The Securities and Exchange Commission is scrutinizing themethod Standard & Poor's used to cut the U.S.'s credit ratingand whether the firm properly protected the confidential decision,according to a person with direct knowledge of the matter.

SEC inspectors are examining S&P's policies for conductingsuch analyses and whether those procedures were followed when theNew York-based firm downgraded the U.S.'s credit rating Aug. 5,said the person, who declined to be identified because the inquiryisn't public.

S&P's downgrade of the U.S. contributed to an equity routthat erased about $6.8 trillion from global stocks since late July.U.S. officials have said the downgrade was based on a flawedanalysis that overstated the nation's debt by about $2 trillion,while S&P said the discrepancy doesn't change projections thatthe U.S. debt-to-gross domestic product ratio will probablycontinue to rise in the next decade.

The rating company lowered the nation's AAA grade to AA+ afterwarning on July 14 that it would reduce the ranking in the absenceof a credible plan to decrease deficits even if the nation's $14.3trillion debt limit were lifted.

The decision was at odds with the other two main ratingscompanies, Moody's Investors Service and Fitch Ratings, which bothsaid the U.S. continues to deserve the top credit rating.

Possible Leaks
SEC staff also are lookinginto whether certain market participants learned of the downgradebefore its announcement. The inquiry, which is in preliminarystages, may not result in a referral to the SEC's enforcementdivision, the person said.

Ed Sweeney, an S&P spokesman, said the firm doesn't discussspecific interactions it has with regulators.

“S&P takes its confidential information and securitiestrading policies, and the related securities regulation, veryseriously,” Sweeney said in a statement. “Our policies prohibitanalysts or rating committee members from trading and holdingsecurities or options of the companies or governments theyrate.”

Sweeney said the firm has “long-standing policies and proceduresin place” to protect confidential information. Sweeney also saidthe firm had previously indicated in a July statement that therewas a chance of a downgrade.

S&P “published several reports and broadly communicated ourviews regarding the potential impact on other fixed-incomesecurities,” the statement said.

'Market Turmoil'
The rating downgradeadded to concern that the economy is weakening as Europe's debtcrisis deepened. U.S. stocks fell for a third straight week, withthe S&P 500 losing 1.7 percent to 1,178.81 in the five daysended Aug. 12, capping a week of record swings.

Treasuries rose, with 10-year yields falling as much as 52 basispoints this week, the most since December 2008, and signaling thelower rating hasn't reduced confidence in the nation'screditworthiness. The yield declined nine basis points to 2.26percent as of 5:02 p.m. on Aug. 12 in New York, according toBloomberg Bond Trader prices.

The downgrade followed an Aug. 2 agreement among U.S. lawmakersto raise the nation's debt ceiling and put in place a plan toenforce $2.4 trillion in spending reductions over the next 10years, less than the $4 trillion that S&P had said itpreferred. The political wrangling that preceded the debt pact wasalso a concern, S&P said.

The “debate this year has highlighted a degree of uncertaintyover the political policymaking process which we think isincompatible with the AAA rating,” S&P analyst David Beers saidon an Aug. 6 conference call with reporters.

'Quadruple A'
Former Treasury Secretary HenryPaulson said he would invest in U.S. government securities beforeother sovereign debt even though the nation's political processisn't working as well as it could be.

“Our political process, our government, hasn't been working at aAAA level,” Paulson, 65, said on Aug. 11. “I would take U.S.Treasuries over other sovereign debt, other AAA sovereign debt, anyday of the week. That's not to say we don't have important issuesto deal with in this country.”

Warren Buffett also criticized the rating company's decision,saying the U.S. merits a “quadruple A” rating, in an interview withBetty Liu of Bloomberg Television.

'Some Spine'
Bill Gross, manager of theworld's biggest bond mutual fund, said on Aug. 7 that S&P“demonstrated some spine.” The manager of Pimco Total Return Fundhas said that Treasuries are unattractive because yields don'toffer enough compensation for the risk of inflation.

Still, U.S. bonds remain in demand at a time when Europe'ssovereign debt crisis threatens to spread to Italy and Spain fromGreece, Ireland and Portugal. The Treasury's Aug. 9 auction of $32billion in three-year notes attracted $3.29 in bids for each dollarof debt sold. Indirect bidders, the class that includes foreigncentral banks, bought 47.9 percent of the issue, the most since May2010.

The inquiry was reported earlier by the FinancialTimes.

Copyright 2018 Bloomberg. All rightsreserved. This material may not be published, broadcast, rewritten,or redistributed.