Risk & Compliance

SEC Sues Morningstar Over CMBS Ratings

The firm allegedly made undisclosed changes to its ratings model that allowed issuers to shortchange investors on interest.
Matthew HellerFebruary 17, 2021

Morningstar has been charged with failing to disclose changes to its model for determining the ratings of commercial mortgage-backed securities that resulted in lower projections of loan losses.

The U.S. Securities and Exchange Commission tightened its oversight of credit ratings agencies after the mass defaults of highly rated structured finance products in 2007 and 2008 led to a renewed focus on the quality of ratings.

According to the SEC, Morningstar made undisclosed “loan-specific” adjustments to key stresses in its rating model in determining the ratings for 30 CMBS transactions totaling $30 billion from at least 2015 through 2016.

The adjustments, the SEC said in a civil complaint, allowed Morningstar to rate below-investment-grade securities as investment-grade, benefiting issuers that paid for the ratings by enabling them issuers to pay investors less interest than they would have without the adjustments.

“The federal securities laws require credit-rating agencies to disclose how ratings are determined and to have effective internal controls to ensure they adhere to their ratings methodologies,” Daniel Michael, chief of the SEC enforcement division’s complex financial instruments unit, said in a news release. “Morningstar failed on both counts.”

As The Wall Street Journal reports, Morningstar has made a push to become a big player in the bond-rating business, buying rival DBRS Inc. from two private-equity firms for $669 million in 2019.

In May 2020, the firm paid $3.5 million to settle a separate SEC enforcement investigation that alleged it violated conflict-of-interest rules by mixing ratings work with sales and marketing efforts.

The CMBS-rating case involves Morningstar’s model for stress-testing cash flows and valuation measures for underlying commercial properties based on different economic environments.

Morningstar failed to disclose that a central feature of [its model] allowed analysts to make “loan-specific” adjustments to the stresses, the SEC said, resulting in the lowering of projected losses for many classes of the CMBS certificates it rated and leaving investors unable to “adequately assess” the ratings.

The firm said it followed the rules, accusing the SEC of “overstepp[ing] its regulatory limitations by imposing requirements that would regulate the substance of credit-rating methodologies.”