On May 4, 2012, a United States District Court in New York, held that Credit rating agencies may have a duty under New York law to give accurate ratings to subprime-mortgage-backed securities targeted for sale to to a select group of buyers in private placements.
In June 2007, IKB Deutsche Industriebank AG (“IKB”), a German banking institution created Rhinebridge, a so-called “structured investment vehicle” (“SIV”) that was allegedly secretly loaded with toxic subprime mortgages. Morgan Stanley & Co., operated as a Co–Arranger and placement agent for Rhinebridge, and through marketing materials provided potential investors with the allegedly misleading ratings, accompanying definitions of the ratings, and statements regarding the Senior Notes‘ safety and stability. Additionally, the following creadit agencies falsely stamped the SIV’s securities with a tripple-A rating to lure institutional investors: Standard & Poor’s Rating Services (“S & P”), Moody’s Investors Service, Inc. (“Moody’s”), and Fitch, Inc. (“Fitch”).
“Structured investment vehicles” are special purpose entities that borrow money by issuing short- and medium-term debt, and then use that money to buy longer-term securities including mortgage bonds and other asset-backed securities. The notes that SIV investors purchase typically receive very high or “investment grade” ratings from Rating Agencies. Rating agencies, such as defendants Moody’s, S & P, and Fitch, use public, and sometimes non-public, information regarding the assets of issuers to evaluate and rate debt offerings; the ratings are intended to convey information about the creditworthiness of the issuer’s debt to potential creditors and investors.
However, the role allegedly played by Moody’s, S & P, and Fitch in creating, operating and rating Rhinebridge represents a deviation from the historical role of rating agencies. The rating agencies knew that their ratings were false or misleading because they: (1) had access to confidential information about the assets held by Rhinebridge; (2) had knowledge unavailable to the public regarding the assumptions and methodologies used in rating the SIV; and (3) knew that, although the goal of an SIV is to acquire high-quality assets making it worthy of a “Top Rating,” the Rhinebridge SIV included low-quality toxic mortgage-backed assets.
The Rhinebridge SIV’s initially sold to investors with top ratings, less than for months later Rhinebridge was forced into receivership, becoming perhaps the shortest-lived “Triple A” investment fund in the history of corporate finance.
The Court held that plaintiffs‘ negligent-misrepresentation claim also may go forward against the rating agencies. Judge Scheindlin said, “The rating agencies intended that their ratings would be used to evaluate the SIV; intended that the plaintiffs — members of a select group of qualified investors — would rely on their ratings to evaluate the SIV; and prepared their ratings with the end and aim of inducing investors such as the plaintiffs to invest in the SIV”. Additionally, Judge Scheindlin said that the claim also may go forward against Morgan Stanley and IKB.