Moody’s Investors Service, Moody’s Analytics, and their parent, Moody’s, have reached a nearly $864 million settlement agreement with the Department of Justice, 21 states, and the District of Columbia to resolve allegations arising from Moody’s role in providing credit ratings for residential mortgage-backed securities and collateralized debt obligations.
The settlement includes a $437.5 million federal civil penalty—the second largest payment of this type ever made to the federal government by a ratings agency. The remainder will be distributed among the settlement member states in alignment with terms of the agreement.
In a statement in response to the settlement, Moody’s said it “determined that the agreement, which removes significant legacy legal risk and avoids costs and uncertainty associated with continued investigations and litigations, is in the best interest of the company and its shareholders. Moody’s stands behind the integrity of its ratings, methodologies and processes, and the settlement contains no finding of any violation of law, nor any admission of liability.”
The settlement follows an investigation by the Justice Department’s Consumer Protection Branch and the U.S. Attorney’s Office for the District of New Jersey into potential claims pursuant to the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) and investigations conducted by various State Attorneys General pursuant to state law.
“Our investigation revealed, and Moody’s has now acknowledged, that Moody’s used a more lenient standard than it had itself published,” Principal Deputy Assistant Attorney General Benjamin Mizer, head of the Justice Department’s Civil Division, said in a statement.
“Moody’s touted a particularly robust analytical framework for rating RMBS and CDOs,” said U.S. Attorney Paul Fishman for the District of New Jersey. “Moody’s now admits that it deviated from its methodologies and failed to disclose those changes to the public.”
Statement of facts. The multi-faceted settlement includes a statement of facts in which Moody’s acknowledges key aspects of its conduct and a compliance agreement to prevent future violations of law. The statement of facts addresses Moody’s representations to investors and the public generally about its objectivity and independence; its management of conflicts of interest; its compliance with its own stated RMBS and CDO rating methodologies and standards; and the analytic integrity of certain rating methodologies.
Among other things, Moody’s acknowledges in the statement of facts:
Moody’s published and maintained online its “Code of Professional Conduct” for the stated purpose of promoting the “integrity, objectivity, and transparency of the credit ratings process,” including managing conflicts of interest that it publicly acknowledged arose from the fact that RMBS and CDO issuers determined whether to retain Moody’s to rate these securities.
Moody’s acknowledges that it passed these conflicts on to the managing directors of the business units, who were then asked to resolve the “dilemma” between maintaining ratings quality and the need to win business from the issuers that selected them.
Moody’s publicly stated that its ratings “primarily address the expected credit loss an investor might incur,” which included its assessment of both the “probability of default” and the “loss given default” of rated securities.
Starting in 2001, Moody’s RMBS group began using an internal tool in rating RMBS that did not calculate the loss given default or expected loss for RMBS below Aaa and did not incorporate Moody’s own rating standards. Instead, the tool was designed to “replicate” ratings that had been assigned based on a previous model that calculated expected loss for each tranche and incorporated Moody’s rating level standards. In 2007, a senior manager in Moody’s Asset Finance Group (AFG) noted the following about Moody’s RMBS ratings derived from the tool: ‘I think this is the biggest issue TODAY. [A Moody’s AFG senior vice president and research manager]’s initial pass shows that our ratings are four notches off.”
Starting in 2004, Moody’s did not follow its published idealized expected loss standards in rating certain Aaa CDO securities. Instead, Moody’s began using a more lenient standard for rating these Aaa securities but did not issue a publication about this practice to the general market.
In 2005, Moody’s authorized the expanded use of this practice to all Aaa CDO securities and, in 2006, formally authorized the use of this practice, or of an even more lenient standard, to all Aaa structured finance securities. Throughout this period, although “[m]any arrangers and issuers were aware” that Moody’s was using a more lenient Aaa standard, Moody’s did not issue publications about these decisions to the general market.
The statement of facts further addresses other important aspects of Moody’s rating methodologies, including its “inconsistent use of present value discounts” in assigning CDO ratings and its selection of assumptions about the correlations between assets in CDOs.
Compliance commitments. Under the terms of the compliance commitments, Moody’s agrees to maintain a host of compliance measures designed to ensure the integrity of its credit ratings.
These include, but are not limited to:
Separation of Moody’s commercial and credit rating functions by excluding analytical personnel from any commercial related discussions and excluding personnel responsible for commercial functions from determining credit ratings or developing rating methodologies;
Independent review and approval of changes to rating methodologies by maintaining separate groups to develop and review rating methodologies;
Changes to ensure that specified personnel are not compensated on the basis of the company’s financial performance;
Enhancing Moody’s oversight functions to monitor the content of press releases and the timeliness of methodology development;
Deploying new technological platforms and centralized systems for documentation of rating procedures; and
Certifications of compliance by the president/CEO of Moody’s with these commitments for at least five years.
The states involved in the settlement include Arizona, California, Connecticut, Delaware, Idaho, Illinois, Indiana, Iowa, Kansas, Maine, Maryland, Massachusetts, Mississippi, Missouri, New Hampshire, New Jersey, North Carolina, Oregon, Pennsylvania, South Carolina and Washington as well as the District of Columbia.