Moody's Wells Notice Blues

By Eric Jackson
RealMoney Contributor
5/10/2010 5:00 PM EDT
Click here for more stories by Eric Jackson

A couple of weeks ago, I offered up a negative short-term view of Moody's (MCO - commentary - Trade Now), saying it was too risky to hold the stock, given the Securities and Exchange Commission's suit against Goldman Sachs (GS - commentary - Trade Now). That move signaled regulators would likely pursue other high-profile symbolic targets, with Moody's near the top of the list.

Late on Friday, Moody's disclosed in its latest quarterly filing that it had received a Wells Notice from the SEC on March 18, saying Moody's Investors Service, the credit-ratings unit, may face SEC action over its June, 2007, application for renewal of its status as a nationally recognized statistical ratings company, or NRSRO, an official designation that is crucial to its business. According to Moody's, the SEC believes that the MIS "...description of its procedures and principles were rendered false and misleading..." in the application because the company had determined that one of its employees had violated its internal ratings committee policy.

Moody's said it disagreed with the Wells Notice and has submitted a response "explaining why its initial application was accurate and why it believes an enforcement action is unwarranted."

This news first broke on the Zerohedge blog, and has been widely reported since. It is big news, and in line with my previously stated concerns.

For those who don't know, the NRSRO status is enormously important for Moody's. The SEC determines which credit-ratings agencies can rate certain types of securities. Certain investors, think pension funds, can only purchase securities that have been rated a certain level by an NRSRO-accredited agency.

Until recently, only Moody's, Standard & Poor's, a unit of McGraw-Hill (MHP - commentary - Trade Now), and Fitch Ratings were official players. Then, a few years ago, the SEC widened the field, accrediting smaller players, such as DBRS, Egan-Jonesand others.

If the SEC stripped Moody's of its accreditation, it would shut the company out of a major part of its high-margin business, which would deal a huge blow to the stock, with likely spillover to other parts of its business. Earlier today, the stock plunged as much as 12.1% on the Wells Notice news, before recovering to close down 6.8%, at $21.77 a share in regular trading, on a day when the Dow Jones Industrial Average surged 3.9%.

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