SEC investigating Moody's, sending stock price down

McClatchy NewspapersMay 10, 2010 

WASHINGTON — While the Dow Jones Industrial Average rose almost 4 percent Monday, share prices for Moody's Corp. tumbled 6.807 percent as investors digested confirmation of a Securities and Exchange Commission investigation into the credit-rating agency.

The fall in Moody's share value of to $21.77, down $1.59, dragged down its chief competitor, Standard & Poor's, part of McGraw-Hill Companies, which fell almost 4 percent.

Investors rely on ratings agencies to determine whether a bond or complex security is considered investment grade. These companies are now in the crosshairs of Congress and regulators for their role in the biggest financial crisis since the Great Depression.

In a quarterly report filed late Friday to the SEC, Moody's quietly disclosed that its Wall Street Analytics unit is cooperating with an investigation by the SEC and the Department of Justice into "certain financial institutions" and the valuations used in "certain financial instruments."

A Moody's spokesman declined to discuss the companies involved in the probe or whether one is Goldman Sachs, whose complex products rated by Moody's were the subject of recent congressional hearings.

The SEC brought civil fraud charges against Goldman last month for failing to disclose the details of one complex deal to investors, and the Department of Justice has opened an investigation, but the Moody's disclosure points to a probe into how securities were valued, not what was disclosed about them.

In late 2006, Moody's acquired Wall Street Analytics, which analyzes complex financial instruments involving loans or parts of loans that are bundled together for sale to investors.

A McClatchy investigation last October and subsequent congressional hearings this year revealed how Moody's packaged ratings on complex bonds without due regard for their investment quality, in exchange for huge fees from Wall Street banks.

Under Moody's Code of Professional Conduct for ratings agencies, McClatchy has learned, the firm's office of compliance is responsible for ensuring that proper policies and procedures are followed.

However, in congressional testimony last year, Scott McCleskey, then Moody's compliance officer, told lawmakers that he routinely was excluded from matters in his office's domain, and that he sometimes was told not to put potentially damaging information in writing, where it wouldn't be protected by attorney-client privilege.

In the quarterly report, Moody's said the SEC also was investigating how the company dealt with a significant ratings error in Europe.

Moody's spokesman Anthony Mirenda told McClatchy on Monday that the probe arose from a spring 2008 article by the Financial Times alleging that Moody's masked an error in rating a complex European bond.

Rather than have its own compliance office investigate, however, Moody's hired Wall Street law firm Sullivan & Cromwell to pursue the newspaper's allegation, which allowed it to maintain attorney-client privilege if litigation resulted.

The law firm disproved the allegation, Mirenda said, but it found that a Moody's European ratings surveillance committee had violated the internal Code of Professional Conduct. This information was shared with regulators and made public on July 1, 2008, he said.

"At the time, we reported the incident to regulators and initiated disciplinary proceedings against these employees, including terminations. We have responded to all of the requests and communications on this matter by the SEC staff and will continue to do so," Mirenda said.

Former compliance chief McCleskey confirmed to McClatchy that neither he nor his department probed the allegations the Financial Times raised or the subsequent discovery of internal violations.

Moody's also confirmed that it received a "Wells Notice" from the SEC on March 18 notifying the company that it's the subject of a probe and faces a staff-recommended administrative cease-and-desist order.

The SEC thinks the error in the European ratings rendered Moody's application in June 2007 to register as a nationally recognized statistical organization "false and misleading."

"I cannot confirm or deny," SEC spokesman John Heine said, saying the agency comments only if charges are brought.

The McClatchy investigation last year found that officials such as McCleskey were pushed aside or out and replaced by executives from the high-profit division that rated complex deals for Wall Street banks, who took over most senior executive positions.

Last month's Senate hearings showed how Moody's and S&P gave favorable investment-grade ratings to complex bonds and ignored analysts' concerns that underlying loans were of poor quality.

Moody's CEO Raymond McDaniel acknowledged to senators that he was unaware that his company had continued to give investment-grade ratings to complex deals in December 2007, just months after a massive downgrade of similar deals worth billions of dollars.

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