King Cnty., Wash. v. IKB Deutsche Industriebank AG

Decision Date04 May 2012
Docket NumberNo. 09 Civ. 8387 (SAS).,09 Civ. 8387 (SAS).
PartiesKING COUNTY, WASHINGTON, and Iowa Student Loan Liquidity Corporation, Plaintiffs, v. IKB DEUTSCHE INDUSTRIEBANK AG, IKB Credit Asset Management, GmbH, Moody's Investors Service, Inc., Moody's Investors Service Limited, The McGraw Hill Companies, Inc. (d/b/a Standard & Poor's Ratings Services), Fitch, Inc., Morgan Stanley & Co. Incorporated, and Morgan Stanley & Co. International Limited, Defendants.
CourtU.S. District Court — Southern District of New York


Daniel S. Drosman, Esq., Jessica T. Shinnefield, Esq., Darryl J. Alvarado, Esq., Anne L. Box, Esq., James A. Caputo, Esq., Patrick J. Coughlin, Esq., Nathan R. Lindell, Esq., David C. Walton, Esq., X Jay Alvarez, Esq., Christina A. Royce, Esq., Robbins, Geller, Rudman & Dowd, LLP, San Diego, CA, Luke O. Brooks, Esq., Jason C. Davis, Esq., Robbins, Geller, Rudman & Dowd, San Francisco, CA, Samuel H. Rudman, Esq., Jarrett S. Charo, Esq., David A. Rosenfeld, Esq., Robert M. Rothman, Esq., Robbins, Geller, Rudman & Dowd, LLP, Melville, NY, for Plaintiffs King County, Washington and Iowa Student Loan Liquidity Corporation.

James P. Rouhandeh, Esq., Antonio Jorge Perez–Marques, Esq., William Ross Miller, Jr. Esq., Christopher Joseph Roche, Esq., Andrew Dickens Schlichter, Esq., Davis, Polk & Wardwell, L.L.P., New York, NY, for Defendants Morgan Stanley & Co., Inc. and Morgan Stanley & Co. International Limited.

John D. McFerrin–Clancy, Esq., Zachary D. Rosenbaum, Lowenstein Sandler PC, New York, NY, Thomas E. Redburn, Jr., Esq., Jennifer Jane McGruther, Esq., Michael James Hampson, Esq., Lowenstein Sandler PC, for Defendants IKB Deutsche Industriebank AG and IKB Credit Asset Management, GmbH.

Mario Aieta, Esq., James J. Coster, Esq., Joshua M. Rubins, Esq., Justin E. Klein, Esq., James J. Regan, Esq., Joshua M. Rubins, Esq., Aaron M. Zeisler, Esq., Satterlee, Stephens, Burke & Burke, LLP, New York, NY, for Defendants Moody's Investors Service Limited and Moody's Investors Service, Inc.

Dean I. Ringel, Esq., Andrea R. Butler, Esq., Floyd Abrams, Esq., Jason M. Hall, Esq., Brian T. Markley, Esq., Tammy L. Roy, Esq., Adam N. Zurofsky, Esq., Cahill, Gordon & Reindel LLP, New York, NY, for Defendant The McGraw Hill Companies, Inc. d/b/a Standard & Poor's Rating Services.

Andrew J. Ehrlich, Esq., Martin Flumenbaum, Esq., Donna M. Ioffredo, Esq., Roberta A. Kaplan, Esq., Mark S. Silver, Esq., Tobias J. Stern, Esq., Julia Tarver–Mason Wood, Esq., Paul, Weiss, Rifkind, Wharton & Garrison LLP, New York, NY, for Defendant Fitch, Inc.


SHIRA A. SCHEINDLIN, District Judge:


Institutional investors King County, Washington (King County) and Iowa Student Loan Liquidity Corporation (ISL) bring this action to recover losses stemming from the October, 2007 collapse of Rhinebridge, a structured investment vehicle (“SIV”). Plaintiffs' First Amended Complaint included claims of common law fraud and aiding and abetting fraud against two individuals—who have since been dismissed from the action—and eight corporate entities: Deutsche Industriebank AG and IKB Credit Asset Management, GmbH (together, IKB); The McGraw Hill Companies, Inc. d/b/a Standard & Poor's Rating Services (S & P); Moody's Investors Service, Inc. and Moody's Investors Service Ltd. (together, Moody's); Fitch, Inc. (“Fitch,” and, with S & P and Moody's, the “Rating Agencies”); Morgan Stanley & Co. Incorporated and Morgan Stanley & Co. International Limited (together, Morgan Stanley,” or “MS”).1

