[ by Howard Haykin ] The SEC on Wednesday charged the U.S. broker-dealer subsidiary of Mizuho Financial Group and 3 former employees with misleading investors in a collateralized debt obligation (CDO) by inflating the deal’s credit ratings.  Also charged were the firm serving as the deal’s collateral manager and the person who was its portfolio manager. SEC Findings and Allegations. Mizuho Securities USA Inc., made about $10 million in structuring and marketing fees in a CDO deal that Mizuho structured and marketed -  Delphinus CDO 2007-1, that was backed by subprime bonds at a time when the housing market showed signs of severe distress.  The deal was contingent upon Mizuho obtaining credit ratings to use for marketing the notes to investors.  However, that proved to be a huge obstacle. All collateral assets for Delphinus had been purchased by 7/17/07, and the transaction was scheduled to close on 7/19.  But on 7/18, around noon, S&P issued a press release announcing changes to its CDO rating criteria requiring certain categories of subprime residential mortgage-backed securities (RMBS's) to be adjusted downward for purposes of calculating their default probability. The Mizuho employees knew that Delphinus’s actual portfolio contained a substantial amount of RMBS's that were subject to the downward ratings, and that Delphinus, as constructed, would not meet the new tougher rating standards.  So, in order for the Mizuho employees to get the Delphinus CDO rated and closed by the following day, they e-mailed multiple alternative portfolios to S&P contained dummy assets that were superior in credit quality to the assets that had been acquired for the CDO. Upon receiving the necessary ratings (based on the dummy or fictitious assets), Mizuho closed the Delphinus transaction by mid-afternoon on 7/19 and securities were sold using the fraudulently obtained higher ratings.  Investors were thus misled into believing that the Delphinus notes were backed by stronger collateral than they actually were.  Delphinus defaulted in 2008 and eventually was liquidated in 2010. Mizuho sustained substantial losses from Delphinus.

"This case demonstrates once again that bankers and market participants who embrace a ‘get the deal done at all costs’ strategy will be identified, charged, and punished.  This is a constant theme throughout the many SEC enforcement actions arising out of the financial crisis, and is one that everyone involved in securities transactions and our financial markets would be well-advised to respect." -- Robert Khuzami, Director of SEC Enforcement.

Responsible Employees and Third Parties. Alexander Rekeda headed the group that structured the $1.6 billion CDO.  Xavier Capdepon modeled the transaction for the rating agencies.  Gwen Snorteland was the transaction manager responsible for structuring and closing Delphinus.  Delaware Asset Advisers (DAA) served as the collateral manager for Delphinus, and  Wei (Alex) Wei was DAA's portfolio manager. Shortly thereafter, in connection with Delphinus’s subsequent request for a required rating confirmation from S&P, Mizuho employees provided and arranged for others to provide further inaccurate information about the composition of Delphinus’s assets.  Primarily, they misrepresented that Delphinus’s effective date was 8/6 rather than 7/19.  S&P then provided Delphinus with the ratings confirmation using the improper effective date of 8/6/07. SEC Sanctions. To settle SEC charges, Mizuho agreed to pay $127.5 million in disgorgement, prejudgment interest and penalties ($115 million penalty).  The settlement requires court approval. Administrative proceedings were instituted against the others, as follows:

• Rekeda: agreed to a $125K penalty, and a 12-month suspension, for his alleged violation of Sections 17(a)(2) and (3) of the Securities Act.
• Capdepon: agreed to a $125K penalty and to be barred from the industry for his alleged violation of Section 17(a).
• Snorteland: agreed to be barred from the industry for his alleged violation of Section 17(a);  the SEC will decide later on whether to issue a monetary penalty.

Settled administrative proceedings were instituted against DAA and Wei based on their post-closing conduct, as follows:

• DAA: the firm agreed to pay $4.8 million in disgorgement, prejudgment interest, and penalties for violating Section 17(a)(2) and (3) of the Securities Act and Section 206(2) of the Advisers Act.
• Wei: agreed to a $50K fine and a 6-month suspension from associating with any investment adviser, for violating Section 17(a)(2) and (3) of the Securities Act and Section 206(2) of the Advisers Act.

The SEC investigation into the Delphinus transaction continues. SEC Staff Credits. Investigation by Enforcement's Structured and New Products Unit, led by Kenneth Lench and Reid Muoio.  Investigative attorneys were Robert Leidenheimer, Lawrence Renbaum, and James Murtha.  Trial attorneys were Jan Folena, Suzanne Romajas, and Alan Lieberman. For further details, go to:  [SEC PR 12-139, 7/18/12] and these additional materials:

• Complaint: Mizuho Securities USA Inc.
• Administrative Proceeding: Alexander V. Rekeda
• Administrative Proceeding: Xavier Capdepon and Gwen Snorteland
• Administrative Proceeding: Delaware Asset Advisers and Wei (Alex) Wei