In the late 1990s, Barbara Duka began employment at Standard & Poor's Ratings Services ("S&P") as an analyst, and by 2008, she had risen to Manager of the Commercial Mortgage-Backed Securities ("CMBS") New Issuance ratings group, where her primary responsibilities included managing the rating process, identifying changes to the criteria used to rate CMBS transactions, and managing development of the model used to rate transactions. With the onset of the Great Recession in 2008 and 2009, employees were shifted from the New Issuance group to Surveillance and by 2009, only five or six people reported to Duka. Around early 2011, Duka purportedly had responsibility for the surveillance ratings of CMBS.
3. These proceedings involve a scheme and fraudulent practice or course of business that led to false and misleading statements by S&P concerning its post-financial crisis methodology for rating conduit/fusion CMBS. The disclosures at issue concern S&P's calculation of the Debt Service Coverage Ratio ("DSCR"), a key quantitative metric used to rate CMBS transactions.
4. S&P used DSCRs to predict defaults of loans in CMBS pools and thereby determine appropriate levels of Credit Enhancement ("CE") for particular ratings. CE is a critical component of a credit rating; in general terms, ratings with higher levels of CE are more conservative and provide greater protection against loss to investors.
5. Duka led and was responsible for the actions of the analytical group within S&P that analyzed and assigned ratings to new issue CMBS transactions, and (after approximately early January 2011) that assigned surveillance ratings to outstanding CMBS bonds (the "CMBS Group"). In late 2010, S&P's CMBS Group, acting through and led by Duka, loosened its methodology for calculating DSCRs, resulting in CE requirements that were approximately 25% to 60% lower for bonds at each different level of the capital structure. This change to S&P's methodology was designed to make S&P's ratings more attractive to fee-paying CMBS issuers. Duka ordered the change because she perceived that S&P's criteria were too conservative and were causing S&P to lose rating assignments, thereby threatening both the profitability of the CMBS Group she led and her position within the firm.
6. S&P's CMBS Group, acting through and led by Duka, published eight CMBS Presale reports between February and July 2011 in which S&P failed to disclose its relaxed methodology for calculating DSCRs. The reports instead represented that S&P used a more conservative methodology for calculating DSCRs when rating the transactions. Market participants were therefore misled into believing that the ratings at issue were more conservative than they actually were.
7. S&P and Duka acted with scienter in connection with the false and misleading CMBS Presales, in that Duka and the CMBS Group knew that the Presales contained inaccurate data and intentionally or recklessly caused such inaccurate data to be published, and for other reasons discussed below.
8. S&P failed to follow its own established internal policies and procedures when the CMBS Group changed its method for calculating DSCRs and in connection with ratings that the CMBS Group assigned by using the undisclosed new methodology. Duka caused and aided and abetted such failures, among other things, by causing the CMBS Group to prepare internal documents that failed to describe the new methodology, contrary to the policies that governed such documents, and by changing the numerical model for CMBS ratings without adequately communicating those changes to the responsible persons within S&P's internal control structure.
ALJ Initial Decision
After a nine-day hearing running from November 21, 2016 to January 4, 2017, at which the Division of Enforcement called 11 witnesses and Duka called seven, Administrative Law Judge ("ALJ") James E. Grimes issued a comprehensive 86-page Initial Decision. In the Matter of Barbara Duka (Initial Decision, SEC, Init. De. Rel. No. 1167; Admin. Proc. File No. 3-16349 / August 29, 2017). The Division had requested the imposition of a Cease-And-Desist Order; monetary penalties, and a Bar from certain capacities in the securities industry. Readers are referred to the full-text Initial Decision for the ALJ's thoughtful and compelling presentation of the numerous facts and considerations. In brief, and as set forth in the Syllabus to the Initial Decision [Ed: Footnotes omitted]:
At bottom, this case concerns a simple question: whether Respondent Barbara Duka committed fraud to generate business for her employer, Standard & Poor's Ratings Services (S&P). The devil is in the details, however. Resolving the question requires consideration of complex and sometimes arcane concepts concerning how S&P-a nationally recognized statistical rating organization-rates commercial mortgage-backed securities.
The Division of Enforcement contends that Duka changed S&P's methodology for rating commercial mortgage-backed securities to help the company generate ratings business from issuers. Although it is clear that Duka sought to, and did, change S&P's methodology, there is no evidence she did so for a commercial purpose or any reason other than the belief that the change was analytically justified. After agreeing to do so, however, Duka negligently failed to ensure the change in methodology was disclosed in presale reports distributed to investors.
Based on Duka's negligent omission, I find that she violated Section 17(a)(3) of the Securities Act of 1933 and caused S&P's violation of Section 15E(c)(3) of the Securities Exchange Act of 1934. All other charges are dismissed. For her violations, I order Duka to cease and desist and impose a censure and a monetary penalty of $7,500.