The Securities and Exchange Commission’s (SEC) Division of Enforcement said Tuesday, August 31, that it decided to drop a fraud case against Moody’s Corp.’s credit ratings arm over an inflated ratings matter regarding European debt because the SEC questioned its own authority to bring the case to the United States. However, the SEC issued a warning to credit ratings agencies on the same day that the Dodd-Frank law granted the SEC more powers to regulate overseas ratings fraud.

In the Report of Investigation, the SEC notes that it has investigated whether Moody’s Investors Service, Inc., the credit rating business segment of Moody’s Corporation, violated the nationally recognized statistical rating organization (NRSRO) registration provisions or the antifraud provisions of the federal securities laws.

This report, the SEC says, “serves to caution NRSROs that, where appropriate, the Commission will utilize recent legislative provisions [under Dodd-Frank] granting jurisdiction for enforcement actions alleging otherwise extraterritorial fraudulent misconduct that involves significant steps or foreseeable effects within the United States.” The Commission, the SEC says, “also cautions NRSROs that they should implement sufficient and requisite internal controls over policies, procedures, and methodologies used to determine credit ratings.”

According to the Report, an Moody’s Investor Service (MIS) analyst discovered in early 2007 that a computer coding error had upwardly impacted by 1.5 to 3.5 notches the model output used to determine MIS credit ratings for certain constant proportion debt obligation notes. Nevertheless, the report says, “shortly thereafter during a meeting in Europe, an MIS rating committee voted against taking responsive rating action, in part because of concerns that doing so would negatively impact MIS’s business reputation.”

MIS applied in June 2007 to be registered with the Commission as an NRSRO. The Report notes that “the European rating committee’s self-serving consideration of non-credit related factors in support of the decision to maintain the credit ratings constituted conduct that was contrary to the MIS procedures used to determine credit ratings as described in the MIS application to the SEC.”