Former Moody’s Executives Criticize Firm’s Credit Rating Process

By | September 30, 2009

The former head of compliance overseeing Moody’s Corp.’s credit ratings business was routinely ignored when he warned that the firm was not properly monitoring municipal bond ratings, according to a letter obtained by Reuters Tuesday.

Scott McCleskey, who is scheduled to testify Wednesday at a House Oversight and Government Reform Committee hearing, said some high profile issuers, such as New York City, received periodic reviews. But he added that the vast majority of municipal bond issuers were hardly reviewed.

“I feel that in the current economic environment this failure could have far-reaching systemic consequences,” McCleskey said in a March 2009 warning letter to the U.S. Securities and Exchange Commission.

The SEC would not confirm whether it had received the letter.

McCleskey is one of two former Moody’s executives who have alleged that the credit agency favored revenues over ratings quality. Eric Kolchinsky, a recently suspended managing director at Moody’s, told Congress in testimony to be released Wednesday that analysts are “bullied” by managers who override their decisions to generate revenue.

McCleskey said he was Moody’s head of compliance until last September. While in that role, McCleskey said he became aware that virtually no surveillance was being performed on debt issued by states, counties and municipalities. In some cases, McCleskey said, bonds had not been reviewed for two decades since their original rating,

“I raised concerns about this, stating that at a minimum we needed to characterize such ratings as ‘point in time’ ratings so that investors did not assume that the stale ratings were still current,” the letter said. “My guidance was, to put it politely, ignored.”

In fact, McCleskey, whose title was senior vice president of compliance, said he was advised not to mention the issue in e-mails or any other written form.

“The decree… to avoid a paper trail is particularly disconcerting, but it is in character with the general approach of Moody’s to compliance,” the letter to the SEC said. “While I was there, I found that my guidance was routinely ignored if that guidance meant making less money.”

McCleskey said that the credit crisis prompted Moody’s to take steps to address the matter but that the size of the team was not adequate to properly look at all the municipal bond ratings.

Nonetheless, senior management was unwilling to tell the public that virtually all municipal securities ratings were out of date, contrary to their representations in congressional hearings and public statements, the letter said.

McCleskey was concerned that there was a real probability that there would be a wave of municipal defaults in the coming year.

“Investors may think they are holding investment grade bonds when in fact the issuer is teetering on the edge of bankruptcy,” the letter said.

McCleskey urged the SEC to rigorously review Moody’s and other credit rating agencies’ surveillance of municipal bond ratings.

A representative from Moody’s is expected to testify at the hearing. Calls to Moody’s were not immediately returned.

The House subcommittee on capital markets also will hold a hearing to examine the credit rating agencies and a draft bill that would expose the agencies to more liability. Top executives from the largest rating agencies McGraw-Hill’s Standard & Poor’s, Fimalac SA’s Fitch Ratings and Moody’s will testify.

SEC spokesman John Nester said: “The SEC has established an examination program for credit rating agencies registered with the commission 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,” Nester said.

(Reporting by Rachelle Younglai with additional reporting by Jonathan Stempel in New York; editing by Carol Bishopric)

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