From time to time, Moody’s is involved in legal and tax proceedings, governmental investigations, claims and litigation that are incidental to the Company’s business, including claims based on ratings assigned by MIS. Moody’s is also subject to ongoing tax audits in the normal course of business. Management periodically assesses the Company’s liabilities and contingencies in connection with these matters based upon the latest information available. Moody’s discloses material pending legal proceedings pursuant to SEC rules and other pending matters as it may determine to be appropriate.
Following the events in the U.S. subprime residential mortgage sector and the credit markets more broadly over the last two years, MIS and other credit rating agencies are the subject of intense scrutiny, increased regulation, ongoing investigation, and civil litigation. Legislative, regulatory and enforcement entities around the world are considering additional legislation, regulation and enforcement actions, including with respect to MIS’s compliance with newly imposed regulatory standards. Moody’s has received subpoenas and inquiries from states attorneys general and other governmental authorities and is responding to such investigations and inquiries. Moody’s Wall Street Analytics unit is cooperating with an investigation by the SEC and the Department of Justice concerning services provided by that unit to certain financial institutions in connection with the valuations used by those institutions with respect to certain financial instruments held by such institutions.
On July 1, 2008, Moody’s publicly announced the results of the Company’s investigation into the issues raised in a May 21, 2008 newspaper report concerning a coding error in a model used in the rating process for certain constant-proportion debt obligations. The Company’s investigation determined that, in April 2007, members of a European rating surveillance committee engaged in conduct contrary to Moody’s Code of Professional Conduct. On March 18, 2010, MIS received a “Wells Notice” from the Staff of the SEC stating that the Staff is considering recommending that the Commission institute administrative and cease-and-desist proceedings against MIS in connection with MIS’s initial June 2007 application on SEC Form NRSRO to register as a nationally recognized statistical rating organization under the Credit Rating Agency Reform Act of 2006. That application, which is publicly available on the Regulatory Affairs page of http://www.moodys.com, included a description of MIS’s procedures and principles for determining credit ratings. The Staff has informed Moody’s that the recommendation it is considering is based on the theory that MIS’s description of its procedures and principles were rendered false and misleading as of the time the application was filed with the SEC in light of the Company’s finding that a rating committee policy had been violated. MIS disagrees with the Staff that the violation of a company policy by a company employee renders the policy itself false and misleading and has submitted a response to the Wells Notice explaining why its initial application was accurate and why it believes an enforcement action is unwarranted.
The Wells Notice apparently relates to the Moody's admission back in July 2008 that:
...members of a European CPDO monitoring committee engaged in conduct contrary to Moody’s Code of Professional Conduct. Specifically, some committee members considered factors inappropriate to the rating process when reviewing CPDO ratings following the discovery of the model error. According to Moody’s Code of Professional Conduct, a committee may consider only credit factors relevant to the credit assessment and may not consider the potential impact on Moody’s, or on an issuer, an investor or other market participant.Translation: "Moody’s had wrongly bestowed triple-A ratings on billions of dollars of so-called constant proportion debt obligations." (Stacy-Marie Ishmael in FT Alphaville)
According to Henry Blodget:
Wells Notices are usually precursors to full SEC complaints (and most of them result in the agency going forward with charges). The SEC is preparing to file a "cease and desist". It's not clear how broad the threat is here. It might just require Moody's to re-file its application. If the action could be a "cease-and-desist from being a ratings agency," however, Moody's is potentially screwed.