The Department of Justice, 21 states, and the District of Columbia, reached a nearly $864 million settlement agreement with Moody’s Investors Service Inc., Moody’s Analytics Inc., and their parent, Moody’s Corporation (collectively, Moody’s). The settlement resolved allegations arising from Moody’s role in providing credit ratings for residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDO), contributing to the worst financial crisis since the Great Depression.
During the years leading up to the financial crisis, Moody’s was a nationally recognized statistical ratings organization. For a fee, Moody’s issued alphanumeric credit ratings of structured finance instruments, including RMBS and CDOs. Moody’s also issued credit ratings of corporate bonds and other types of structured finance instruments, financial and non-financial entities, and governments, among other things.
The settlement agreement resolved pending state court lawsuits in Connecticut, Mississippi, and South Carolina, as well as potential claims by the Justice Department, 18 states and the District of Columbia. The multi-faceted settlement included a statement of facts in which Moody’s acknowledged key aspects of its conduct, and a compliance agreement to prevent future violations of law.
Statement of Facts. The statement of facts addressed Moody’s representations to investors and the public generally about: 1) its objectivity and independence; 2) its management of conflicts of interest; 3) its compliance with its own stated RMBS and CDO rating methodologies and standards; and 4) the analytic integrity of certain rating methodologies.
The statement of facts addressed whether Moody’s credit ratings were compromised by what Moody’s itself acknowledged were the conflicts of interest inherent in the so-called "issuer pay" model, under which Moody’s and other credit rating agencies were selected by the same entity that put together and marketed the rated securities and therefore stood to benefit from higher credit ratings.
Among other things, Moody’s acknowledged:
- Moody’s published and maintained online its "Code of Professional Conduct" for the stated purpose of promoting the "integrity, objectivity, and transparency of the credit ratings process, " including managing conflicts of interest that it publicly acknowledged arose from the fact that RMBS and CDO issuers determined whether to retain Moody’s to rate these securities.
- Moody’s passed these conflicts on to the managing directors of the business units, who were then asked to resolve the "dilemma" between maintaining ratings quality and the need to win business from the issuers that selected them.
- Moody’s publicly stated that its ratings "primarily address the expected credit loss an investor might incur, " which included its assessment of both the "probability of default" and the "loss given default" of rated securities.
- Starting in 2001, Moody’s RMBS group began using an internal tool in rating RMBS that did not calculate the loss given default or expected loss for RMBS below Aaa and did not incorporate Moody’s own rating standards. Instead, the tool was designed to "replicate" ratings that had been assigned based on a previous model that calculated expected loss for each tranche and incorporated Moody’s rating level standards. In October 2007, a senior manager in Moody’s Asset Finance Group (AFG) noted the following about Moody’s RMBS ratings derived from the tool: "I think this is the biggest issue TODAY. [A Moody’s AFG Senior Vice President and research manager]’s initial pass shows that our ratings are 4 notches off."
- Starting in 2004, Moody’s did not follow its published idealized expected loss standards in rating certain Aaa CDO securities. Instead, Moody’s began using a more lenient standard for rating these Aaa securities but did not issue a publication about this practice to the general market.
- In 2005, Moody’s authorized the expanded use of this practice to all Aaa CDO securities and, in 2006, formally authorized the use of this practice, or of an even more lenient standard, to all Aaa structured finance securities. Throughout this period, although "[m]any arrangers and issuers were aware" that Moody’s was using a more lenient Aaa standard, Moody’s did not issue publications about these decisions to the general market.
The statement of facts further addressed other important aspects of Moody’s rating methodologies, including its "inconsistent use of present value discounts" in assigning CDO ratings and its selection of assumptions about the correlations between assets in CDOs.
Compliance commitments. Under the terms of the compliance commitments, Moody’s agreed to maintain a host of measures designed to ensure the integrity of its credit ratings. These include:
- Separation of Moody’s commercial and credit rating functions by excluding analytical personnel from any commercial related discussions and excluding personnel responsible for commercial functions from determining credit ratings or developing rating methodologies;
- Independent review and approval of changes to rating methodologies by maintaining separate groups to develop and review rating methodologies;
- Changes to ensure that specified personnel are not compensated on the basis of the company’s financial performance;
- Enhancing Moody’s oversight functions to monitor the content of press releases and the timeliness of methodology development;
- Deploying new technological platforms and centralized systems for documentation of rating procedures; and
- Certifications of compliance by the President/CEO of Moody’s with these commitments for at least five years
Penalties. In addition to the non-monetary measures, such as the compliance commitments, the settlement includes a $437.5 million federal civil penalty, which is the second largest payment of this type ever made to the federal government by a ratings agency. The remainder, over $426 million, will be distributed among the settlement member states in alignment with terms of the agreement, as compensation for the harm they suffered as a result of Moody’s conduct.
Companies: Moody’s Investors Service Inc.; Moody’s Analytics Inc.; Moody’s Corp.
MainStory: TopStory CreditRatingAgencies Enforcement FraudManipulation
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