The SEC issued a report today under Section 21(a) of the Securities Exchange Act of 1934 "cautioning credit rating agencies about deceptive ratings conduct and the importance of sufficient internal controls over the policies, procedures, and methodologies the firms use to determine credit ratings." Under Section 21(a), the agency may investigate violations of the federal securities laws and at its discretion "publish information concerning any such violations."

The SEC's report, available here, follows the Enforcement Division's inquiry into whether rating agency Moody's Investors Service, Inc. (MIS) violated the registration provisions or the antifraud provisions of the federal securities laws. The SEC notes in the report that it decided not to bring an enforcement action against MIS because of "uncertainty regarding a jurisdictional nexus between the United States and the relevant ratings conduct." However, it found that

an MIS analyst discovered in early 2007 that a computer coding error had upwardly impacted by 1.5 to 3.5 notches the model output used to determine MIS credit ratings for certain constant proportion debt obligation notes. Nevertheless, shortly thereafter during a meeting in Europe, an MIS rating committee voted against taking responsive rating action, in part because of concerns that doing so would negatively impact MIS's business reputation.

When MIS subsequently applied in June 2007 to be registered with the SEC as a nationally recognized statistical rating organization (NRSRO), the "European rating committee's self-serving consideration of non-credit related factors in support of the decision to maintain the credit ratings constituted conduct that was contrary to the MIS procedures used to determine credit ratings as described in the MIS application to the SEC," the report states.

The report cautions NRSROs that, when appropriate, the SEC will pursue antifraud enforcement actions against deceptive ratings conduct. In a statement today, Enforcement Director Rob Khuzami added that

Investors rely upon statements that NRSROs make in their applications and reports submitted to the Commission, particularly those that describe how the NRSRO determines credit ratings. It is crucial that NRSROs take steps to assure themselves of the accuracy of those statements and that they have in place sufficient internal controls over the procedures they use to determine credit ratings.