12 in New York, according to Bloomberg Bond Trader prices.

The downgrade followed an Aug. 2 agreement among U.S. lawmakers to raise the nation's debt ceiling and put in place a plan to enforce $2.4 trillion in spending reductions over the next 10 years, less than the $4 trillion that S&P had said it preferred. The political wrangling that preceded the debt pact was also a concern, S&P said.

The “debate this year has highlighted a degree of uncertainty over the political policymaking process which we think is incompatible with the AAA rating,” S&P analyst David Beers said on an Aug. 6 conference call with reporters.

'Quadruple A'
Former Treasury Secretary Henry Paulson said he would invest in U.S. government securities before other sovereign debt even though the nation's political process isn't working as well as it could be.

“Our political process, our government, hasn't been working at a AAA level,” Paulson, 65, said on Aug. 11. “I would take U.S. Treasuries over other sovereign debt, other AAA sovereign debt, any day of the week. That's not to say we don't have important issues to deal with in this country.”

Warren Buffett also criticized the rating company's decision, saying the U.S. merits a “quadruple A” rating, in an interview with Betty Liu of Bloomberg Television.

'Some Spine'
Bill Gross, manager of the world's biggest bond mutual fund, said on Aug. 7 that S&P “demonstrated some spine.” The manager of Pimco Total Return Fund has said that Treasuries are unattractive because yields don't offer enough compensation for the risk of inflation.

Still, U.S. bonds remain in demand at a time when Europe's sovereign debt crisis threatens to spread to Italy and Spain from Greece, Ireland and Portugal. The Treasury's Aug. 9 auction of $32 billion in three-year notes attracted $3.29 in bids for each dollar of debt sold. Indirect bidders, the class that includes foreign central banks, bought 47.9 percent of the issue, the most since May 2010.

The inquiry was reported earlier by the Financial Times.

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