Yesterday, California Attorney General Edmund G. Brown Jr. launched an investigation into credit rating agencies' role in "fueling the financial crisis," by issuing subpoenas to Standard & Poor's, Moody's and Fitch to determine whether the firms violated California law when they "recklessly gave stellar ratings to shaky assets." The investigation comes a few months after the California Public Employees’ Retirement System sued the three agencies over approximately $1 billion in investment losses. Brown's office stated that the rating agencies "put their seal of approval on high risk mortgage-backed securities," but "either ignored or did not understand the risks of the debt they rated." He is requiring the credit rating agencies to provide information, no later than October 19, that will help answer a variety of questions, as summarized below:

  • Whether the rating agencies failed to conduct adequate due diligence in the rating process, made fraudulent representations concerning the quality or independence of their ratings, and or gave high ratings to particular securities when they knew or had reason to know that high ratings were not warranted;
  • Whether the rating agencies failed to comply with their own codes of conduct in rating certain securities, compromised their standards and safeguards for profits, conspired with the companies whose products they rated to the detriment of investors, and or profited from giving inaccurate ratings to particular securities; and
  • Whether the rating agencies' statistical models captured the risk inherent in subprime and other risky assets and, if not, what was the rating agencies' response.

During the past several months, Congress and the SEC have been investigating the role of credit agencies in the financial crisis and the need for additional regulation. Yesterday, the SEC unanimously voted to take several rulemaking actions to bolster oversight of credit ratings agencies by enhancing disclosure and improving the quality of credit ratings, and earlier this summer, the Obama Administration delivered specific legislation to Congress to overhaul the regulatory framework for credit rating agencies.