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Rating Agencies and Morgan Stanley Still on the Hook After Summary Judgment in Rhinebridge

January 3, 2013

On January 3, 2013, Judge Shira A. Scheindlin of the Southern District of New York denied defendants’ motions for summary judgment on plaintiffs’ fraud claims against three rating agencies and an aiding and abetting fraud claim against Morgan Stanley over what was dubbed “the shortest-lived ‘Triple-A’ investment fund in the history of corporate finance.”

Rhinebridge Plc was a $2.5 billion structured investment vehicle (“SIV”) that was structured by its placement agent, Morgan Stanley. Rhinebridge collapsed four months after its creation and a matter of weeks after plaintiffs King County, Washington and Iowa Student Loan Liquidity Corporation invested in it. The rating agencies Standard & Poor’s (“S&P”), Moody’s and Fitch all gave Rhinebridge their highest ratings despite the fact that they knew the SIV contained toxic assets, such as unsellable home equity loans.

The recent decision in King County, Washington v. IKB Deutsche Industriebank AG (“Rhinebridge”) comes after Judge Scheindlin denied similar motions in August 2012 in the $9.5 billion Cheyne SIV action (Abu Dhabi Commercial Bank, et al. v. Morgan Stanley & Co., Inc., et al., No. 1:08-cv-7508-SAS, Opinion & Order (S.D.N.Y. Aug. 17, 2012)) (“Abu Dhabi”), for fraud claims against rating agencies and aiding and abetting against Morgan Stanley. The cases share so many issues, counsel and parties that Judge Scheindlin repeatedly referred to her findings in the summary judgment order in Abu Dhabi in her Rhinebridge decision.

Judge Scheindlin wrote that the rating agencies’ ratings were, by their nature, not merely opinions, but opinions based on facts after “the rating agency has analyzed data, conducted an assessment, and reached a fact-based conclusion as to creditworthiness. If a rating agency knowingly issues a rating that is either unsupported by reasoned analysis or without a factual foundation, it is stating a fact-based opinion that it does not believe to be true.” The court held that plaintiffs need show only “that the rating agency issued a rating that it knew was unsupported by facts or analysis – that the rating agency did the equivalent of issuing a restaurant review despite never having dined at the restaurant.”

As to Moody’s, the judge referred to similarities between Rhinebridge and Cheyne: “First, plaintiffs provide a litany of e-mails, deposition quotes and internal documents indicating an awareness that the rating model was unsupported and a concern with the state of the Residential Mortgage Backed Securities (‘RMBS’) market. Second, plaintiffs offer ample evidence that Moody’s viewed Rhinebridge as being extremely similar to Cheyne, [in] that it used the same rating model for both SIVs,” as both were arranged by Morgan Stanley, the Rhinebridge capital model was “identical to that of Cheyne’s,” and Moody’s methodology for determining capitalization sufficiency, known as “haircut matrices,” was, “if not identical, very similar” to Cheyne. “Thus,” the judge wrote, “as in the Abu Dhabi matter, plaintiffs’ evidence is sufficient to create a disputed issue of fact as to whether Moody’s believed its rating when it issued it.”

S&P’s arguments fared no better, and Judge Scheindlin wrote that “plaintiffs have offered evidence that S&P used the same rating methodology for Rhinebridge as it did for Cheyne. I held in the Abu Dhabi opinion that there was sufficient evidence from which a jury could infer that S&P did not believe its Cheyne rating when it issued it. Not only is there no reason to believe that S&P was more confident in its SIV rating methodology when it rated Rhinebridge, but plaintiffs have offered evidence that S&P was even more concerned about the state of the RMBS market when it rated Rhinebridge than when it rated Cheyne two years earlier.”

Fitch had opted out of rating the Cheyne SIV, and thus was not a defendant in that action. However, Judge Scheindlin held that “[p]laintiffs have offered evidence that Fitch assigned its top rating to Rhinebridge despite concerns just as pronounced as those held by Moody’s and S&P. There are documents and testimony indicating that Fitch was expecting the mortgages underlying the RMBSs in Rhinebridge to see an increased delinquency rate.” Fitch correspondence revealed that one of its primary Rhinebridge analysts considered the ratio of home equity loans in the SIV to be “aggressive” and “pushing the boundaries,” while another wrote that he did not have the resources to give an analysis of the SIV. The judge wrote that “[d]espite the paucity of information and the risky boundary-pushing nature of Rhinebridge, Fitch assigned the Rhinebridge CP its highest rating. That Fitch refused to rate Cheyne – an SIV very similar to Rhinebridge – is further support for the inference that Fitch viewed the rating of SIVs as a dubious endeavor. In sum, plaintiffs have provided sufficient evidence from which a jury could infer that Fitch did not believe its Rhinebridge rating when it issued it.” Shortly after the court denied Fitch’s summary judgment motion, Fitch entered into a settlement with the plaintiffs.

As to scienter and reliance, the judge wrote that based on what plaintiffs had provided, she found that a jury could reasonably infer scienter, and that as to reliance, “given plaintiffs’ evidence of asymmetric access to information and the fact that SIVs like Rhinebridge were – as a Moody’s employee called them – ‘the most opaque structured credit vehicles and transactions in the market’… ‘plaintiffs had no choice but to rely on the ratings and thus reliance may be presumed.’”

Morgan Stanley could not escape plaintiffs’ allegations that it aided and abetted the rating agencies’ fraud, as the judge held that, just as in Abu Dhabi, “plaintiffs had ‘offered sufficient evidence from which a jury could infer that Morgan Stanley: (1) had actual knowledge of the Rating Agencies’ fraud; and (2) provided substantial assistance to the Rating Agencies in perpetrating the fraud.’ There is evidence that Morgan Stanley not only did the same with Rhinebridge, but that it was even more aware of how inaccurate the top ratings were.”

Now that Judge Scheindlin has ruled that there is sufficient evidence from which a reasonable jury could render a verdict in favor of plaintiffs, both cases are gearing up for trial: Abu Dhabi has a scheduled trial date of May 13, and the Rhinebridge trial will take place shortly after the conclusion of the trial in the Abu Dhabi case.

Robbins Geller attorneys litigating the Rhinebridge action include Daniel S. Drosman, Luke O. Brooks, Darryl J. Alvarado and Angel P. Lau.

King County v. IKB Deutsche Industriebank AG, 916 F. Supp. 2d 442 (S.D.N.Y. 2013).

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