By Rachelle Younglai
WASHINGTON (Reuters) - A U.S. congressional panel is expanding its probe of credit rating agencies to look at why securities regulators ignored warnings from former Moody's Corp <MCO.N> executives about the company's weak compliance department and ratings process.
Rep. Edolphus Towns, chairman of the House Oversight and Government Reform Committee, criticized the U.S. Securities and Exchange Commission for failing to investigate allegations Moody's managers were eager to curry favor with customers by assigning favorable ratings to their products.
"I am concerned by the SEC's inaction after receiving Mr. McCleskey's letter containing serious allegations of wrongdoing at Moody's," Towns said, referring to Scott McCleskey, who was dismissed as Moody's senior vice president of compliance in 2008. McCleskey sent the SEC a letter in March 2009 detailing his concerns.
"Mr. McCleskey's allegations indicate troubling behavior that requires oversight by the SEC," Towns said.
Top executives from the largest credit agencies -- Standard & Poor's <MHP.N>, Fitch Ratings <LBCP.PA> and Moody's -- were to testify later on Wednesday at a House Financial Services subcommittee hearing. The panel is considering legislation that would curtail rating companies' practices and expose them to greater liability.
The rating firms "played a starring role in the collapse of the financial system last year," because they failed to capture the true risk of securities linked to poorly written mortgages, Towns said.
Moody's has born the brunt of criticism recently. Its stock has lost roughly one-fourth of its value in the past two weeks and shares were down 6 percent to $19.55 in late morning trade on the New York Stock Exchange.
McCleskey testified at the hearing, flanked by another former Moody's executive, Eric Kolchinsky, and by Moody's current chief credit officer, Richard Cantor. The three men sat at the same table and Cantor stared straight ahead as his former colleagues described their concerns to the lawmakers.
McCleskey said Moody's ignored his warnings that the company failed to properly monitor municipal bond ratings. The company also spurned his suggestion to erect a firewall between the compliance department and its revenue-generating units, he said.
Kolchinsky, a recently suspended managing director at Moody's, told lawmakers that Moody's compliance group was understaffed and lacked independence. Kolchinsky alleged that the firm knowingly issued misleading ratings on complex securities and that analysts were "bullied" by managers who overrode their decisions to protect revenue.
"Kolchinsky tried to tell the SEC about his concerns but his calls were not returned," according to a memo prepared by Republican members of the committee and obtained by Reuters.
Cantor told lawmakers that Moody's recently hired an independent law firm to review Kolchinsky's allegations.
ANOTHER BLACK MARK FOR SEC?
Allegations that the SEC ignored the whistleblowers' concerns could be another black mark against the regulator, which is still reeling from its failure to uncover Bernard Madoff's $65 billion investment scam.
An SEC spokesman has said the agency has established an examination program for credit rating agencies that includes reviews of disclosures, policies, and procedures regarding municipal securities ratings.
"We are focusing carefully on the tips and complaints we receive and following up, where appropriate, with examinations targeting suspected problems," SEC spokesman John Nester said.
The SEC contacted Kolchinsky last week after his concerns became public, Kolchinsky said.
Global policymakers are trying to make credit agencies more accountable, blaming them for fueling the credit crisis by assigning top ratings to toxic mortgage securities that later deteriorated in value. Lawmakers and the SEC are trying to increase competition in the industry, which is dominated by Moody's, McGraw-Hill Cos Inc's <MHP.N> Standard & Poor's, and Fimalac SA's <LBCP.PA> Fitch Ratings.
(Reporting by Rachelle Younglai, additional reporting by Jonathan Stempel in New York; editing by John Wallace and Leslie Gevirtz)