Trial Looms in Cheyne SIV Case

August 17, 2012

On August 17, 2012, United States District Judge Shira A. Scheindlin issued a landmark opinion that cleared the way for the majority of plaintiffs’ claims to proceed to trial in the Southern District of New York. In four years of hard-fought litigation leading to the court’s decision, a team of Robbins Geller attorneys, led by partners Daniel S. Drosman and Luke O. Brooks, uncovered substantial evidence of malfeasance by each of the defendants. The plaintiffs, more than a dozen large institutional investors, including banks and funds such as Abu Dhabi Commercial Bank and King County, Washington, seek to recover damages they suffered in connection with their purchases of “fraudulently rated” Cheyne SIV debt securities structured and marketed by Morgan Stanley.

After reviewing the evidence submitted by both sides in connection with defendants’ motions for summary judgment, the court upheld plaintiffs’ fraud claims against defendants Moody’s and Standard & Poor’s, holding that a jury could reasonably infer the rating agencies acted fraudulently in assigning top AAA/Aaa ratings to the Cheyne SIV, which was, in fact, a risky debt vehicle packed with securities backed by subprime mortgages. The court also upheld plaintiffs’ allegations that Morgan Stanley, who designed and promoted the Cheyne notes, aided and abetted the rating agencies’ fraud.

Judge Scheindlin found that the rating agencies could not escape liability if their ratings “both misstated the opinions or beliefs held by the Rating Agencies and were false or misleading with respect to the underlying subject matter they address.” She observed that plaintiffs “offered a statement from a Moody’s analyst explaining that a Triple-A rating describes assets that ‘should survive the equivalent of the US Great Depression, undoubtedly with downgrades but with no loss to Aaa holders.’ Nonetheless, in an e-mail, a lead analyst for Moody’s observed that there was ‘no actual data backing the current model assumptions’ on the Cheyne deal,” and “[t]he same [Moody’s] analyst admitted that, although the Cheyne SIV contained a high percentage of RMBSs, he had little knowledge of the U.S. RMBS market when he rated Cheyne.” The Cheyne SIV’s ratings proved wildly false when, the court noted, two years after the Cheyne SIV was launched, it “breached its ‘Major Capital Loss Test,’ thus triggering ‘enforcement,’ an irreversible operating state requiring that a receiver be appointed” to liquidate the SIV, leading to plaintiffs’ losses.

As a result of Robbins Geller’s efforts, the court found that “[p]laintiffs have offered extensive evidence from which a jury could infer that the ratings were either disbelieved when made or issued in a manner that was ‘highly unreasonable and which represent[ed] an extreme departure from the standards of ordinary care.’” Judge Scheindlin also held that plaintiffs submitted evidence that “Morgan Stanley manipulated the Cheyne SIV modeling process to create the ratings it desired,” and that “a jury could reasonably infer that . . . Morgan Stanley had actual knowledge that the Rating Agencies were assigning ratings they did not believe in; and . . . Morgan Stanley not only substantially assisted the Rating Agencies in perpetrating a fraud, but actively encouraged them to do so.”

“We are pleased that the court, after examining the evidence, has recognized the validity of our fraud claims against Morgan Stanley and the rating agencies,” said Drosman.

The landmark litigation will be the first United States civil action against the rating agencies to proceed to trial since the financial crisis. “We believe that the rating agencies and investment banks like Morgan Stanley were instrumental in causing the financial crisis, and we look forward to presenting evidence of their fraud to a jury,” said Brooks.

Abu Dhabi Commercial Bank v. Morgan Stanley & Co., 888 F. Supp. 2d 431 (S.D.N.Y. 2012)

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