Moody's may bear brunt of rating agency mistrust

NEW YORK (Reuters) - Rating agency Moody’s Corp may bear the brunt of regulatory scrutiny of the industry, after a former analyst sent congressional investigators a memo stating that the company knowingly assigned incorrect ratings to a security as recently as this year, according to a source familiar with the memo.

Moody’s, along with other major rating agencies McGraw-Hill’s Standard & Poor’s and Fimalac SA’s Fitch Ratings, are in regulators’ sights for fueling the two-year-old financial crisis by assigning high ratings to mortgage-backed securities. A House committee will hear testimony on ratings firm reform on Thursday.

While the three have all made changes in a bid to appease regulators, the allegations of the former analyst -- who will testify before the committee -- could prove a further blow to embattled Moody’s, which lately has seen its share price drop much faster than that of its peers after a slew of bad publicity.

Since the beginning of September, Moody’s shares have dropped 25 percent; McGraw-Hill is down 23 percent and Fimalac is up 1.4 percent.

The New York-based ratings company attracted more attention than its rivals after first declining to attend a hearing held by insurance regulators to discuss improving the ratings process. It later reversed the decision, but its shares fell 5.7 percent on Monday.

“It’s the kind of thing that just makes them look bad,” said James Gellert, chief executive of Rapid Ratings, a smaller rival to Moody’s that charges investors a fee for its research rather than charging issuers, as Moody’s, S&P and Fitch do.

Warren Buffett’s Berkshire Hathaway earlier this month trimmed its stake in Moody’s to 16.6 percent from 17 percent. The stake had been 20.4 percent in mid-July.

Moody’s shares closed down 8.4 percent on Tuesday at $20.49.


Adding to Moody’s difficulties, Eric Kolchinsky, a managing director at the company who has now been suspended, will tell the U.S. House Oversight and Government Reform Committee that Moody’s senior managers still favor revenue over ratings, according to testimony obtained by Reuters.

The firm’s credit policy group is weak and short-staffed and its analysts are “bullied” by managers who override their decisions to generate revenue, Kolchinsky said in the testimony.

“Moody’s is committed to upholding the highest standards of professional conduct and analytical integrity,” said Michael Adler, a spokesman for Moody’s in an emailed statement.

“Moody’s takes seriously all allegations of potential impropriety,” Adler wrote, adding that the company is reviewing Kolchinsky’s latest claims and will not comment on the reasons for his paid suspension.

The emergence of a whistle-blower, combined with the company’s reversal on its appearance at the insurers’ hearing, has led some industry experts to believe that Moody’s may attract more attention from regulators than its peers.

“There’s a marginal difference in degree of aggression,” said Joseph Mason, banking professor at Louisiana State University. “Moody’s is a little bit higher than S&P, who went into lock-down earlier, and Fitch is bringing up the rear as having committed fewer errors generally.”

Moody’s is also battling criticism from hedge fund manager David Einhorn, who questioned Lehman Brothers’ health four months before its collapse, and announced a short position against Moody’s at the end of May.

The share price, after reaching a high of $31.23 on May 8, has plummeted 34 percent, while other financial stocks have rallied. The KBW Banks index, for instance, is up 10 percent over the same period.

Of course, all three major rating agencies are under scrutiny and Moody’s has not been singled out. Einhorn told Reuters earlier this month he is also shorting Standard & Poor’s parent McGraw-Hill Cos Inc.

Securitization industry officials said all three companies have become more conservative in their ratings since regulators started to call for reforms and they see little difference between them.

But Kolchinsky’s testimony is likely to get regulators’ attention.

“I think a story like that affects Congress and regulators more than it affects people that use ratings agencies,” said Jason Kravitt, partner and founder of the securitization practice at law firm Mayer Brown in New York.

Reporting by Elinor Comlay and Rachelle Younglai, editing by Leslie Gevirtz