The SEC took its first swing at the failure of credit rating
agencies by serving a Wells Notice on Moody's Investor Service.
At issue, according to the Moody's filing, is the
determination in 2007 that members of one of its European rating committees
"engaged in conduct contrary to Moody's Code of Professional Conduct."
Members of a credit committee knew that some of the products had been given
inflated ratings because of a problem in the company's risk modeling software.
Moody's is one of only 10 Nationally
Recognized Statistical Rating Organizations under the Credit Rating Agency Reform Act of 2006.
The disclosure in Moody's 10-Q states that the SEC "is
considering recommending that the SEC institute administrative and
cease-and-desist proceedings against MIS in connection with MIS's initial June
2007 application on SEC Form NRSRO to register as a nationally recognized
statistical rating organization under the Credit Rating Agency Reform Act of
2006." The theory is that Moody's description of its procedures and principles
were "rendered false and misleading" as of the time the application because of the
Company's finding that a rating committee policy had been violated.
The case reminds me of the Hennessee Group action where the SEC brought an action
against a hedge fund for failing to conduct adequate diligence. The reason was
that the hedge fund claimed that they had a particular due diligence program,
but failed to follow the program. The diligence failure by itself was not
actionable, but failing to live up to your self-professed standards made it
actionable.
It sounds the SEC is making a similar case against Moody's.
In their application, they claimed to have a certain procedure but failed to
follow it. We all know that credit agencies did a poor job of rating CDOs. That
by itself caused damages but may not be actionable. So the SEC is going after
them for failing to follow their own self-professed standards and policies.
It's too early to tell what may happen. A worst case
scenario would be removing Moody's status as a NRSRO. Obviously that
would be a nuclear option that would destroy the company. The SEC action sounds
like it is related to Moody's ratings of just one type credit product, so the
effects might be minimal.
Will the SEC go after the other rating agencies? or will
Moody's be the sacrificial lamb to warn the others?
Sources:
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