Rating Companies, Banks Must Face Suits Over Investments

Credit-rating companies Moody’s, Standard & Poor’s and Fitch must face a claim they misled investors who lost money in structured investment vehicles, a federal judge ruled.

U.S. District Judge Shira Scheindlin in Manhattan dismissed several claims from suits filed by institutional investors in two vehicles, named Rhinebridge and Cheyne. Scheindlin said the investors may go forward with claims the rating companies and other defendants, including Morgan Stanley and IKB Deutsche Industriebank AG, negligently misrepresented the quality of the investments.

“Plaintiffs have sufficiently alleged that the rating agencies possessed unique or specialized expertise, and that the rating agencies knew and intended that their ratings would be used by investors in deciding whether or not to invest in Rhinebridge,” Scheindlin said in an opinion filed publicly today.

In a separate opinion, Scheindlin said her reasoning also applied to the case filed by investors in the Cheyne structured investment vehicle.

King County, Washington, and Iowa Student Loan Liquidity Corp. sued Morgan Stanley & Co., IKB, Moody’s Investors Service Inc., Standard and Poor’s Ratings Services and Fitch Inc. They claimed Morgan Stanley and IKB structured Rhinebridge to hold low-quality mortgage-backed securities and misled investors into believing the vehicles were safe.

‘Deeply Entrenched’

The rating companies collaborated in structuring the investments and gave them a falsely high rating, according to the investors’ complaint.

“Regardless of their historical roles, the rating agencies did not merely provide ratings; rather, they were deeply entrenched in the creation and operation of Rhinebridge,” Scheindlin wrote, citing the investors’ complaint.

“We are pleased that Judge Scheindlin dismissed most of the claims that the plaintiffs tried to add into the cases,” said John Piecuch, a Standard and Poor’s spokesman, in a statement. “As the ruling permits the negligent misrepresentation claim to survive this preliminary motion to dismiss, we believe the ruling is inconsistent with decisions of other courts and incorrect.”

“We are pleased that the court dismissed three of the four claims made by plaintiff,” Daniel J. Noonan, a Fitch spokesman, said in a statement. “We respectfully disagree with the court’s decision with respect to the fourth claim and we will continue to vigorously defend ourselves in this case.”

Martin Act

Moody’s didn’t immediately respond to a voice-mail left with its media relations desk seeking comment on the ruling.

Scheindlin said that after the investors sued, the federal appeals court in New York ruled for the first time that common-law claims for securities fraud aren’t preempted by a New York state law, the Martin Act.

The investors then amended their suit to include claims against the defendants for negligence, negligent misrepresentation, breach of fiduciary duty and aiding and abetting. Scheindlin today said the plaintiffs may go forward with the negligent misrepresentation claims and dismissed the others.

Scheindlin made similar rulings in the suit filed by Cheyne investors. In that case, investors including Abu Dhabi Commercial Bank are seeking damages from Morgan Stanley, Moody’s and Standard and Poor’s.

Morgan Stanley spokeswoman Mary Claire Delaney declined to comment on the rulings. Joerg Chittka a spokesman for Dusseldorf, Germany-based IKB, didn’t immediately return a voice-mail message left after business hours.

The cases are King County, Washington v. IKB Deutsche Industriebank AG, 09-CV-8387; Abu Dhabi Commercial Bank v. Morgan Stanley & Co., 08-CV-7508, U.S. District Court, Southern District of New York (Manhattan).

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