A slew of corporate scandals in recent years has prompted hundreds of companies to eliminate the appearance of conflicts of interest on their boards of directors. A notable exception: Moody's Corp.
Most of its board members serve as directors of companies it rates. The higher the rating, the cheaper it is for these companies to borrow money by issuing bonds.
Moody's Investors Service published in January 2003 a list of core principles designed to "protect the integrity, objectivity and timeliness" of the ratings process. Excerpts:
• "A Moody's rating is not the view of any one individual person, but rather the product of a rating committee that has taken a decision based on the consensus of its majority."
• "Free exchange of opinions will be encouraged and fostered ..."
• "Rating decisions should be consistent with" the company's rating policies and methodologies.
• Analysts who have a conflict of interest such as ownership of stock in a client firm "must be excluded" from a rating decision.
• "If non-public information is provided to a Moody's analyst by the issuer [of bonds], Moody's will not make the information itself public ..."
One case that illustrates the potential conflict involves Clifford L. Alexander Jr., former chairman of Moody's, parent of Moody's Investors Service, its rating division. He spent 19 years on the board of MCI Communications Corp., staying as a director through the long-distance company's growth and absorption by WorldCom Inc.
Alexander resigned from WorldCom's board in December 2001, about six months before it went bankrupt. Moody's had long maintained a solid investment-grade rating on WorldCom, which has since reverted to its old name, MCI. Even while bond traders were selling WorldCom at "junk" levels, an indication of financial trouble, Moody's continued to give the telephone giant a high rating about four months after Alexander's departure.
Moody's cut the telephone company to junk status that May. About a month later, WorldCom fired its chief financial officer after discovering nearly $4 billion in improper accounting. WorldCom subsequently filed the largest bankruptcy in U.S. history, and stock and bond investors lost several billion dollars.
In 1999, Alexander exercised stock options in the company worth more than $1.7 million, according to public records. At the same time, he sold shares worth nearly $692,000. Alexander said he also lost $460,000 in WorldCom investments last year. In October 2003, Alexander retired from Moody's.
Alexander said he played no role in WorldCom's ratings. "At no time did I in any way talk to anyone or do anything that would attempt to influence any rating," he said in an interview.
Moody's president, Raymond W. McDaniel Jr., said: "The board has nothing to do with our professional ratings practices. They are not involved in individual rating actions."
As proof, Moody's analyzed its ratings in response to questions from The Washington Post. In cases where its directors serve on companies rated by Moody's, the credit rater found its ratings are in line with industry trends. Moody's also said its ratings are higher than S&P in five cases, lower in two and the same in eight.
Some industry observers say the board's affiliations present at least an appearance of a conflict of interest.