Moody's Whistleblowers Allege Misconduct

A member of the U.S. House of Representatives walks up the House steps on his way to vote on the Emergency Economic Stabilization Act of 2008 on Monday, Sept. 29, 2008 on Capitol Hill in Washington. (AP Photo/Lauren Victoria Burke)
AP Photo/Lauren Victoria Burke
Two former Moody's Investors Service employees detailed allegations of misconduct at the big ratings firm as U.S. lawmakers took aim at a credit rating 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 on Wednesday questioned a high-level Moody's executive, who denied the former employees' claims.

At the same time, some lawmakers warned the public to watch for new moves by the rating agencies on emerging investments they said could spark the next financial blowup.

"They could be setting us up for the same thing all over again," said Rep. Dennis Kucinich. He said the recent emergence of Re-Remics, repackaged securities backed by commercial properties sold as new products, and the agencies' ratings of them, are troubling.

Congress is escalating its scrutiny of the Wall Street rating industry, dominated by Moody's, Standard & Poor's and Fitch Ratings. The industry was widely criticized for failing to identify risks in securities backed by subprime mortgages, whose collapse touched off the financial meltdown.

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.

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 Rep. Paul Kanjorski, who is critical of perceived conflicts of interest in the rating industry, 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 said she found that "shocking."

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