Ex-Moody's employee warned SEC about muni issues

[September 30, 2009]  WASHINGTON (AP) -- As Congress steps up scrutiny of the credit rating industry, allegations by another former employee of Moody's Investors Service have come to light and the big rating agency is being called to account before a House panel.

A former Moody's employee warned the Securities and Exchange Commission in March about deficiencies in the firm's monitoring of municipal bonds after being rebuffed by Moody's executives, a document shows.

Scott McCleskey, who was a senior vice president for compliance at Moody's until he left a year ago, wrote a letter to an official at the SEC alleging a "lack of meaningful surveillance of municipal securities, contrary to statements by Moody's to the public and to Congress."

McCleskey will testify Wednesday at a hearing by the House Government Oversight Committee, which is examining the role of the Wall Street rating agencies in the financial crisis and weighing regulatory changes to help prevent future blowups.

McCleskey's allegations add to the recent public complaint by another former Moody's analyst who said the firm continues to inflate its ratings and is gripped by conflicts of interest. The former analyst, Eric Kolchinsky, also will testify at the hearing.

Spokesmen for Moody's in New York had no immediate comment Tuesday evening. Richard Cantor, the chief risk officer of the agency's parent, Moody's Corp., and the chief credit officer of Moody's Investors Service, is scheduled to appear at the hearing as well.

The credit rating industry -- dominated by Moody's, Standard & Poor's and Fitch Ratings -- was widely criticized for failing to identify risks in securities backed by subprime mortgages, whose collapse touched off the financial crisis.

The agencies had to downgrade thousands of the securities last year as home-loan delinquencies soared and the value of those investments plummeted. The downgrades contributed to hundreds of billions in losses and writedowns at big banks and investment firms.

"Now, one year later, little has changed," Rep. Edolphus Towns, D-N.Y., chairman of the oversight panel, said in a statement Tuesday.

Another House panel, the Financial Services subcommittee on capital markets, is holding a hearing Wednesday on reform of credit rating agencies. An SEC official as well as high-ranking executives of Moody's, S&P and Fitch are scheduled to testify.

The agencies are crucial financial gatekeepers, issuing ratings on the creditworthiness of public companies and securities. Their grades can be key factors in determining a company's ability to raise or borrow money, and at what cost securities will be purchased by banks, mutual funds, state pension funds or local governments.

The SEC recently proposed rules designed to stem conflicts of interest and provide more transparency for credit rating agencies.

SEC spokesman John Nester said the agency "has established an examination program for credit rating agencies ... that includes reviews of disclosures, policies and procedures regarding municipal securities ratings."

"We are focusing carefully on the tips and complaints we receive and following up, where appropriate, with examinations targeting suspected problems," he said.

Regulators say they hope to spur more competition in the rating industry, with possibly new entrants -- as well as the other seven existing agencies -- challenging the dominant firms. One of the SEC's proposals would bar companies from "shopping" for favorable ratings of their securities, by requiring companies to disclose whether they had received preliminary ratings from other agencies.

McCleskey said in his March 12 letter to the SEC that in his position as a compliance officer, he became aware that Moody's did "virtually no surveillance" on public finance securities, the debt issued by states, counties, towns and school districts.

When he raised concerns to managers, he said, "My guidance was, to put it politely, ignored." In fact, at one point last year he and others were told in a meeting that they were forbidden to mention the issue in any e-mails or other written form, McCleskey said.

"Senior management at Moody's is well aware of these facts but is unwilling to make more than a token effort," he wrote.

Kolchinsky has said that Moody's knowingly assigned inaccurate ratings to complex securities this year. He told another executive of the firm in a detailed memo in August that he believed Moody's was engaging in illegal conduct.

The mounting regulatory pressure on Moody's and the other major credit rating agencies, meanwhile, appears to be making investors nervous.

Over the past few weeks, Moody's stock plummeted from a Sept. 16 high of $25.93 to $18.50 on Friday. The stock recovered some ground on Tuesday by gaining about 11 percent, to close at $20.81, but Moody's shares are still well below last September's 52-week high of $34.64.

Edward Atorino, an analyst with The Benchmark Co., said he thinks short sellers have been concentrating more on Moody's than the other credit ratings agencies, contributing to the stock's volatility.

"They're under just continued attack and it just doesn't seem to be going away," Atorino said.

[Associated Press; By MARCY GORDON]

AP Business Writers Josh Funk in Omaha, Neb., and Sara Lepro in New York contributed to this report.

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