Shares of Moody's Corp. plunged 16% on Wednesday after the debt-grading firm said it had launched a review of whether a computer error resulted in triple-A ratings on complex European debt securities that later fell in value.
The Financial Times reported Wednesday that some senior Moody's staff members were aware in early 2007 that so-called constant-proportion debt obligations -- sold by leveraged investment funds to bet on credit-default swaps -- should have been rated as many as four grades lower. Moody's altered some assumptions to avoid having to assign the lower grades after fixing the error, the newspaper said, citing company documents.
"If it is true, does that mean other products haven't been rated correctly?" said Puneet Sharma, head of investment-grade credit strategy for Barclays Capital in London. "Will they be downgraded? It could lead to turmoil."
Connecticut Atty. Gen. Richard Blumenthal said Wednesday that he was investigating potential fraud tied to top rankings that New York-based Moody's may have erroneously given to some debt securities.
"The question is whether the defects were purposeful" and whether Moody's sought to hide the errors, he said.
U.S. Sen. Charles E. Schumer (D-N.Y.) called on the Securities and Exchange Commission to investigate the matter.
The allegations raise questions about internal controls at rating firms as they face scrutiny from lawmakers and regulators for assigning top grades to bonds backed by sub-prime home loans.
Moody's said it had hired law firm Sullivan & Cromwell to look into its ratings of about $4 billion in constant-proportion securities.
"The integrity of our ratings and rating methodologies is extremely important to us, and we take seriously the questions raised," Moody's said in a statement. "We are therefore conducting a thorough review of this matter."
The firm said it "would be inconsistent with Moody's analytical standards and company policies to change methodologies in an effort to mask errors."
Moody's shares sank $6.99 to $36.91. Shares of McGraw-Hill Cos., which owns rival rating firm Standard & Poor's, fell $2.41, or 5.5%, to $41.18.