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The Securities and Exchange Commission is dropping an investigation into alleged fraudulent behaviour at ratings agency Moody's because it is not sure if it has legal jurisdiction over the company.

Moody's was accused of awarding wrongly high ratings to various constant proportion debt obligation notes - the infamous structured debt products which turned out to be not much more than bundles of dodgy US mortgages re-packaged to look like they were almost risk-free.

The SEC said: "Because of uncertainty regarding a jurisdictional nexus between the United States and the relevant ratings conduct, the Commission declined to pursue a fraud enforcement action in this matter."

The problem came to light when the FT got hold of internal documents showing Moody's had been aware it had been wrongly awarding AAA ratings.

The SEC Report of Investigation said that Moody's discovered in early 2007 that it was ramping up ratings by 1.5 to 3.5 notches. But the company decided not to take any action because it didn't want to damage its own reputation. Moody's at the time blamed a computer error.

The SEC said it was warning ratings agencies of the importance of proper internal procedures and controls to stop them issuing incorrect ratings.

The regulator said: “It is crucial that nationally recognized statistical rating organizations take steps to assure themselves of the accuracy of those statements and that they have in place sufficient internal controls over the procedures they use to determine credit ratings.”

The SEC said new security laws meant it would have no problem taking action against a firm in future for failing to follow a proper methodology for setting ratings. It warned it would take anti-fraud action against companies within the US or whose actions would have an impact within the US.

Moody's issues ratings for all sorts of financial instruments including company bonds and even countries' sovereign debt. Some investors, like pension funds, can only invest in products with high, AAA ratings. ®

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