Moody’s, S&P Must Face Fraud Claims in Subprime Suit

Moody’s Corp. and Standard & Poor’s lost a bid for dismissal of fraud claims in a suit by investors claiming the companies falsely assigned inflated ratings to notes sold by Morgan Stanley that were backed by subprime mortgages.

U.S. District Judge Shira Scheindlin yesterday declined a request to throw out fraud claims against the two rating companies and a claim of aiding and abetting fraud against Morgan Stanley. Scheindlin narrowed the suit, dismissing claims by three of the 15 plaintiffs.

Scheindlin also dismissed the investors’ fraud claims against the bank and aiding-and-abetting claims against the rating companies, ruling that it was the rating companies, not Morgan Stanley, that issued the ratings.

The suit was filed in 2008 by institutional investors including Abu Dhabi Commercial Bank, based in the United Arab Emirates, and Washington’s King County, which includes Seattle, in a structured investment vehicle named Cheyne. The investors claim Morgan Stanley pressured the rating companies to give erroneous investment-grade ratings to the notes.

Scheindlin also yesterday ordered the investors to explain why their claims for negligent misrepresentation against Morgan Stanley and the rating companies shouldn’t be thrown out. Those claims weren’t part of the motion decided today.

“We’re pleased that the court, after examining the evidence, has recognized the value of our fraud claims against Morgan Stanley and the rating agencies,” said Daniel Drosman, a lawyer with the firm Robbins Geller Rudman & Dowd LLP who represents the investors.

“We are pleased that the court dismissed several claims against Standard & Poor’s,” a spokesman for that firm, Edward Sweeney, said in an e-mail. “Importantly, the court is also requiring the plaintiffs to show cause why their negligent misrepresentation claims should not be dismissed based upon a recent favorable ruling of the Court of Appeals.”

Michael Adler, a Moody’s spokesman, didn’t immediately return a voice-mail message seeking comment on the ruling after regular business hours yesterday. New York-based Morgan Stanley spokeswoman Mary Claire Delaney declined to comment.

The judge said the investors have offered sufficient evidence for a jury to consider whether the ratings were misleading when they were issued. She cited instant messages between two S&P analysts after the Cheyne investment had been issued. The judge said it would be up to a jury to decide whether the messages are discussing Cheyne.

“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.

Scheindlin also said that even if the messages refer to other investments, if such evidence is admissible, a jury could infer from them that S&P was in the practice of issuing ratings it didn’t believe were accurate.

The case is Abu Dhabi Commercial Bank v. Morgan Stanley & Co., 08-CV-7508, U.S. District Court, Southern District of New York (Manhattan).

(Corrects description of analysts’ messages in ninth paragraph of story published Aug. 18.)
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