May 22 (Bloomberg) -- Moody's Corp., owner of the second- largest credit-rating company, faces increased government scrutiny after starting an internal probe into whether a computer error gave top rankings to securities that didn't deserve them.

Connecticut Attorney General Richard Blumenthal said yesterday he is investigating New York-based Moody's for ``potential fraud'' in connection with a possible ``cover-up'' of inaccurate ratings. U.S. Senator Charles Schumer urged regulators to examine the matter and fine the company if it delayed disclosing the mistake to investors.

Moody's plunged as much as 24 percent in New York trading since the ratings company yesterday said it is conducting ``a thorough review'' of whether a computer glitch caused it to assign Aaa rankings to about $4 billion of European securities that later fell in value. Blumenthal said his office was aware of possible errors before they were reported this week by the Financial Times.

``We have been aware of allegations that, in effect, there was a cover-up of these ratings inaccuracies and defects in the models applied to these complex structured securities,'' Blumenthal said in an interview yesterday. ``The question is whether the defects were purposeful'' and whether Moody's subsequently sought to hide the errors, he said.

Moody's, which is 19.6 percent owned by Warren Buffett's Berkshire Hathaway Inc., fell $3.49, or 9.5 percent, to $33.42 at 9:42 a.m. in New York Stock Exchange trading. The stock slumped 16 percent yesterday, the biggest decline since Aug. 20, 1999, and is down 46 percent in the past year before today.

Adjusting Models

Some senior staff at Moody's ratings unit, Moody's Investors Service, were aware in early 2007 that constant proportion debt obligations, funds that used borrowed money to bet on credit- default swaps, should have been ranked as much as four levels lower, the FT reported. Moody's altered some assumptions to avoid having to assign lower grades after fixing the error, the FT said, citing internal Moody's documents.

After the report, Moody's said it began an investigation. The company also retained law firm Sullivan & Cromwell, according to a statement issued yesterday.

Moody's ``adjusted its analytical models on the infrequent occasions that errors have been detected,'' the statement said. ``It would be inconsistent with Moody's analytical standards and company policies to change methodologies in an effort to mask errors.''

Tony Mirenda, a Moody's spokesman, declined to comment on Blumenthal's allegations. He said the rating company would cooperate with an investigation.

``As you might expect in this market, we receive various governmental inquiries and we would fully assist with each of these inquiries,'' Mirenda said. ``We don't think it's appropriate to comment on any specific inquiry.''

`Shirking Responsibilities'

Moody's has already been criticized by lawmakers and regulators for giving top rankings to subprime-mortgage related securities that have tumbled in value as borrower defaults soar to records.

Schumer, a New York Democrat, said in a letter to SEC Chairman Christopher Cox yesterday that the ``revelations'' are ``indicative of a culture of shirking responsibility that must end.''

``We have an abiding interest in this subject and will ensure that our ongoing examinations include this area in a robust way,'' Cox told reporters after a public meeting in Washington. He said jurisdiction for the CPDO computer error may be in Europe because that's where the incident occurred.

Banks created at least $4 billion of CPDOs, promising annual interest of as much as 2 percentage points above money-market rates combined with the highest rankings. Standard & Poor's, the largest credit ratings company, also awarded top grades to CPDOs.

Australian Review

Moody's and S&P stripped CPDOs of their top ratings this year as rising defaults in the U.S. housing market caused the cost of credit-default swaps referenced by the funds to soar amid concern the economy might be plunged into recession.

Australian regulators plan to review the rules governing ratings companies, Corporate Law Minister Nick Sherry said today, citing ``some very serious concerns'' about the firms' role in the recent market turmoil. Sherry said he has held talks on the credit ratings companies with the International Organization of Securities Commissions.

``In relation to research houses, I've requested a review of the appropriateness of the current regulator framework and whether it might require updating,'' Sherry said.

`Systemic Issues'

Blumenthal said the investigation into Moody's potential errors was part of an antitrust investigation into the three largest credit-ratings companies he disclosed last year. He's also been scrutinizing links between Moody's and Berkshire. Both Moody's and Buffett have said credit ratings awarded to units of Berkshire haven't been influenced by their ties.

``There are a series of problematic revelations that very dramatically point to systemic issues,'' Blumenthal said of Moody's and its competitors, Standard & Poor's and Fitch Ratings.

Buffett yesterday described the disclosure as a one-day event.

``I would doubt very much that any events of any one day will permanently change the franchise value of Moody's,'' Buffett said at a Madrid news conference as he tours Europe in search of family-owned companies to acquire.

To contact the reporters on this story: Erik Holm in New York at eholm2@bloomberg.net; Jesse Westbrook in Washington at jwestbrook1@bloomberg.net.

Last Updated: May 22, 2008 09:44 EDT