The United States Securities and Exchange Commission (SEC) has issued
a report cautioning credit rating agencies about their ratings conduct and the
importance of sufficient internal controls over the policies, procedures, and
methodologies the firms use to determine credit ratings.
The SEC's report stems from an inquiry into whether Moody's Investors
Service, Inc. (MIS), the credit rating business segment of Moody's Corporation, violated the registration provisions or the antifraud provisions of the federal
securities laws.
The report notes that the recently-enacted Dodd-Frank Wall Street Reform and
Consumer Protection Act amended the securities laws to require nationally recognized
statistical rating organizations (NRSROs) to "establish, maintain, enforce,
and document an effective internal control structure governing the implementation
of and adherence to policies, procedures, and methodologies for determining
credit ratings."
"Investors rely upon statements that NRSROs make in their applications
and reports submitted to the SEC, particularly those that describe how the NRSRO
determines credit ratings," said Robert Khuzami, Director of the SEC's
Division of Enforcement. "It is crucial that 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."
According to the report, an MIS analyst discovered in early 2007 that a computer
coding error had upwardly impacted by 1.5 to 3.5 notches the model output used
to determine MIS credit ratings for certain constant proportion debt obligation
notes. Nevertheless, shortly thereafter 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.
In the report, the SEC makes clear that credit rating agencies registered with
the SEC must implement and follow appropriate internal controls and procedures
governing their determination of credit ratings, and must also take reasonable
steps to ensure the accuracy of statements in applications or reports submitted
to the SEC.
The report cautions NRSROs that, when appropriate, the SEC 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.
The SEC has acknowledged the assistance and cooperation of foreign regulatory
authorities in Europe in this investigation but the report says that, because
of uncertainty regarding a jurisdictional nexus between the US and the relevant
ratings conduct, the SEC has declined to pursue a fraud enforcement action.
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