Moody's Dodges The SEC Bullet On Inflated Ratings Issue

The management and investors of Moody’s Investment Services can breathe a sigh of relief. The SEC will not pursue charges against the company for its inflation of the ratings on a number of securities including mortgage-backed paper. Moody’s and its competitors at S&P and Fitch gave Aaa ratings on derivatives which defaulted in large numbers as the housing crisis deepened. That, in turn, cause a large part of the credit crisis that nearly took the US financial system down.

The SEC said it decided not to pursue action “because of uncertainty regarding a jurisdictional nexus between the United States and the relevant ratings conduct.” The agency added “the Commission declined to pursue a fraud enforcement action in this matter.” As an alternative, The SEC is 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.

Put another way, the SEC slapped the hands of the three firms and warned them against future behavior that would mirror their ratings systems actions before the credit crisis.

The decision does not prevent investors in mortgage securities or shareholders in Moody’s from pursuing legal actions, but those pale in comparison to a protracted fight with the SEC.

The action has to be seen as another blow to the SEC’s reputation which has been badly damaged by a string of events which include its tardiness to investigate Bernie Madoff, the rejection of its initial settlement with the Bank of America (NYSE: BAC) over compensation packages paid while it acquired Merrill Lynch, and what many consider a modest $500 million fine of Goldman Sachs Group (NYSE: GS) after the blue-chip bank faced fraud charges.

There is hardly any question that Moody’s actions did a huge amount of financial damage to its customers and the clients of those firms. Both the SEC and Congress went to great lengths to examine Moody’s behavior. At the end of the day, despite a great deal of evidence to the contrary, each body came up with nothing.

Douglas A. McIntyre