Credit rating agency Moody’s Investors Service has agreed to pay a total of $16.25 million in penalties to settle charges involving internal control failures and failing to clearly define and consistently apply credit rating symbols. It is the first time the Securities and Exchange Commission has filed an enforcement action involving rating symbol deficiencies.

Moody’s agreed to pay $15 million to settle charges of internal controls failures involving models it used in rating U.S. residential mortgage-backed securities (RMBS) and will retain an independent consultant to assess and improve its internal controls. Moody’s separately agreed to pay $1.25 million and to review its policies, procedures, and internal controls regarding rating symbols. Moody’s did not admit or deny the SEC’s charges.

According to the SEC’s order in the internal controls proceeding, Moody’s failed to establish and document an effective internal control structure as to models that Moody’s had outsourced from a corporate affiliate and used in rating RMBS from 2010 through 2013. Moreover, Moody’s failed to maintain and enforce existing internal controls that should have been applied to the models. 

Ultimately, Moody’s corrected more than 650 RMBS ratings with a notional value exceeding $49 billion, due, in part, to errors in the models. Also, in 54 instances, Moody’s failed to document its rationale for issuing final RMBS ratings that deviated materially from model-implied ratings, the SEC said.

“Rating agencies play a critical role in our capital markets and need to have effective controls over their rating processes,” Antonia Chion, associate director of the SEC’s Division of Enforcement, said in a statement. “As our order notes, the SEC put Moody’s on notice about its internal controls obligations, yet it did not develop an effective process to ensure the accuracy of the models it relied upon when rating residential mortgage-backed securities.”

In the SEC’s order relating to rating symbols, for 26 ratings of securities known as “combo notes” with a total notional value of about $2 billion, Moody’s assigned ratings to combo notes in a manner that was inconsistent with other types of securities that used the same rating symbols.  

“Investors expect and the law requires that symbols used by rating agencies be clearly defined and consistently applied,” said Reid Muoio, deputy chief of the Enforcement Division’s Complex Financial Instruments Unit. The SEC’s proceeding is its first to enforce the Universal Ratings Symbol requirement, “and we will continue to pursue failures that render rating symbols unclear or inconsistent,” Muoio said.

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