Barbara Duka was an employee of Standard & Poor’s Ratings Services. The SEC contended that Duka loosened S&P’s methodology for rating commercial mortgage-backed securities to help the company generate ratings business from issuers. S&P had settled allegations against it in a separate matter.
The SEC brought charges against Duka in the SEC’s administrative court. Duka contended the administrative proceeding was unconstitutional and the United States District Court for the Southern District of New York agreed and preliminarily enjoined the SEC from conducting the proceeding. The Second Circuit later vacated the District Court’s order and the administrative proceeding progressed to a conclusion. The industry watched to see if the SEC administrative court would render a one-sided decision in favor of the SEC.
The SEC charged Duka with willfully violating the anti-fraud provisions set forth in Securities Act Section 17(a) and Exchange Act Section 10(b) and Rule 10b-5. Resolution of the charges came down to whether the Division of Enforcement met its burden to show that Duka acted with the intent to deceive, manipulate, or defraud. Considering the record, the Administrative Law Judge found there was no evidence that Duka acted with such intent. Instead, the evidence told a different story that was inconsistent with the SEC’s arguments. It demonstrated that Duka, in effecting a change in rating methodology, did so for analytical reasons—rather than for commercial or professional gain—and with the knowledge of appropriate S&P personnel.
The SEC also charged Duka with negligently violating Section 17(a)(2) and (3) of the Securities Act. The charges centered around an alleged failure to disclose the revised ratings methodologies. To demonstrate liability under Section 17(a)(2), the SEC was required to show that Duka negligently obtained money or property by means of any untrue statement or omission of a material fact. The Administrative Law Judge easily dispensed with the SEC’s argument. Duka did not receiving any money or property from the ratings process, and the fact that her employer did was insufficient.
To demonstrate liability under Section 17(a)(3), the Administrative Law Judge had to determine Duka failed to exercise reasonable care and thereby caused investors to receive misleading information about the issuers’ transactions or somehow prevented investors from learning material information about those transactions. While S&P’s disclosures were unclear on the issue, and could perhaps be viewed as literally true, the Administrative Law Judge found the documentation presented an incomplete picture and omitted information about the revised ratings methodologies. The Administrative Law Judge found Duka failed to exercise reasonable care because approval to use the revised methodology was contingent on the methodology being disclosed in relevant documentation. Whether Duka was normally responsible for reviewing the documentation was not relevant. According to the Administrative Law Judge, she agreed as a condition of using the new methodology to ensure that use was disclosed and failed to live up to her end of that agreement.
The Administrative Law judge found that Duka did not aid or abet S&P’s violations in two other instances but that Duka caused S&P’s violation of Section 15E(c)(3) of the Exchange Act. The reason was S&P’s publication of ratings did not fully disclose the change in methodology and that violated S&P’s code of conduct. As a result, S&P failed to maintain or enforce an effective internal control structure governing the implementation of and adherence to policies, procedures, and methodologies for determining credit ratings.
The Administrative Law Judge issued a cease and desist order and required Duka to pay a civil monetary penalty of $7,500. The Administrative Law Judge declined to bar Duka from associating with a nationally recognized statistical rating organization.