4th UPDATE: Memo: SEC Didn't Return Kolchinsky's Calls

House Republicans accused the U.S. Securities and Exchange Commission of being slow to respond to an ex-Moody's Investors Service analyst who complained in September that the ratings agency might be inflating complex securities ratings.

Eric Kolchinsky, the former Moody's employee, testified at a U.S. House committee hearing that he was contacted by the SEC last week after he went public with new allegations against the rating service.

Kolchinsky has complained to the SEC twice this year - first in March and again shortly after he was suspended in early September. SEC officials said they were in touch with Kolchinsky after his March complaint.

His most recent contact with the SEC was about a memo he wrote in the summer where he outlined concerns the firm had engaged in illegal conduct that needed to be addressed. House Oversight Chairman Edolphus Towns, D-N.Y., said he was also concerned the SEC failed to properly respond to a second ex-Moody's employee. That former employee, Scott McCleskey, also testified about problems at the company.

"I am concerned by the Securities and Exchange Commission's inaction after receiving Mr. McCleskey's letter containing serious allegations of wrongdoing at Moody's," Towns said. "Mr. McCleskey's allegations indicate troubling behavior that requires oversight."

An SEC spokesman said: "In both instances, the agency followed up on the complaints almost immediately and took the appropriate action.”

McCleskey, a former Moody's compliance officer, sent a letter to the SEC in March alleging Moody's had failed to update municipal ratings. The letter also said Moody's had replaced compliance officers in 2008 with analysts and managers who were previously involved in rating structured-finance and mortgage securities. He said he was forced out at that time.

Republicans appeared equally concerned about the possible lapses at the SEC.

The SEC's failure to return Kolchinsky's calls "is unfortunately not surprising given the SEC's failure to respond to concerns raised about the Madoff Ponzi scheme," the Republican memo says. "It also raises serious questions about the wisdom of current Democrat proposals to entrust the SEC with increased regulatory authority."

An SEC spokesman said the agency has "established an examination program for credit-rating agencies" and is "focusing carefully on the tips and complaints" it receives and "following up, where appropriate."

At the hearing, Kolchinsky alleged Moody's gave a high rating to complicated debt securities in January 2009, knowing that it was planning to downgrade assets that backed the securities. Within months, the securities were put on review for downgrade.

He said he had reviewed internal Moody's memos showing executives had approved ratings methodology changes in December 2008 that they expected to lead to large-scale ratings downgrades.

Moody's Chief Risk Officer Richard Cantor on Wednesday said an internal review showed "the claims of misconduct are unsupported." But he added the company has separately hired an outside law firm to investigate Kolchinsky's claims.

Moody's Investors Service is a unit of Moody's Corp. (MCO).

Later Wednesday, the heads of Moody's, Standard & Poor's, and Fitch Ratings will separately testify about a new U.S. House proposal drafted by Rep. Paul Kanjorski, D-Pa., who is a senior lawmaker on the House Financial Services Committee.

That bill goes further than an Obama administration proposal by imposing stronger legal liability standards on credit raters to hold them more accountable for the accuracy of their ratings.

The legislation would change the pleading standards in private securities litigation cases to make it easier for investors to sue. And it would allow the SEC to take civil action against raters. A controversial component of the bill would create a collective liability regime that would force nationally designated firms to be held responsible for each other's actions.

All three of the companies are planning to criticize that section of the bill, saying it would be harmful and unfair to the industry.

-By Sarah N. Lynch, Dow Jones Newswires; 202-862-6634; [e-mail]