March 31, 2016 / 11:18 AM / 2 years ago

HK tribunal upholds action against Moody's for report on China companies

HONG KONG (Reuters) - A Hong Kong tribunal upheld on Thursday disciplinary action against Moody’s Investor Services for a report it published on Chinese companies, in a landmark decision that could curtail the services rating agencies can offer in the financial center.

A Moody's sign on the 7 World Trade Center tower is photographed in New York August 2, 2011. REUTERS/Mike Segar

The Hong Kong Securities and Futures Appeals Tribunal (SFAT) said Moody’s did breach the Securities and Futures Commission (SFC) code of conduct through the publication of a July 2011 report that raised corporate governance concerns over 49 Chinese companies, contributing to a fall in their share prices.

Lawyers said the decision, which marks the first disciplinary action against a credit rating agency since the activities of such firms became directly regulated by the SFC in June 2011, would act as a roadmap for future regulatory action.

“Given this decision, credit rating agencies will generally have to exercise more caution, as it seems the court agrees with the SFC that these type of research activities are within its remit,” said Michael Cheng, a consultant solicitor at law firm Andrew W Y Ng & Co in Hong Kong.

The tribunal did not uphold all of the SFC’s claims against Moody‘s, more than halving the regulator’s proposed HK$23 million ($2.97 million) fine to HK$11 million and directing the SFC to re-draft its public reprimand against the agency.

Moody’s will also be required to pay 60 percent of the SFC’s legal costs.

“As one of the three largest credit rating agencies in the world, Moody’s must have appreciated that the report would carry considerable weight in the market,” the tribunal noted in its ruling.

“Yet, despite internal concerns as to the accuracy of the red flag framework, Moody’s persisted in the publication.”

Moody’s so-called Red Flag report devised a framework for identifying governance and accounting risks when investing in emerging market fixed income securities.

Following an inquiry into the report, the SFC attempted to fine and reprimand Moody’s in November 2014, but Moody’s appealed against the action.

The SFC alleged during a September appeals tribunal that Moody’s broke a code of conduct by publishing what its counsel, Benjamin Yu, described as a “half-baked” idea that had not been properly tested and which contained mathematical and input errors.

As such, the report fell short of the SFC’s required due diligence requirements, the SFC said.

Moody’s disputed the SFC’s power to sanction it and argued the report was merely a useful “screen” for analyzing companies and was not part of its regulated credit-rating activities.

It also contested the proportionality of the fine.

The tribunal found, however, that the report did constitute Moody’s regulated activity as a rating agency, and was within the SFC’s jurisdiction, a finding that could force ratings agencies and banks to review their research strategy.

The tribunal did not agree with the SFC’s claim, however, that Moody’s acted dishonestly, and did not uphold the SFC’s assertion that Moody’s did not have adequate internal controls and procedures in place.

Moody’s said in a statement it appreciated the SFAT’s decision to reduce the penalty.

“However, Moody’s does not believe that research reports such as the one Moody’s published back in 2011 fall within the ambit of the SFC. Moody’s is considering its options.”

Reporting by Michelle Price; Editing by Ryan Woo, Robert Birsel

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