Tuesday, May 27, 2008

SEC probing main credit rating agencies

(Reuters) - The U.S. Securities & Exchange Commission (SEC) is looking into the workings of the three main credit rating agencies, prompted by their handling of the subprime crisis and a report of computer errors at Moody's (MCO.N: Quote, Profile, Research).

"We sent letters to Moody's, Standard & Poor's and Fitch asking for them to get back to us on aspects of their methodology," said Erik Sirri, director of the SEC's trading and markets division.

"We asked them to explain the policies and procedures used to detect errors in ratings of structured finance products and to tell us about any errors that they found in structured finance products over the last four years, including steps that they followed to correct the problem," he added.

Rating agencies have come in for criticism for not giving early warning of a number of big corporate debt scandals, and also for their ratings of complex products that were hit hard by widespread defaults on U.S. subprime mortgages and the ensuing credit market crisis.

Supervisors have also drawn criticism for inadequate scrutiny of events.

SEC Chairman Christopher Cox had earlier told Reuters that his regulatory body had started an inquiry into Moody's, whose shares have plummeted over the last week on concerns that it may have made ratings errors.

"We have ample jurisdiction to look into this," said Cox.

"On June 11, the SEC will formally propose new rules concerning credit rating agencies," he added.

The Financial Times reported last week that Moody's had wrongly assigned triple-A ratings to complex European debt products called constant proportion debt obligations, or CPDOs.

Moody's said it rated 44 European CPDO tranches totaling about $4 billion. It said it had hired law firm Sullivan & Cromwell to conduct an investigation into why the coding error in a computer model caused the products to be given a rating four notches higher than they merited.

LONG-STANDING PROBLEMS

Cox, who was speaking on the sidelines of the 2008 International Organisation of Securities Commissions conference in Paris, said there were long-running problems concerning the rating agencies.

The agencies had already come under fire from 2001-2002 for not having spotted signs of problems at Enron and WorldCom, the U.S. utility and telecoms giants that went bankrupt after the publication of fraudulent accounts.

Cox said there were similarities between the rating agencies' decision to rate certain subprime assets with investment grade ratings and earlier decisions to give out similarly high ratings to assets that later proved worthless.

"In the largest municipal bankruptcy in American history, in Orange County (1994), we had the same problem of paper being rated very highly on the eve of collapse," said Cox.

"These problems are long-standing, and they need to be addressed."

Cox also reiterated that plans were under way for the SEC to tighten up its monitoring of the top five U.S. investment banks, following the collapse of Bear Stearns due to the subprime crisis.

The SEC currently monitors Morgan Stanley (MS.N: Quote, Profile, Research), Lehman Brothers (LEH.N: Quote, Profile, Research), Merrill Lynch & Co Inc (MER.N: Quote, Profile, Research), Goldman Sachs Group (GS.N: Quote, Profile, Research) and Bear Stearns as part of its consolidated supervised entities program.

"We are discussing with each of the firms various stress scenarios that include not only impairment of unsecured funding but also of secured funding," Cox said.

"We now live in a post Bear Stearns reality."

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