New York, NY – Last week, a Manhattan US District Judge refused to dismiss a lawsuit seeking to hold S&P and Moody’s responsible for misleading investors about the safety of an instrument backed by subprime mortgages that the two firms rated. In addition, the judge ruled that claims that Morgan Stanley, the firm that marketed the instrument in question, aided and abetted fraud in this case should stand.
Background of the Case
The lawsuit, brought initially in 2008, claimed that Abu Dhabi Commercial Bank, King County in Washington State, and a group of other investors suffered significant losses when a structured investment vehicle named Cheyne went bankrupt in August 2007. The investors claimed that Morgan Stanley, the firm that marketed Cheyne, pressured the ratings companies to provide overly optimistic investment-grade ratings to the instruments.
The plaintiffs are seeking unspecified damages. The plaintiffs say that by the time Cheyne collapsed it was worth about $9 billion.
S&P and Moody’s and Morgan Stanley moved to have the charges dismissed, arguing that there was no wrongdoing and that the ratings they submitted on the SIV constitute independent opinions by the agencies.
Ratings Agencies Take Heat From Judge
However, U.S. District Judge Shira Scheindlin disagreed with the defendants’ arguments. In an 89-page opinion, the judge threw out the two ratings agencies move to dismiss the claims, saying that a jury could reasonably infer that the agencies acted fraudulently over their activities regarding the Cheyne structured investment vehicle.
Judge Scheindlin also concluded that the “plaintiffs have also offered sufficient evidence from which a reasonable jury could infer that the rating agencies did not believe the ratings when they issued them.” She cited an instant message between two S&P analysts discussing the Cheyne investment.
“That deal is ridiculous,” one analyst said, adding “We should not be rating it.”
“We rate every deal,” the second analyst replied.
“It could be structured by cows and we would rate it,” the first analyst replied.
Platintiffs Score Some Points With Judge
However, the judge’s opinion was not a complete win for the plaintiffs. In her opinion, Judge Scheindlin dismissed the fraud charge against Morgan Stanley, explaining that “even if Morgan Stanley had actual knowledge that the ratings were false, it could only be liable for aiding and abetting fraud… because the ratings cannot be attributed to Morgan Stanley.”
In addition, Scheindlin narrowed the suit, dismissing claims by three of the 15 plaintiffs. More importantly, the judge also ordered the investors to file briefs by the end of the month demonstrating why their negligent misrepresentation claims against the rating agencies should stay in place in light of a recent federal appeals court decision.
The case is Abu Dhabi Commercial Bank et al v. Morgan Stanley & Co et al, U.S. District Court, Southern District of New York, No. 08-cv-07508.