Connecticut Attorney General's Office
Attorney General Submits Congressional Testmony Branding Rating Agencies “Enablers Of Wrongdoing,” Calling For Reform
April 23, 2010
Attorney General Richard Blumenthal in Congressional testimony today branded financial rating agencies “enablers of wrongdoing” for purposely skewing their ratings of financial instruments to please big clients and called for sweeping reform.
Blumenthal submitted his testimony to the U.S. Senate’s Permanent Subcommittee on Investigations. He did not attend the hearing in Washington D.C.
Blumenthal sued Moody’s and S&P last month accusing them of awarding top ratings to securities they knew were very risky in order to earn large fees. Blumenthal repeated those allegations in his testimony, accusing the two agencies of deceiving investors and helping cause the financial meltdown.
“The rating agencies have been enablers of the wrongdoing that brought our nation to the brink of economic catastrophe,” Blumenthal said in his testimony. “The harm caused by this catastrophic failure was not just borne by the rich. In addition to financial institutions and hedge funds, structured finance securities are found in the portfolios of pension funds of schoolteachers, policemen, factory workers; hardworking average Americans who count on these investments to fund their future. Essentially, these credit rating agencies gave the best ratings money could buy, thus serving their powerful investment banking clients rather than objectively rating risky securities.
“Moody’s and S&P are aware of investors and other market participants’ reliance on their ratings of structured finance securities and encourage this reliance by making repeated public representations assuring the independence and objectivity of their analysis. Indeed, Moody’s and S&P take every opportunity to proclaim that their ratings are objective, independent, and not influenced by either their own or their clients’ financial interests. These statements of independence and objectivity are simply untrue, and Moody’s and S&P know it.
“Specifically, as far back as 2001, Moody’s and S&P knowingly catered to the demands of investment banks and other large issuers of structured finance securities in order to increase their own revenues. As a result, many risky structured finance securities undeservedly received Moody’s and S&P’s highest ratings.”
Blumenthal noted that financial instruments at the center of the Securities and Exchange’s (SEC) recent lawsuit accusing Goldman Sachs of fraud were given the highest rating by both Moody’s and S&P. The SEC alleges that the underlying securities were selected precisely because they were so risky and that, unbeknownst to investors, the instrument was designed to fail. Despite investment grade ratings, within months of issuance, the instrument, called ABACUS, was nearly worthless.
“ABACUS is just one of several significant examples of the credit rating agencies’ dismal and deceptive conduct,” Blumenthal said. “In the absence of meaningful and systematic reform, our country will be left with more of these ticking time bombs, likely culminating in another financial crisis.”
Blumenthal called on Congress to compel the agencies to reform.
“The credit rating agencies have been allowed to claim immunity for their willful misconduct for far too long,” Blumenthal said. “Accountability is what I encourage the subcommittee to foster and the lawsuits filed by my office seek to provide.”
Blumenthal said the rating agencies’ “issuer pays” business model is fatally flawed and must be discarded. That model created severe conflicts of interest that led the agencies to abandon objective ratings to maximize profit.
“With ‘Issuer Pays,’ Moody’s and S&P -- in order to maintain their revenue, high profit margins, and win new business -- have to continually please the large issuers of structured finance securities, who are their repeat customers and collectively account for a large percentage of both companies’ revenue,” Blumenthal said. “As my investigation and others show, Moody’s and S&P decided that the best way to please issuers of structured finance securities was to weaken criteria for evaluating these investments so that a high credit rating was more readily given. Contrary to their public promises, both Moody’s and S&P willfully relaxed standards in order to further their own and their clients’ financial interests.”
Blumenthal accused the agencies of purposely failing to update rating methodologies -- and at times easing those standards -- to produce or preserve undeservedly high ratings, thereby protecting their bottom lines.
“The pressure to increase revenue and win business also ultimately influenced the methodologies that Moody’s and S&P developed for rating structured finance securities,” Blumenthal said. “Going back to at least 2001 for S&P and 2004 for Moody’s, both companies hid from the general public that their respective ratings methodologies were directly influenced by the wishes of their clients. Moody’s and S&P adopted this approach specifically to please their clients (i.e., the issuers that paid their fees) and to enhance their revenue. Whether Moody’s and S&P’s ratings methodologies accounted for all the credit risk that Moody’s and S&P knew existed was of secondary importance to their own bottom line. Moreover, the independence and objectivity that both companies promised to the marketplace was largely forgotten.”
Blumenthal charged that Moody’s punished employees who objected to its failure to accurately rate securities.
“Specifically, employees who raised concerns about Moody’s practices were given negative performance reviews, reassigned or demoted and, in some cases, were ultimately forced out of the company,” Blumenthal said. “The message to Moody’s employees was clear: If you speak up and potentially interfere with Moody’s plan to please issuers and, therefore, generate additional revenue for Moody’s, you should be prepared to suffer the consequences. This incentive was directly at odds with Moody’s public emphasis on maintaining independence and objectivity in its ratings and damaged the quality of Moody’s ratings on structured finance securities.”
Blumenthal accused the rating agencies of succumbing to “ratings shopping” – the practice of pitting raters against each other and awarding business to the one that awarded the highest ratings.
“Between at least 2006 and 2007, both Moody’s and S&P were repeatedly pitched by issuers attempting to influence the rating assigned to a specific security,” Blumenthal said. “Upon learning of the rating the competition was likely to assign to a transaction, Moody’s and S&P routinely relaxed their analysis and agreed to provide the higher rating. Moody’s and S&P’s greed clouded their judgment, as both companies chose to increase their revenue rather than lose out on business to a competitor.”
View the entire testimony - (PDF-35KB)