SEC Fines Morningstar $3.5M for Conflict of Interest Violations

Morningstar agreed to pay $3.5 million to settle charges by the Securities and Exchange Commission that its New York-based credit rating division, Morningstar Credit Ratings, violated a conflict of interest rule designed to separate credit ratings and analysis from sales and marketing efforts.

Without admitting or denying the findings, the firm agreed to pay the civil money penalty to the SEC for transfer to the general fund of the U.S. Treasury Department, according to the SEC's order posted on its website Friday.

The SEC's order found that from mid-2015 through September 2016, credit rating analysts in Morningstar's asset-backed securities group engaged in sales and marketing to prospective clients, the regulator said. According to the order, Morningstar's head of business development instructed analysts to identify business targets and pursue them through marketing calls, meetings, and offers to provide indicative ratings.

As one example, the order found that one ABS analyst at Morningstar wrote a commentary specifically targeted at a potential client issuer and sent it to the issuer for the purpose of obtaining the business of the issuer, who eventually became a Morningstar client, the SEC said.

The order also found Morningstar issued and maintained ABS ratings for certain entities where an analyst who participated in determining or monitoring the credit rating also participated in the sales or marketing of a Morningstar product or service.

Additionally, the order found that between at least June 2015 and November 2016, Morningstar failed to maintain written policies and procedures reasonably designed to sufficiently separate the firm's analytical and business development functions, the SEC said.

The SEC's order found that Morningstar violated Rule 17g-5(c)(8)(i), which prohibits a rating agency from issuing or maintaining a credit rating where an analyst who participates in determining or monitoring credit ratings also participates in sales and marketing activity, as well as Section 15E(h)(1) of the Securities Exchange Act of 1934, which requires credit rating agencies to establish, maintain and enforce policies and procedures reasonably designed to address and manage conflicts of interest, the regulator said.

In addition to the $3.5 million penalty, as part of the settlement, Morningstar also "committed to conduct training and implement changes to its internal controls, policies, and procedures related to the charged provisions," the SEC said.

Morningstar Credit Ratings "cooperated with the SEC's multi-year investigation and believes the settlement is in the best interest of the company," Morningstar said in a statement. "There are no allegations that any credit ratings issued by MCR were affected by the conduct described in the settlement," it said.

MCR "takes its regulatory obligations seriously, and the integrity of its credit ratings is of paramount importance," the firm also said, pointing out: "As part of its integration with DBRS, [the ratings business] Morningstar acquired last year and well after the investigated activity took place, the combined DBRS Morningstar has enhanced and will further strengthen policies, procedures, and internal controls. It will also conduct additional training to reinforce compliance with regulations."

The SEC's concerns about conflict of interest among Morningstar and other credit agencies originated several years ago. In 2014, the SEC said nationally recognized statistical rating organizations were lacking in their management of conflicts of interest, as well as information technology and cybersecurity issues. The SEC issued its annual staff report at the time on the findings of examinations of credit rating agencies registered as nationally recognized statistical rating organizations (NRSROs) and submitted a separate report on NRSROs to Congress. The SEC had not determined at that time whether any finding "constitutes a material regulatory deficiency," it said. MCR was one of 10 credit rating agencies registered as NRSROs as of Dec. 1, 2014.

"Credit rating agencies must be vigilant to prevent potential conflicts of interest between their ratings functions and their sales and marketing activities," Daniel Michael, chief of the SEC Enforcement Division's Complex Financial Instruments Unit, said in a statement Friday. "As the SEC's order finds, Morningstar sometimes enlisted its analysts in business development efforts, introducing the exact conflict of interest that the rule is intended to eliminate," he said.

— Check out 'Be Wary of Bond Ratings': NASAA on ThinkAdvisor.