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Regulation

Moody’s settles SEC charges over ratings symbols and RMBS rating errors

Moody's Investors Service will pay $16.25 million to settle charges that it used erroneous models and internal controls to rate residential mortgage-backed securities from 2010 to 2013, and that some of its rating symbol methodologies were deficient, the Securities and Exchange Commission said Tuesday.

The company did not admit or deny the findings and said in a statement that it is "pleased to have resolved these legacy matters, which reach back to 2010. Moody's Investors Service regularly reviews and refines its policies and procedures and is committed to maintaining strong controls around models used in the rating process."

Moody's will pay $15 million to settle SEC allegations that after Moody's revised its RMBS rating methodology in 2010 and incorporated cash-flow waterfall models developed by subsidiary Moody's Analytics, it failed to establish and follow proper internal controls. Under those models, terms of specific securities issuances such as RMBS are coded into computer script, and future cash flows for specific tranches of an RMBS transaction are projected. When "significant" coding errors were discovered in 2013, the company eventually began improving internal controls, but it had to correct more than 650 RMBS ratings with a notional value exceeding $49 billion, due in part to errors in the models, the SEC order said. In another 54 instances, the company failed to document rationales for deviating from its model, the order said.

Antonia Chion, SEC enforcement division associate director, said in a statement that the SEC had put Moody's on notice in 2010 about its internal controls obligations after separate reviews had turned up problems, "yet it did not develop an effective process to ensure the accuracy of the models."

Moody's also agreed to retain an independent consultant to recommend internal control improvements.

Moody's will also pay $1.25 million to settle charges that between June 2015 and April 2016 it applied inconsistent rating symbols for 26 ratings of securities known as "combo notes" with a total notional value of about $2 billion, and failed to ensure clearly defined and consistently applied ratings symbols. Combo notes are a type of resecuritization of collateralized loan obligations backed by portfolios of corporate loans that combine the unrated equity tranche and one or more rated debt tranches of a given CLO, and they do not have credit enhancements.

It is the SEC's first enforcement action involving universal ratings symbol rules mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act, which called for rating agencies to clearly define and disclose the meaning of any symbol used to denote a credit rating, and to apply them consistently for all types of securities and money market instruments. Reid Muoio, deputy chief of the SEC's complex financial instruments enforcement unit, said in the same statement that the SEC "will continue to pursue failures that render rating symbols unclear or inconsistent."