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SEC Cautions Rating Agencies That It Will Use Enhanced Extraterritorial Jurisdiction Given by Dodd-Frank

By Jim Hamilton

The SEC has issued a report cautioning credit rating agencies that, where appropriate, the Commission will utilize Section 929P of the Dodd-Frank Act, which grants jurisdiction for SEC enforcement actions alleging otherwise extraterritorial fraudulent misconduct that involves significant steps or foreseeable effects within the United States. Under Section 21(a) of the Securities Exchange Act, the Commission may investigate violations of the federal securities laws and at its discretion publish information concerning any such violations. This report of investigation inquires into whether Moody's Investors Service, Inc. (MIS), the credit rating business segment of Moody's Corporation, violated the registration provisions or the antifraud provisions of the federal securities laws. (Release No. 34-62802)

The Report says that because of pre-Dodd-Frank uncertainty regarding a jurisdictional nexus between the United States and the relevant ratings conduct, the Commission declined to pursue a fraud enforcement action in this matter. The Report notes that Section 929P of the Dodd-Frank Act provides federal district courts with express jurisdiction over SEC enforcement actions alleging violations of the antifraud provisions of the securities laws involving conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors or conduct occurring outside the United States that has a foreseeable substantial effect within the United States. Rating agencies were cautioned that they should expect that the Commission, where appropriate, will pursue antifraud enforcement actions, including pursuant to such jurisdiction.

According to the Report, an MIS analyst discovered in early 2007 that a computer coding error had upwardly impacted by 1.5 to 3.5 notches the model output used to determine MIS credit ratings for certain constant proportion debt obligation notes. Nevertheless, shortly thereafter during a meeting in Europe, an MIS rating committee voted against taking responsive rating action, in part because of concerns that doing so would negatively impact MIS's business reputation. The CPDO notes were arranged by European banks and marketed in Europe. Also, The rating committee responsible for the credit ratings of the CPDO notes met in France and the United Kingdom.

The Report noted that the European rating committee's self-serving consideration of non-credit related factors in support of the decision to maintain the credit ratings constituted conduct that was contrary to the MIS procedures used to determine credit ratings as described in the MIS application to the SEC.

According to Rep. Paul Kanjorski, section 929P of the Dodd-Frank Act authorizing the SEC and the Justice Department to bring civil or criminal enforcement actions involving transnational securities fraud is intended to rebut the recently announced US Supreme Court presumption against extraterritorial application of the federal securities laws. In Morrison v. National Australia Bank, Dkt. No. 08-1191, the Court ruled, in a private securities fraud action, that section 10(b) of the Exchange Act applies only to transactions in securities listed on United States exchanges and transactions in other securities that occur in the United States. In this case, the Court also said that it was applying a presumption against extraterritoriality. Cong Record, June 30, 2010, p. H5237.

In floor comments on the day the House passed the Dodd-Frank Act, Rep. Kanjorski, said that the Act?s provisions concerning extraterritoriality of the federal securities laws are intended to rebut that presumption by clearly indicating that Congress intends extraterritorial application in cases brought by the SEC or the Justice Department. More specifically, the Chair of the Capital Markets Subcommittee explained that the purpose of the language of section 929P, which he authored, is to clarify that in actions and proceedings brought by the SEC or the Justice Department, the specified provisions of the Securities Act, the Exchange Act and the Investment Advisers Act may have extraterritorial application, and that extraterritorial application is appropriate, irrespective of whether the securities are traded on a domestic exchange or the transactions occur in the U.S., when the conduct within the United States is significant or when conduct outside the U.S. has a foreseeable substantial effect within the United States. Cong Record, June 30, 2010, p. H5237

Full post as published by Jim Hamilton's World of Securities Regulation on September 02, 2010 (boomark / email).