Opinion

Alison Frankel

New brief: Morgan Stanley, rating agencies conspired on 2007 SIV

Alison Frankel
Oct 10, 2012 23:45 UTC

A few months ago, plaintiffs’ lawyers at Robbins Geller Rudman & Dowd created quite a stir when they filed thousands of pages of deposition transcripts and other juicy discovery in an investors’ fraud case against Morgan Stanley, Standard & Poor’s and Moody’s. The documents — exhibits to the investors’ summary judgment motion — included never-before-seen internal communications between Morgan Stanley and the rating agencies as they worked on a structured investment vehicle known as Cheyne, putting on public display the allegedly half-cocked evaluations that Moody’s and S&P performed in 2005, when they were swamped with subprime mortgage-backed financial instruments to rate.

On Wednesday, the Robbins Geller team, led by Daniel Drosman and Luke Brooksfiled a new brief in a parallel case accusing Morgan Stanley, S&P, Moody’s and Fitch of defrauding two pension funds that invested in an SIV called Rhinebridge, which, in contrast to the Cheyne SIV, was sold in July 2007, as the housing bubble was already collapsing. It’s another must-read for students of the financial crisis.

The Rhinebridge brief, which also references all kinds of evidence from inside the bank and the rating agencies, doesn’t have as many notable quotables as the Cheyne filing. But its allegations are, in a way, even grimmer. According to the brief, which opposes motions for summary judgment by Morgan Stanley and the rating agencies, the defendants all knew the end was near for mortgage-backed securities. Yet (again, according to the brief) Morgan Stanley pushed the agencies to deliver high ratings on the Rhinebridge SIV, even as S&P and Moody’s supposedly questioned the percentage of shaky mortgage loans packed into it. Then, despite internal fears that Rhinebridge was too risky to survive, Morgan Stanley allegedly marketed the SIV to Robbins Geller’s clients, mentioning nothing about its concerns the investment would collapse. Just four months after Rhinebridge launched, and two months after the pension funds bought in, the SIV defaulted, en route to being auctioned off at steep losses for investors.

I should note here that Morgan Stanley and the credit rating agencies have also moved for summary judgment, arguing that the plaintiffs, which are sophisticated investors, haven’t produced evidence that the defendants engaged in fraud or that the funds justifiably relied on the defendants’ representations about Rhinebridge. (Here’s the Morgan Stanley summary judgment brief, filed by its lawyers at Davis Polk & Wardwell; here’s the joint brief on behalf of Moody’s and S&P, which are represented by Satterlee Stephens Burke & Burke and Cahill Gordon & Reindel; and here’s Fitch’s summary judgment brief, filed by Paul, Weiss, Rifkind, Wharton & Garrison.) Representatives for all of the defendants told me the allegations in the investors’ summary judgment brief are meritless, that they behaved properly and that they will eventually prevail in the litigation; S&P spokesman Edward Sweeney said, in particular, that the defense will respond specifically to the plaintiffs’ assertions in a forthcoming brief.

Nevertheless, it’s news when evidence about the credit rating agencies’ role in the financial crisis comes to light. And according to this brief, the agencies were much more concerned about maintaining their lucrative business in rating structured finance products than about the quality of their ratings. In part, that meant conceding to the demands of a client like Morgan Stanley, according to the brief. The Rhinebridge SIV had significantly higher exposure to subprime mortgages than was typical, so, according to the brief, Morgan Stanley had to push S&P and Moody’s to confer top ratings. The filing cites, for instance, a document from Morgan Stanley banker Gregg Drennan to SIV manager IKB Deutsche Industriebank, calling on IKB to “lobby” S&P because the agency “suggested that [it] might not rate the deal!!!”

Angry about possible U.S. downgrade? Don’t bother suing raters

Alison Frankel
Aug 2, 2011 22:27 UTC

With U.S. markets fretting Tuesday at the prospect of a downgrade in the government’s triple-A credit rating, you may be wondering: Who can we sue? Litigation, after all, is practically an unalienable American right. The problem, however, is that any attempt to sue the credit rating agencies for downgrading U.S. securities will run smack into the Bill of Rights. The rating agencies, as many a disgruntled mortgage-backed securities investor has discovered in the last few years, are shielded from liability because their ratings are considered to be public opinion protected by the First Amendment of the U.S. Constitution.

The agencies’ First Amendment protection dates back at least to 1999, when the U.S. Court of Appeals for the Tenth Circuit upheld a Colorado judge’s dismissal of a case against Moody’s Investor’s Services. The Jefferson County School District had sued Moody’s, claiming that the credit rating agency published an unfair assessment of the district’s 1993 bond offering. (The suit alleged that Moody’s was retaliating because the district hired other agencies to rate the bonds, but that wasn’t important in the case’s outcome.) Jefferson County, which had to re-price the bonds after the unfavorable Moody’s report, claimed the rating agency had illegally interfered with its bond offering and also committed antitrust violations.

The trial court treated Moody’s as a member of the media and found that the First Amendment protected its report on the school district bond offering from both state and federal claims. On appeal, the school board argued that the report was not protected free speech, but the Tenth Circuit disagreed. The appellate panel didn’t even waste much time discussing the trial court’s assumption that Moody’s is entitled to the same First Amendment protection as, say, Reuters. Instead, the Tenth Circuit opinion analyzed the allegedly false statements in the Moody’s report and concluded they’re too vague to be “provably false,” so Moody’s was constitutionally protected.

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