Moody’s avoids prosecution, on a technicality… | FT Alphaville

Moody’s avoids prosecution, on a technicality…

A feather (of sorts) in the cap of one Sam Jones.

The young, former Alphavillain wrote this for us two years ago:

FT Alphaville exclusive: Moody’s error gave top ratings to debt products

Moody’s awarded incorrect triple A ratings to billions of dollars worth of a type of complex debt product due to a bug in its computer models, an Financial Times investigation has discovered.

Internal Moody’s documents seen by the FT show that some senior staff within the credit agency knew early in 2007 that products rated the previous year had received top-notch triple A ratings and that, after a computer coding error was corrected, their ratings should have been up to four notches lower…

On Tuesday, the SEC finally released this:

The Securities and Exchange Commission today issued 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.

The SEC’s Report of Investigation stems from an Enforcement Division 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 says that because of uncertainty regarding a jurisdictional nexus between the United States and the relevant ratings conduct, the Commission declined to pursue a fraud enforcement action in this matter…

So, Moody’s only escaped prosecution for fraud because the relevant American legislation was defective – a shortcoming, the SEC notes, that has been expressly addressed in the newly-minted Dodd-Frank Wall Street Reform and Consumer Protection Act (or whatever it’s called this week).

You can read the full report here. In the meantime, here are some more trumpet-blowing extracts:

Late in the day on May 20, 2008, the Financial Times published on its Web site an article that disclosed the coding error, citing internal Moody’s documents that showed the error had been discovered by MIS almost a year earlier, and alleged that MIS had incorrectly awarded Aaa credit ratings to CPDO notes because of the error. When Moody’s was contacted by reporters gathering information for the story, the company began an internal investigation into the coding error and the CPDO rating committee conduct. On July 1, 2008, a year and a half after the coding error had been discovered, and over a year after the European rating committee had declined to downgrade the credit ratings, Moody’s issued a press release discussing the investigation results and stating that “some committee members considered factors inappropriate to the rating process when reviewing CPDO ratings following the discovery of the model error.” Thereafter, MIS took personnel action with respect to management of the CPDO group and members of the committee, including termination of the Group Managing Director and two Team Managing Directors…

…Further, we conclude that, in early 2007, members of the European rating committee believed they could violate MIS’s procedures without detection, and in fact the conduct did not come to light until the Financial Times contacted MIS about the error in the CPDO model and an investigation ensued…

Related links:
Full 15 article series on Moody’s CPDO rating error – FT Alphaville

You can follow Sam Jones, the FT’s hedge fund correspondent, on Twitter @samgadjones