Securities Regulation Daily Moody's settles charges of RMBS internal controls failures and ratings symbols deficiencies
Tuesday, August 28, 2018

Moody's settles charges of RMBS internal controls failures and ratings symbols deficiencies

By Rodney F. Tonkovic, J.D.

Moody's Investors Services has agreed to pay a total of $16.25 million in penalties to settle charges of internal controls failures and ratings symbols deficiencies. The SEC charged Moody's with failing to establish and document an effective internal control structure with regard to the models it used in its methodology for rating U.S. residential mortgage-backed securities (RMBS). Errors in these models led to Moody's correcting hundreds of ratings. Also, in the first SEC enforcement action involving rating symbol deficiencies, Moody's agreed to pay $1.25 million to settle charges that it assigned ratings to a type of securities known as "combo notes" in a way that was inconsistent with other types of securities that used the same rating (In the Matter of Moody's Investors Service, Inc.Release No. 34-83965 and Release No. 34-83966, August 28, 2018).

Model failures. According to the Commission, from 2010 to 2013, Moody's lacked an effective internal control structure regarding its use of certain models in its methodology for rating RMBS. During this time, Moody's had incorporated a cashflow waterfall model that had been developed by an affiliate. The firm, however, failed to apply its existing policies and procedures to oversee its outsourcing relationship with the affiliate. Moreover, Moody's failed to establish and document any internal controls over the waterfall models, instead relying on the affiliate and informal reviews by analysts who were not qualified to conduct quality control over the complex models.

As a result, the Commission found, Moody's failed to detect and prevent numerous errors in the models used in the credit rating process for RMBS. In early 2013, Moody's discovered coding errors in a group of models that caused it to correct over 650 ratings with a notional value exceeding $49 billion. It was only in late 2013, however, that Moody's took steps to establish an effective system of internal controls concerning the waterfall models. Additionally, in 54 instances, Moody’s failed to document its rationale for issuing final RMBS ratings that deviated materially from model-implied ratings.

Antonia Chion, Associate Director of the SEC’s Division of Enforcement, noted that Moody's had previously been put on notice about its internal controls obligations "yet it did not develop an effective process to ensure the accuracy of the models it relied upon when rating residential mortgage-backed securities." In addition paying a $15 million civil penalty, Moody's agreed to retain an independent consultant to assess and improve its internal controls.

Rating symbols. In a separate order, Moody's settled charges based on its failure to clearly define and consistently apply credit rating symbols. Here, the Commission found that Moody's issued and maintained ratings of a type of securities known as "combo notes" in a manner that was consistent with other types of securities that used the same rating symbols. While representing that it had policies and procedures designed to ensure consistent application of its rating symbols across all securities for which the symbols were used, as required by the Exchange Act, Moody's used a definition of "credit risk" with respect to the combo notes that did not adequately present what the rating did or did not address. During the relevant period, Moody's rated 26 combo notes with a total notional value of approximately $2 billion.

Moody's agreed to pay a $1.25 million civil penalty and to review its policies, procedures, and internal controls concerning its ratings symbols. Reid Muoio, Deputy Chief of the Enforcement Division’s Complex Financial Instruments Unit said that "Investors expect and the law requires that symbols used by rating agencies be clearly defined and consistently applied." He added: "Today’s proceeding is the SEC’s first enforcing the Universal Ratings Symbol requirement and we will continue to pursue failures that render rating symbols unclear or inconsistent."

The releases are No. 34-83965 and No. 34-83966.

Companies: Moody’s Investors Service, Inc.

MainStory: TopStory CreditRatingAgencies Enforcement NewYorkNews

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