SEC won't pursue Moody's fraud case

By Zachary A. Goldfarb
Washington Post Staff Writer
Wednesday, September 1, 2010

Moody's, one of three major credit-rating firms that misjudged many of the securities at the center of the financial crisis, escaped legal action Tuesday when federal regulators said they would not sue the company for fraud despite finding evidence that the firm misled investors.

The Securities and Exchange Commission said Moody's executives discovered they had issued overly optimistic ratings but decided not to correct them out of concern that "downgrades could negatively affect Moody's reputation."

The SEC said it chose not to file suit because of "jurisdictional" limitations. The activities at the center of the SEC investigation took place in Europe, beyond the agency's reach at the time.

But the agency said it might have made a different decision under the terms of the legislation enacted this summer to overhaul financial regulations. The bill gave the SEC the power to sue credit-rating firms engaged in "otherwise extraterritorial fraudulent misconduct."

"Moody's is pleased that this matter has been resolved and that the commission determined the investigation should be closed without pursuing any enforcement action," Michael Adler, a Moody's spokesman, said Tuesday.

The SEC seldom issues a report when it concludes an investigation without taking action. But agency officials said they wanted to send a message in reviewing their findings in the Moody's probe that credit-rating firms would face increased scrutiny.

The SEC's release of the report was one of the most significant steps regulators have taken to shed light on the conduct of credit-rating firms in the years leading up to the financial crisis.

The big three firms - Moody's, Standard & Poor's and Fitch Ratings - have faced far less regulatory and legal action than banks and other financial firms implicated in the meltdown. Federal regulators haven't sued any of the credit-rating firms. And the new financial regulatory law does not require an overhaul of the industry.

In the years leading up to the crisis, these firms issued letter grades to the complex securities that later contributed to the meltdown. In many cases the firms gave high grades to securities that turned out to be excessively risky, such as subprime mortgage-backed securities that received the highest AAA rating.

Congressional investigators have revealed that some employees of the credit-rating firms knew they were giving high grades to overly risky securities. Regulators also have warned that the firms may have been more interested in generating fees from banking clients who paid for securities to be rated than in offering an unbiased assessment.

At the same time, though, the credit-rating firms have enjoyed a privileged status with federal agencies. Regulators often make use of credit ratings to assess the financial health of banks and other financial firms and put limits on what they can do.

Credit-rating agencies, for their part, say they have revamped how they operate. They also say that they are simply issuing opinions on the quality of securities and that investors should not rely solely on their judgments.

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