Moody's launches inquiry after rating error report

By Richard Barley

LONDON (Reuters) - Moody's Investors Service, already under fire over its role in the U.S. mortgage crisis, took another blow on Wednesday as it launched an external investigation after a report that it wrongly assigned triple-A ratings to complex European debt products.

Shares of Moody's (MCO.N) closed almost 16 percent lower, the most ever in a single day, after the Financial Times said a coding error in a Moody's computer model caused the products to be given a rating four notches higher than they merited.

Moody's said in a statement it recently hired law firm Sullivan & Cromwell and initiated a "thorough external review" of its rating process for the securities and would take any appropriate actions after the review is completed.

The FT reported that internal Moody's documents the newspaper had obtained showed the agency had discovered the error early in 2007.

Moody's corrected the coding glitch at that time and instituted changes to its methodology, the FT said. But the products, called constant proportion debt obligations, or CPDOs, kept their triple-A rating until January 2008, when turmoil in financial markets worldwide led to hefty downgrades, the newspaper reported.

Moody's said in a statement it rated 44 European CPDO tranches totalling about $4 billion (2 billion pounds).

A Moody's spokesman said the company hired the law firm to conduct the review after it heard the FT's story was in the works.

"This is a serious hit," said Andrea Cicione, a credit strategist at BNP Paribas. "The FT is reporting that some people in (Moody's) have known about the problem since early 2007. Clearly the (ratings) should have been lowered."

Moody's said in an earlier statement on Wednesday that the company regularly changes its analytical models and methodologies for a variety of reasons. It said it has adjusted its models occasionally when errors have been detected.

"However, it would be inconsistent with Moody's analytical standards and company policies to change methodologies in an effort to mask errors," the statement said.

"The integrity of our ratings and rating methodologies is extremely important to us, and we take seriously the questions raised about European CPDOs. We are therefore conducting a thorough review of this matter."

CLASS ACTION LAWSUIT

Roger Kirby, a managing partner with law firm Kirby McInerney LLP in New York, said the outcome of Moody's inquiry may affect an existing class-action lawsuit against the rating company.

The Teamsters Local 282 pension fund is lead plaintiff in a case charging that Moody's stock prices were inflated due to withholding of important information or due to bad information about a company or ratings on debt, said Kirby, whose firm represents the plaintiffs.

"If it's proven to be true, this bears directly on charges that Moody's failed to tell the marketplace some very important information that had a direct bearing on its stock," Kirby said.