Monday, July 7, 2008

SEC Probe of Raters Uncovers `Significant Problems'

Classification: UNCLASSIFIED

By Jesse Westbrook and David Scheer

July 7 (Bloomberg) -- A U.S. Securities and Exchange Commission investigation into credit-rating companies found the firms improperly managed conflicts of interest and violated internal procedures in granting top rankings to mortgage bonds.

``The public will see that there have been significant problems,'' SEC Chairman Christopher Cox said in a Bloomberg Television interview today. ``There have been instances in which there were people both pitching the business, debating the fees and were involved in the analytical side.''

Pension and money-market funds bought AAA-rated securities backed by mortgages made to the riskiest borrowers because the instruments offered higher returns than government bonds with the same ratings. In many cases, credit raters were paid by the investment banks selling the bonds, prompting regulators and lawmakers to question their independence.

Credit raters were ``deluged with requests'' for ratings, leading to lapses, Cox said. ``The volume of work taxed the staffs in ways that caused them to cut corners, that caused them to deviate from their models.''

The SEC may release its findings as soon as this week, Cox said. The agency has been reviewing practices at firms such as Moody's Investors Service, Standard & Poor's and Fitch Ratings since September.

SEC spokesman John Nester declined to comment on whether any findings were referred to its enforcement division, which investigates and prosecutes wrongdoing. Examination reports don't typically describe findings at specific firms, he said.

Company Comments

S&P spokesman Edward Sweeney, Fitch spokesman David Weinfurter and Moody's spokesman Anthony Mirenda declined to comment.

Moody's said July 1 that an independent review found some employees violated internal rules when considering whether to downgrade debt securities whose ratings had previously been based on an error in its computer model. The inquiry found employees didn't change methodology to mask the error, it said. People involved may be subjected to disciplinary proceedings that include termination.

The SEC already has proposed a list of rules and other changes affecting credit ratings, including measures aimed at curbing conflicts of interest.

Last month, the agency acted to reduce investment firms' reliance on ratings by saying it may stop requiring money-market funds buy short-term debt carrying a high ranking. SEC commissioners also proposed rules that would bar credit raters from ranking a bond if they make recommendations to underwriters about how to gain a higher rating.

Ratings Rules

Additional rules under consideration include restricting gifts to credit-rating analysts from employees at investment banks and a requirement that companies label asset-backed securities using symbols different from the rankings placed on corporate and municipal debt.

A CFA Institute poll of almost 2,000 chartered financial analysts released today found that 11 percent said they saw a credit-rating company change its rating in response to pressure from an investor, issuer or underwriter. Fifty-five percent of respondents said credit-rating companies should be overseen by an independent regulator with enforcement


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