Moody's Raters Violated Rules
Wednesday, July 2, 2008
Moody's, the world's second-largest credit-rating company, ousted the head of its structured-finance unit and said employees violated internal rules in assigning ratings to last year's worst-performing securities.
Noel Kirnon, 47, will leave after a company review showed that some staff members at Moody's Investors Service breached rules for ranking European constant proportion debt obligations, or bonds backed by derivatives, the company said in statements yesterday. Moody's awarded Aaa ratings to at least $4 billion of CPDOs, as the securities are known, before they lost as much as 90 percent of their value.
U.S. and European regulators are tightening rules for Moody's, Standard & Poor's and Fitch Ratings after the companies provided top grades to securities backed by U.S. subprime mortgages that sparked $400 billion of write-downs and losses on Wall Street. Moody's said that employees, not the company's practices, were to blame.
"Some of the investors getting involved with complex structured assets like CPDOs that relied on the agencies may not trust them again," said Steven Behr, global head of principal strategies at Royal Bank of Scotland Group in London. "They have a serious credibility issue in admitting to flaws."
Moody's began cutting its grades on CPDOs in September as losses on subprime mortgages spread across credit markets, causing investors to flee all but the safest government debt and driving up the cost of protecting against company risk.
In May, Moody's hired law firm Sullivan & Cromwell to conduct a review of its CPDO ratings. It found that personnel didn't make changes to the methodology for rating European CPDOs to mask any model error, Moody's said yesterday. The staff engaged in "conduct contrary to Moody's code of professional conduct," when considering whether to downgrade the securities after discovering the error, the ratings company said.
Under company guidelines, a committee may only "consider credit factors relevant to the credit assessment and may not consider the potential impact on Moody's, or on an issuer, an investor or market participant," Moody's said.
Some 11 CPDOs worth slightly less than $1 billion were affected by the error in the model, Moody's said. They would initially have been rated in the range of Aa, or one to three steps lower. The firm has since removed its rating on four of the deals after investors sold them back to the sponsor bank or reorganized them.
Employees involved face disciplinary proceedings that may include termination, Moody's said.
"I am deeply disappointed by the conduct that occurred in this incident," chief executive Raymond McDaniel said in a statement.