07/01/2010 03:36 pm ET Updated May 25, 2011

Moody's Credit Rating Cut Threatened By S&P

NEW YORK (AP) -- Standard & Poor's said it may cut its rating on the parent of rival ratings agency Moody's Investors Service, because financial legislation could erode profits in the ratings industry and heighten legal risks.

Standard & Poor's placed Moody's Corp.'s top 'A-1' short-term credit rating on watch for possible downgrade. S&P doesn't anticipate lowering the company's short-term rating more than one notch.

S&P highlighted the risks to the ratings industry from financial overhaul legislation that is nearing final approval, particularly a provision expanding investors' powers to sue ratings agencies. Investors could sue if they could show an agency "knowingly or recklessly failed to conduct a reasonable investigation of the factual elements relied upon by a credit rating agency's rating methodology, or obtain a reasonable verification of those factual elements from independent third-party sources," according to S&P.

Ratings agencies have been criticized for giving high ratings to complex investments backed by risky mortgages whose values fell sharply when the housing market collapsed in 2007 and 2008. When homeowners defaulted, the agencies downgraded billions of dollars of investments at once. That helped spark the financial crisis.

Lawmakers have accused the industry of having a conflict of interest because the agencies are paid by the banks whose investments they rate.

S&P said it's likely that new standard will increase Moody's litigation costs. Moody's management has said it plans to adapt its business practices to partially offset any potential new litigation risks from the legislation. But S&P said it believes Moody's "may face higher operating costs, lower margins, and increases in litigation-related event risk, which would likely increase its business risk."

S&P also said the legislation may reduce investor demand for ratings, depending on whether the final legislation removes many or all references in federal regulations to internationally recognized ratings agencies like Moody's, S&P and Fitch Ratings. The proposal would make many business transactions less reliant on rating agencies' involvement.

Moody's shares fell 6 cents to close at $19.95 Wednesday. Meanwhile, shares of S&P's parent, McGraw-Hill Cos., finished down $1.25, or more than 4 percent, at $28.14.