CDOs are bundles of mortgage-backed securities that are then packaged and sold as investments. Before the financial crisis, some CDOs received ratings that were as safe as U.S. Treasuries but turned out to be made up of loans with a high likelihood of default. That has brought on general dissatisfaction with the credit ratings industry as a whole.
By sending Standard & Poor's what's known as a Wells notice, the SEC is telling the company it wants it to address the regulator's concerns about how it went about rating the CDO in question, known as "Delphinus CDO 2007-1." If the SEC isn't satisfied with S&P's answers, it may press formal charges.
Garbage in, garbage out
But S&P may only be a victim of misleading information it received from the sellers of the CDOs. For example, American International Group
In June, JPMorgan Chase
And in July, Goldman Sachs
It is estimated that financial companies sustained $1.82 trillion in losses when many of the underlying mortgages that were packaged into CDOs defaulted.
Be careful whom you tick off
S&P got off on the wrong foot with the government in early August when it downgraded U.S. credit, something it had been threatening to do if Congress didn't come up with a way to bring the budget deficit down. Even though Congress did pass a settlement of sorts, S&P still went ahead with the downgrade. The stock market then began its freefall.
The present action couldn't have anything to do with that downgrade, could it? I'm just sayin'.
Anyway, it may be that for S&P to avoid SEC action, it will have to show that the CDO sellers were the cause of the inaccurate ratings by giving it misleading information in the first place. In the meantime, this certainly slows down -- or may even put on hold -- McGraw-Hill's grand plan.
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Fool contributor Dan Radovsky has no financial position in any of the companies mentioned. The Motley Fool owns shares of American International Group, Bank of America, and JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.