Moody's investigated for alleged violations of federal securities laws
In a potentially ominous sign for credit ratings agencies, the SEC has disclosed that Moody’s Investor Services (MIS) narrowly avoided fraud-related enforcement action. The SEC issued a Report of Investigation following a query from its Division of Enforcement which focused on whether Moody’s violated the registration and/or antifraud provisions of federal securities laws.
In response to the investigation, the SEC released a report ‘cautioning credit rating agencies about deceptive ratings conduct and the importance of sufficient internal controls over the policies, procedures, and methodologies the firms use to determine credit ratings.’
Robert Khuzami, director of the SEC’s Division of Enforcement, explained in announcing the warning, ‘It is crucial that Nationally Recognized Statistical Ratings Organizations [NRSROs] take steps to assure themselves of the accuracy of those statements and that they have in place sufficient internal controls over the procedures they use to determine credit ratings.’
The report explains that the SEC declined to pursue the matter because of ‘uncertainty regarding a jurisdictional nexus between the United States and the relevant ratings conduct.’
It also highlights the fact that the Dodd-Frank Act expressly provides ‘that federal district courts have jurisdiction over SEC enforcement actions alleging violations of the antifraud provisions of the securities laws when conduct includes significant steps, or a foreseeable substantial effect, within the United States.’
It is alleged in the report that in early 2007, an analyst from Moody’s identified a computer error that resulted in several ratings of debt obligation notes being inappropriately upgraded between 1.5 and 3.5 notches. Despite this, shortly afterward during a meeting in Europe, an MIS rating committee voted against taking responsive rating action, in part because of concerns that doing so would negatively impact MIS’s business reputation.
Under Section 21(a) of the Securities Exchange Act of 1934, the SEC may investigate violations of the federal securities laws and at its discretion ‘publish information concerning any such violations’. As such, the report cautions NRSROs and ratings agencies that, ‘when appropriate, the Commission will pursue antifraud enforcement actions against deceptive ratings conduct, including actions pursuant to the Dodd-Frank Act provisions regarding conduct that physically occurs outside the United States but involves significant steps or foreseeable effects within the US.’
In addition to now being a regulated industry in the US, many ratings firms also fall under the purview of the European Regulation on Credit Rating Agencies, which was passed in April 2009.
