Moody's 'Gave Up Its Analytical Distinctiveness,' Ex-Employee Says

Moody's 'Gave Up Its Analytical Distinctiveness,' Ex-Employee Says

BUSINESSJUNE 2, 2010, 9:33 A.M. ET

By AARON LUCCHETTI

A former Moody's Corp. lawyer who worked in the ratings firm's structured-finance group for a decade planned to tell a congressional panel that the company "gave up its analytical distinctiveness," partly by intimidating analysts who were too tough or angered influential investment bankers .

In written testimony to the Financial Crisis Inquiry Commission, Mark Froeba accused Moody's managers of having "deliberately engineered a change to its culture intended to ensure that rating analysis never jeopardized market share and revenue."

Mr. Froeba is one of three former Moody's employees set to testify Wednesday at a hearing by the bipartisan commission into the credibility of credit ratings, the investment decisions based on those ratings and their role in the financial crisis.

The New York hearing also will include billionaire Warren Buffett, whose Berkshire Hathaway Inc. has long owned a stake in Moody's. Mr. Buffett, who provided no prepared testimony before the hearing, was subpoenaed by the Financial Crisis Inquiry Commission after declining an invitation to appear voluntarily.

The 10-member panel, led by former California Treasurer Phil Angelides, is required to submit a report on its findings by Dec. 15. Four previous hearings have zeroed in on investment banks, subprime mortgages and regulatory oversight of Wall Street, financial firms and government-sponsored entities such as Fannie Mae and Freddie Mac.

Wednesday's hearing is set to begin at 8:30 a.m. ET. Mr. Buffett is expected to testify at about 11:30 a.m. with Moody's Chief Executive Raymond McDaniel, who has led the ratings firm since 2005.

Mr. McDaniel, in his written testimony, told the panel how the firm has improved its internal procedures. He also emphasized the limitations of credit ratings, which focus on the risk of default on debt payments.

Still, the CEO is likely to face tough questions about why the Moody's Investors Service unit of Moody's and its two biggest rivals, the Standard & Poor's unit of McGraw-Hill Cos. and Fimalac SA's Fitch Ratings, gave Triple-A marks to thousands of mortgage-related securities that later plummeted in value and suffered sharp downgrades. The three companies generated combined revenues of $3.6 billion on bond ratings last year.


Last month, Moody's disclosed it had received notice from the Securities and Exchange Commission that the ratings firm may face an enforcement action for allegedly misleading regulators in a 2007 license application. Moody's has said it fixed issues related to the SEC's concerns and has described the problem as isolated.

In his written testimony, Mr. Froeba cited as an example of undue efforts by Moody's to preserve the firm's market share a rating of European collateralized debt obligations that was one or two notches higher than justified. Mr. Froeba is particularly critical of former Moody's President Brian Clarkson, who carried out orders from Mr. McDaniel and the company's board to make the firm more friendly and responsive to bond issuers, according to the written testimony.

Under Mr. Clarkson, analysts were forced to explain even tiny slips in market share on deals, the former Moody's lawyer told the Financial Crisis Inquiry Commission in his written testimony. Such pressure was a repudiation of the independence long cherished by the firm, Mr. Froeba wrote in his prepared remarks for the panel.

"I reject any suggestion … that Moody's sacrificed ratings quality in an effort to grow market share," Mr. Clarkson said in his prepared remarks submitted to the Financial Crisis Inquiry Commission. Mr. Clarkson left Moody's in 2008 and is set to make his first public comments about the financial crisis when he testifies Wednesday afternoon.

In his prepared remarks, Mr. Clarkson told the congressional panel that he was "disappointed" in the performance of Moody's ratings. But the firm's assumptions and methodologies "were overwhelmed by the magnitude and velocity of the unprecedented economic deterioration."

Mr. Clarkson said rating firms and investors need better disclosure from issuers about structured-finance bonds, suggesting that regulators look into stronger rules for mortgage brokers and underwriters.

Ratings firms face the likelihood of toughened oversight under financial-overhaul legislation being debated this month by a conference committee of the House and Senate. The proposals include measures to make rating firms more transparent and effective, while removing some of their market clout and stripping bankers of the ability to shop around for the firm that will give the highest rating.

At Wednesday's hearing, former Moody's rating executive Gary Witt is expected to describe how he removed a legal analyst from collateralized debt obligations, or CDOs, created byGoldman Sachs Group Inc. after the securities firm asked that the analyst "not be assigned to further Goldman Sachs CDOs for the next year," according to Mr. Witt's written testimony.

Mr. Witt told the panel that he worried Goldman would complain to his superiors if he failed to do what the firm wanted, potentially costing the analyst his job. After discussing the matter with the Moody's analyst, "we both agreed that the best course of action was to comply with Goldman's request," according to Mr. Witt's testimony.

—Erik Holm in New York contributed to this article.
Write to Aaron Lucchetti at aaron.lucchetti@wsj.com

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