Swiss banking giant UBS AG (UBS) was recently ordered to pledge its assets or provide bonds worth $35 million by Judge John Blawie at Connecticut Superior Court. The unfavorable order came as a blow after reports claimed that top credit ratings agencies had committed a securities fraud by providing insider trading information to the bank.

Stanford-based hedge fund Pursuit Partners claimed that UBS had entered a deal to sell its investment-grade collateralized debt obligation (CDO) notes in 2007 with the prior knowledge that the securities were about to be downgraded.

The proceedings revealed that the rating agencies Moody’s Corp. (MCO) and Standard & Poor’s provided insider information to UBS regarding their impending decision to downgrade some of the CDOs the bank was selling. The credit crunch led the securities to default only months after they were sold and UBS used the situation to its advantage.

The Court order came at the end of a one-week hearing, where various UBS employees testified and related documents, including internal UBS e-mails, were reviewed. However, UBS pledged innocence saying that the Court’s decision was a routine procedure, requiring defendants to provide security during the case proceedings.

The UBS litigation reflects a negative sentiment that has built up against large credit rating agencies for sharing furtive connections with big investment banks. This would certainly hurt Moody’s goodwill and highlight the fact that rating agencies can be bought. The integrity of the company and its ratings are in question.

Moody’s allegedly hastened the credit crisis earlier in the decade by assigning top ratings to mortgage-backed securities that deteriorated later. Moreover, it is being probed by regulators worldwide, with several ongoing reviews in Europe for rating a European debt product, constant proportion debt obligations (CPDOs), at a higher-than-merited AAA.

The SEC has designed various measures to stop the practice of corporations seeking to buy favorable ratings by negotiating fees with raters. Although Moody’s is not ultimately compensated on the accuracy of its ratings, we believe it will face large penalties similar to investment banks in the wake of the technology bubble earlier in the decade.

The SEC is expected to hold a meeting on Sept. 17 to vote on proposed rules for credit rating agencies and pose restrictions on controversial flash orders. Regulators will also vote on the subject on adopting previously proposed rules to improve credit rating practices. The major credit rating agencies under the scrutiny would be Moody’s, McGraw-Hill (MHP), Standard & Poor’s and Fitch Ratings.

Read the full analyst report on “MCO”
Read the full analyst report on “UBS”
Read the full analyst report on “MHP”
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