At Moody's, Some Debt Was Rated Incorrectly

Already under intense scrutiny for its role in the credit crisis, the Moody’s Corporation said Tuesday that some employees had violated its code of conduct in rating complex European securities.

The company said that it would discipline and possibly fire employees who had been involved in rating the debt, which are known as constant proportion debt obligations. Separately, Moody’s said it was replacing the executive, Noel Kirnon, who was in charge of its structured finance business at its subsidiary, Moody’s Investors Service. It would be the second high-profile executive departure announced by the company in less than two months.


The news comes as policy makers around the world are looking into how Moody’s , and its competitors, Standard & Poor’s and Fitch Ratings, gave high ratings to mortgage and related securities that turned out to be far riskier than their ratings would have implied and have cost the financial system hundreds of billons of dollars. The companies are the subject of several investigations in the United States and Europe.

Critics have asserted that Moody’s and its peers succumbed to pressures from investment banks that were packaging complex and risky debt during the credit boom earlier this decade. The rating firms are paid mainly by issuers of securities, and receive a relatively small percentage of their revenue from investors.

The attorney general of Connecticut, Richard Blumenthal, who has been investigating the rating firms, said Moody’s admission of incorrect debt obligation ratings was “just the tip of the iceberg.” His office is looking at how the firms dealt with investment banks, rated municipal bonds, and handled errors and mistakes.

“This company has far-reaching problems well beyond this one incident,” he said on Tuesday. “This action fails to address those problems.”

Shares of Moody’s fell 51 cents, to $33.93, down about 45 percent from July 2007. The tight credit market has hit the company hard; its first-quarter earnings were down more than 30 percent from the period a year ago.

In a statement, Moody’s said unidentified employees had violated a code that required analysts to consider only credit factors, not “the potential impact on Moody’s, or an issuer, an investor or other market participant.”

The problems affected 11 constant proportion debt obligations totaling about $1 billion. Instead of being rated triple A at the time that they were issued, the securities should have been rated double A, Moody’s said. The firm has removed its ratings on some of those securities and downgraded others to below investment grade, or junk.

Moody’s said an investigation conducted by its law firm, Sullivan & Cromwell, had not determined that employees changed the methodology for rating the securities to mask errors in computer models, as was suggested by a report in The Financial Times in May. But it blamed employees in charge of monitoring and adjusting ratings for considering “factors inappropriate to the rating process” after the errors were discovered.

“The integrity of our rating process is core to Moody’s values and is essential to the market,” Raymond McDaniel, the chairman and chief executive of Moody’s said in a written statement. “If an error occurs, it is crucial that rating committees consider possible rating changes and disclosures in an appropriate manner.”

Moody’s said it was replacing Mr. Kirnon, who will leave July 31, with Andrew E. Kimball, who was until recently the chief credit officer, on a temporary basis until a permanent successor is appointed. The company did not give a reason for the change in executives. Mr. Kirnon did not return a call to his office.

He will leave Moody’s about the same time as another top executive, Brian M. Clarkson. In May, Mr. Clarkson, president and chief operating officer at Moody’s Investors Service, said he would retire this month. Mr. Clarkson and Mr. Kirnon both came up through the fast-growing structured finance business, which rates securities backed by mortgages, auto loans and other debts.

Mr. Kirnon was appointed to head the structured finance business in September just as analysts were beginning to question the high ratings that had been assigned to constant proportion debt obligations by Moody’s and S.& P. Before his promotion, Mr. Kirnon was a senior managing director for global derivatives, managed funds and United States commercial real estate.

One former Moody’s analyst who has worked with Mr. Kirnon praised him and said he appeared to be taking the fall for mistakes made by others. “He was a very thoughtful and very competent analyst,” said the former analyst, Sylvain Raynes, a financial consultant who has been critical of the ratings firms.

A spokesman for Moody’s, Anthony Mirenda, declined to comment on Mr. Kirnon’s departure.

Last month, Standard & Poor’s acknowledged that it had discovered errors in the models it used to rate the debt obligations as well. But the company said the errors had not served to inflate its ratings of the securities.

Constant proportion debt obligations are a relatively new investment vehicle that sold insurance protection on corporate debt issued in Europe and the United States. Investors in the securities were essentially betting that companies would not default on their bonds and loans. If defaults occurred or the cost of insurance rose, as it did last year, investors in the security would suffer big losses.

Relatively few constant proportion debt obligations were issued before credit markets began freezing up last summer. Moody’s rated 44 European debt obligations, totaling about $4 billion.