It is the same story everywhere – when the Stamford court was ordering UBS (see the news item here) to set aside money for damages to Pursuit for selling CDO notes, SDNY judge Shira A. Scheindlin was writing order denying rating agencies’ and Morgan Stanley’s motion to dismiss investors’ claims for losses in structured investment vehicle (SIV).  

The suit, brought by Abu Dhabi Commercial Bank, charged the defendants for misrepresentation, fraud, breach of fiduciary duty, negligence, etc. Morgan Stanley and the rating agencies had filed a motion for dismissal on various grounds.  

Cheyne Finance Plc was a structured investment vehicle that is now in bankruptcy. Cheyne issued 3 types of notes – commercial paper, medium term notes, and mezzanine capital notes, all of which were rated by the rating agencies. This is the common structure of SIVs.  

The case brings to public light the role of rating agencies in structured vehicles such as SIVs. The rating agencies charged upwards of 10 basis points of the capital of the SIVs as their initial fees, and charged $ 1.2 million + 0.055% of the market value of the SIV’s assets. This means the rating agencies continued to gain as the SIVs continued to build more assets. Also, there is a startling fact that the rating agencies in case of SIVs get their fees only if the notes get the AAA ratings. The rating agencies claimed that their opinions are non-actionable – this argument was rejected by the court. “Rating agencies’ opinions are not mere opinions but actionable misrepresentations”, held the Judge. 

In summer  of 2007, Cheyne SIV collapsed. In August 2007, it declared bankruptcy.  

The factual analysis reveals that while the SIV was required to limit its exposure to RMBS to 55%, Morgan Stanley and rating agencies were well aware that the actual investment was well above 55%. The SIV held New Century’s debt, and Morgan Stanley, as New Century’s 4th largest creditor, was aware of facts about New Century that were not in public domain.  The structure of the fees for the rating agencies created a conflict of interest as they were directly connected with the success of the vehicle and its size of assets. “Where both the Rating Agencies and Morgan Stanley knew the ratings were flawed, knew that the portfolio was not safe, stable investment, and knew that the Rating Agencies could not issue an objective rating because of the effect it would have on their compensation, it may be plausibly inferred that Morgan Stanley and Rating Agencies were disseminating false and misleading ratings.” 

[Reported by: Vinod Kothari]

Links: Text of the SDNY ruling is here:

For more on SIVs, see Vinod Kothari’s presentation here: