The Securities and Exchange Commission continues ramping up its offense against the financial industry, as we learn this week that top rating agency Moody's Corp has been under investigation since at least March, though no charges have been filed yet. This news comes just weeks after the SEC announced a lawsuit against major investment bank Goldman Sachs for fraud. Should Moody's worry, or is the SEC just doing some image control?
Perhaps the SEC's recent approach to investigating banks and rating agencies could be better understood through a baseball analogy. Imagine the financial industry as the pitcher and the SEC as the batter. The ball was the crisis. The industry threw the pitch: it sailed past the SEC for a strike. The catcher then threw the ball back to the pitcher. Suddenly, the SEC realized it should swing, and did so. Twice now.
To say the SEC is a little late to diagnose the problems that led to the financial crisis would be kind. Saying it utterly failed in its oversight would be more accurate.
"The timing of this action suggests the SEC may be motivated by a desire to show a 'tough' approach to oversight of the rating agencies rather than by a particularly strong case against Moody's," Peter Appert, an analyst with Piper Jaffray & Co., said in a note to clients today. "The SEC action creates a new source of uncertainty."
Of course, if it actually has found some legitimate wrongdoing, then it could inflict some punishment. Bloomberg further explains the probable reason for the investigation:
Moody's ousted the head of its structured finance unit in 2008 after saying employees broke rules by failing to change the way constant proportion debt obligations were analyzed after discovering a fault in its rating model. Moody's awarded the top Aaa ratings to at least $4 billion of the securities, funds backed by credit-default swaps, before they lost as much as 90 percent of their value.
Two months later, it revealed a second error in the way it assessed the securities, which were sold by banks including ABN Amro Holding NV, JPMorgan Chase & Co. and Lehman Brothers Holdings Inc.
The SEC claims that Moody's made false and misleading statements regarding its rating policies, probably based on this. The regulator is in for a challenge, however: the rating agencies are notoriously difficult to beat in court. They are granted license to say almost whatever they want, due to their employment of First Amendment free speech. Whether that includes the freedom to say that you're doing a) when you're really doing b) is unclear.
But even if the SEC does manage to win, it might not have very significant implications says former lawyer with the regulator Elizabeth Nowicki:
The SEC notice said it is considering cease-and-desist proceedings against the company. That wouldn't likely affect Moody's business of assigning credit ratings, Nowicki said.
"It won't stop them from doing business. It will force them to be more candid about how they assign ratings," she said. "The cease-and-desist order might be the SEC affirmatively ordering Moody's to make better disclosures."
Moody's has likely already begun to do so in regard to the mistakes it made. After all, management was responsible for discovering the misrepresentation to begin with. But perhaps the SEC will order stricter requirements. What's highly unlikely? That Moody's loses its Nationally Recognized Statistical Rating Organization status. Given that it's either the first or second most important rating agency, such an action would seriously disrupt markets.