Wednesday, May 21, 2008

Moody’s launches review in wake of errors

(FT) Moody’s has initiated an external review of its ratings of $4bn of complex debt products after revelations that the agency had awarded incorrect ratings because of a bug in its computer models.

Charles Schumer, the New York senator, called Wedesday for the Securities and Exchange Commission to investigate the matter, which triggered a fall of 16 per cent in its share price. Mr Schumer also said, if a probe proved mistakes had occurred, that the US regulatory agency should impose “appropriate sanctions” in the form of fines. (see letter below)

The letter to Christopher Cox, SEC chairman, was in response to a report in Wednesday’s Financial Times that detailed how some senior staff at Moody’s knew in early 2007 that the ratings on products known as constant proportion debt obligations – complex derivative instruments conceived at the height of the credit bubble – had incorrectly received triple A ratings. Some of the CPDOs should have been rated up to four notches lower due to a computer coding error that was later corrected.

“The ratings inaccuracies that were disclosed are deeply troubling,” Mr Schumer wrote in a letter sent Wednesday. “However, the fact that Moody’s only downgraded these incorrectly rated products in January of 2008, nearly a full year after they became aware of the problem, is much worse, and is indicative of a culture of shirking responsibility that must end.”

Moody’s said Wedneday night: ”Moody’s recognizes the seriousness of questions raised by [the] Financial Times article concerning the analytical models and methodologies used in our European constant-proportion debt obligation ratings process.

“The integrity of our ratings and rating methodologies is extremely important; as such, when the questions were recently raised to us, we retained the law firm of Sullivan & Cromwell and initiated a thorough external review of our European CPDO ratings process. Upon completion of the review, we will promptly take any appropriate actions.”

Shares in Moody’s tumbled 16 per cent Wednesday in the wake of the news, dropping $6.99 to $36.91 – the biggest one-day fall since the agency was listed in 2000.

The SEC has already said it was not certain whether it had jurisdiction over the case.

Powerful democrat US senator Chuck Schumer wrote to SEC chairman Christopher Cox on Wednesday in light of the FT’s exclusive on Moody’s flawed rating of CPDOs. Schumer, who sits on the banking, housing and urban affairs committee of the Senate, and also the finance committee, called too for fines to be imposed on Moody’s.

May 21, 2008

Christopher Cox
Chairman
Securities and Exchange Commission
100 F Street, NE
Washington, DC 20549

Dear Chairman Cox,

I write today to urge you to take decisive action in response to the revelations about Moody’s incorrect ratings that were reported today in the Financial Times. The ratings inaccuracies that were disclosed are deeply troubling. However, the fact that Moody’s only downgraded these incorrectly rated products in January of 2008, nearly a full year after they became aware of the problem, is much worse, and is indicative of a culture of shirking responsibility that must end.

I urge you to fully investigate this matter and impose appropriate sanctions on Moody’s for their failure to disclose their ratings errors to the investor community. Although the products in question appear to be confined to the European markets, Moody’s actions in this case are further evidence that the ratings agencies do not have effective controls and procedures in place to monitor their own activities, which have broad implications for the U.S. financial markets and U.S.-based investors.

When you testified before the Senate Banking Committee last month, you discussed pending SEC rules to further implement the Credit Rating Agency Reform Act of 2006. I urge you to ensure that those rules will ensure that the rating agencies have strong internal controls to prevent these kinds of situations from happening, and when faced with a situation similar to the one Moody’s found itself in, to require the agencies to immediately and fully disclose the nature of their errors to the investment community.

Thank you for your consideration of this issue. I look forward to continuing to work with you as Congress and the SEC endeavor to reform the ratings process.

If you have any questions, please don’t hesitate to contact my staff at 202-224-6542.
Sincerely,

Charles E. Schumer
United States Senator

No comments: