A key U.S. lawmaker wants to make credit rating agencies — which have been criticized for failing to give investors adequate warning of the risks in subprime mortgage securities — responsible for each other's assessments by holding them collectively liable for inaccuracies.
Pennsylvania Democrat Paul Kanjorski's new draft bill includes a plan meant to address what critics contend is the crux of the current system's problem: companies that issue securities — as opposed to investors — pay the agencies for ratings of those securities.
Raymond McDaniel, chairman and CEO of Moody's Corp., said the company supported enhanced regulatory oversight of the industry. But imposing collective liability could increase the number of meritless lawsuits over unhappiness with ratings and create an unpredictable business environment, he told the lawmakers Wednesday.
Kanjorski, chairman of a House Financial Services subcommittee, contends that establishing collective liability could spur the powerful rating agencies — Moody's Investors Service, Standard & Poor's and Fitch Ratings — "to police one another and release reliable, high-quality ratings."
"This is the start of a process," he said at a subcommittee hearing. Kanjorski's draft also includes Obama administration proposals to tighten government oversight of the rating industry, as part of the effort to overhaul the nation's financial rules.
Congress is escalating its scrutiny of the Wall Street rating industry as well as closely examining possible legislative changes to reshape the business.
Alleged misconduct
At another House hearing, two former Moody's employees detailed allegations of misconduct at the big ratings firm as lawmakers took aim at an industry they condemned as rife with conflicts of interest and needing reform.
Seeking accountability for the role of the ratings industry in the financial crisis, members of the House Oversight and Government Reform Committee questioned a high-level Moody's executive, who denied the former employees' claims.
The rating 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.
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.
Moody's Chief Credit Officer Richard Cantor acknowledged that the firm misjudged the extent of the subprime mortgage disaster, but said it has voluntarily made improvements to its operations and transparency over the past year.
Appearing at the hearing next to the two former Moody's insiders, Cantor said the allegations of inflated ratings and conflicts of interest at the firm leveled by ex-analyst Eric Kolchinsky are groundless.
Moody's reviewed the complaints by Kolchinsky, who was suspended from his job, and found them to be "unsupported," Cantor testified. He said Kolchinsky has refused to cooperate with Moody's inquiry into the matter.
Kolchinsky told lawmakers he believed Moody's violated securities laws by issuing credit ratings the firm knew to be inaccurate. "They still went forward and issued the rating," he said.
The Securities and Exchange Commission only contacted him last week on the matter, Kolchinsky said.
‘Troubling behavior’
SEC spokesman John Nester said Tuesday 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.
The House panel's chairman, New York Democrat Edolphus Towns, said the allegations, if true, "indicate troubling behavior" in the credit rating industry.
But Kanjorski was less impressed by the Moody's insiders' allegations.
"I didn't hear anything terribly shocking," he said, asserting they presented no evidence of fraud or "real gross neglect or negligence" by Moody's.
The other former Moody's employee, who was responsible for compliance, warned regulators in March about what he said were deficiencies in the firm's monitoring of municipal bonds.
Scott McCleskey, who was a senior vice president for compliance at Moody's until he left a year ago, wrote a letter to the SEC alleging a "lack of meaningful surveillance of municipal securities, contrary to statements by Moody's to the public and to Congress."
McCleskey told the SEC he became aware that New York-based 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, his views were ignored. 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.
Although he was responsible for compliance, McCleskey said he was excluded from meetings with SEC examiners — who met only with staff from Moody's legal department and outside attorneys. Rep. Marcy Kaptur, an Ohio Democrat, said she found that "shocking."
An SEC official and high-ranking executives of Moody's, S&P and Fitch are scheduled to testify at the Financial Services panel's hearing. S&P is owned by McGraw-Hill Cos. Inc.
The SEC recently proposed rules designed to stem conflicts of interest and provide more transparency for credit rating agencies. 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.