This week's document: Investigation into Unauthorized Disclosure of Non-Public Information
Originating agency: Securities and Exchange Commission (SEC) Office of Inspector General (OIG)
Document date: September 30, 2009
Every Friday, POGO will strive to make one document available that we or others have obtained through the Freedom of Information Act (FOIA), especially documents that have not previously been posted online. Some of these documents will be more important than others, some may only be of historical interest— although relevance is in the eye of the beholder. POGO is doing this to highlight the importance of open government and FOIA throughout the year.
By MICHAEL SMALLBERG
The Securities and Exchange Commission (SEC) recently sent subpoenas to a number of hedge funds, trading shops, and other firms to determine if any investors traded on leaked information regarding Standard & Poor's (S&P) decision to downgrade the U.S. government’s credit rating, according to The Wall Street Journal. However, it wasn’t long ago that the SEC was being investigated by its own watchdog to determine if anyone at the agency improperly provided the Journal with a draft copy of a staff report on S&P and other credit rating agencies, as detailed in a 2009 investigative report by the SEC’s Office of Inspector General (OIG) that was obtained by POGO through the Freedom of Information Act (FOIA).
The OIG provided a summary of this investigation in a semiannual update to Congress, and it was mentioned in several media reports at the time. However, the full version of the report—which is nowhere to be found on the SEC or OIG’s website—provides some colorful new details on the OIG’s investigation, even in the heavily redacted version obtained by POGO.
In July 2008, SEC staff issued a report to summarize the agency’s examinations of three credit rating agencies: Fitch, Moody’s, and S&P. The purpose of the examinations was to analyze the agencies’ ratings of subprime mortgage-related securities during a period of severe market turmoil. Among other things, SEC staff found that some agencies had struggled to keep up with the growth in subprime mortgage-related products, significant aspects of the ratings process were not disclosed, and agencies were not doing an adequate job of managing conflicts of interest. In the summary that was released to the public, however, the SEC did not identify which agencies were experiencing these problems because “Commission Staff examinations of specific firms are non-public in nature.”
The following month, Aaron Lucchetti at The Wall Street Journal reported that problems were “particularly acute” at S&P, citing a draft version of the SEC’s report that identified the agencies. For instance, the Journal reported that an S&P analytical staffer had e-mailed his colleague to say that a certain mortgage or structured finance-related deal was “ridiculous” and that “we should not be rating it.” The other S&P staffer replied that “we rate every deal,” adding that “it could be structured by cows and we would rate it.” In another email cited by the Journal, an S&P analytical manager wrote that “rating agencies continue to create” an “even bigger monster—the [Collateralized Debt Obligation] market. Let’s hope we are all wealthy and retired by the time this house of cards falters.” The Journal also reported that S&P’s revenue from rating mortgage-related bond portfolios had grown by more than 800 percent from 2002 to 2006, at a time when related staffing only doubled.
A few days after the story ran, SEC officials informed the OIG that the Journal had apparently obtained a non-public draft version of the staff report. They told the OIG that “the WSJ’s publication of this information was extremely disturbing to the firms. Moreover, it was embarrassing to the SEC staff because of the assurances of confidentiality that the staff had given” to the rating agencies.
The OIG reviewed 134,000 emails and interviewed 25 SEC staffers in an effort to determine who might have leaked the non-public draft report to the Journal. The OIG confirmed that the Journal reporter “clearly obtained access to the SEC non-public draft [credit rating agency] report as the article contained quotes from [credit rating agency] emails and references to the rating firms that appeared only in the draft version” of the report. In addition, the article “contained several instances of information which was contained only in the internal draft and which was not contained in the redacted version released to the public.”
The OIG reported that Lori Richards, the then-Director of the SEC’s Office of Compliance Inspections and Examinations (OCIE), sent the following email to several OCIE staff members expressing her concern about the Journal article:
[The article] indicates that a non-public draft of our [credit rating agency] exam report showing the names of firms associated with emails and other findings was provided to the reporter, or he obtained access to it. We don’t know whether this is accurate. At any rate, as you know, release of non-public information undermines the exam program, because firms will come to believe that we cannot maintain the confidentiality of the information provided to us. I know that this article must be frustrating to you (as it is to me), as the team worked hard to ensure the confidentiality of the exam and the information provided to us.
In the end, the OIG couldn’t find any evidence in the emails it reviewed to indicate who might have leaked the draft report to the Journal, and all the staffers who testified to the OIG “credibly denied under oath” discussing or leaking the report to anyone outside of the SEC. However, the OIG also acknowledged that an SEC staffer could have leaked the report “without leaving any trace that the OIG could discover.” For instance, there were limitations in the OIG’s ability to review snail mail and faxes sent from the SEC. The OIG also had no way to determine if an SEC staffer communicated with the Journal using their personal email.
We’ve added this report to our resource page of SEC OIG investigative reports. And we’ll be updating this page soon with additional reports we’ve obtained through FOIA, so stay tuned for more.
Michael Smallberg is a POGO Investigator.