At the time the plaintiffs filed their First Amended Complaint, it was settled in the Second Circuit that New York's Martin Act preempted common law tort claims in the securities context. On December 20, 2011, the New York Court of Appeals ruled that the Martin Act does not preempt common law claims in the securities context,2 and on December 27, 2011, I granted plaintiffs leave to amend their complaint to state causes of action for negligence, negligent misrepresentation, and breach of fiduciary duty, as well as aiding and abetting with respect to those claims.3 King County and ISL filed the Second Amended Complaint (“SAC”) on January 10, 2012, and defendants now move to dismiss plaintiffs' claims of negligence, negligent misrepresentation, breach of fiduciary duty and aiding and abetting. For the reasons stated below, defendants' motions are granted in part and denied in part.

II. BACKGROUND4A. Credit Ratings and Rhinebridge

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.5 SIVs are often likened to “conduits” because they raise short-term funds and channel those funds into longer-term assets, and the SIV business model resembles that of a bank in that its goal is to earn a spread between its borrowing interest rate and its lending interest rate.6 Like banks, SIVs have both assets and liabilities.7

As an SIV, Rhinebridge could only operate, raise funds, and invest those funds through its agents, such as the defendants.8 At the direction of the defendants—who controlled Rhinebridge's capital structure and credit ratings—the SIV borrowed money from investors by issuing debt securities of varying maturities and payment priority, including: (1) short term commercial paper (the “Senior Notes”) with maturities of up to 364 days; and (2) several tranches of Capital Notes that were junior to the Senior Notes and would mature in several years.9 Rhinebridge used the proceeds from the sale of these debt securities to acquire various income-producing assets.10 Rhinebridge's securities were not offered or sold to the public but only to a select group of buyers in private placements.11

The notes that SIV investors purchase typically receive very high or “investment grade” ratings from Rating Agencies.12 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. 13

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. Prior to 1975, rating agencies used publicly available information about corporations—such as Securities and Exchange Commission (“SEC”) filings—to generate unsolicited “opinions” on the creditworthiness of corporations, which they then charged investors to view.14 Over time, the market came to trust rating agencies for their integrity and unbiased approach to evaluating bonds.15 In 1975, the SEC created a special status to distinguish the most credible and reliable rating agencies, identifying them as “nationally recognized statistical rating organizations” or “NRSROs” to help ensure the integrity of the ratings process.16

According to the SEC, the “single most important criterion” to granting NRSRO status is that “the rating organization is recognized in the United States as an issuer of credible and reliable ratings by the predominant users of securities ratings” and that part of awarding the NRSRO label to the company hinges on “the rating organization's independence from the companies it rates.” 17

A credit rating is important to both issuers and investors. The Second Circuit has recognized that:

[Issuers] have their securities rated for two reasons. First, once the security or debt has received a favorable rating, that rating makes it easier to sell the security to investors, who rely upon [the rating agency's] analysis and evaluation. The second reason is that a favorable rating carries with it a regulatory benefit as well. Fitch, along with its direct competitors Amici Moody's Investors Service, Inc. (Moody's) and Standard & Poor's (S & P), has been designated by the Securities and Exchange Commission (“SEC”) as a “nationally recognized statistical rating organization” (“NRSRO”) whose endorsement of a given security has regulatory significance, as many regulated institutional investors are limited in what types of securities they may invest based on the securities' NRSRO rating.18

A credit rating provides essential information to potential investors in an SIV because an SIV's success depends on the credit quality of the assets acquired by the SIV.19 Indeed, credit quality is of such paramount importance that SIVs such as Rhinebridge are only supposed to invest in assets of the highest credit quality.20

An SIV's assets typically include some combination of “investment grade” rated asset-backed securities (“ABS”), residential mortgage backed securities (“RMBS”), and collateralized debt obligations (“CDOs”)—this was true of Rhinebridge and its Rated Notes which were invested, in part, in RMBS securities.21 Even though Rhinebridge held over a billion dollars worth of low-quality, mortgage-backed securities, the Senior Notes it issued were “top rated 22—Moody's rated the Senior Notes “Prime–1” and “AAA,” Fitch rated the Senior Notes “F1[+] and “AAA,” and S & P rated the Senior Notes “A–1+” and “AAA” (collectively, “Top Ratings”).23 These ratings are the same as those usually assigned by the Rating Agencies to bonds backed by the full faith and credit of the United States Government, such as Treasury Bills.24 Top Ratings are terms of art in the investment industry, and when assigned to a financial product such as the Senior Notes, they convey to investors that the product has been evaluated by an objective and independent third-party and is found to be “nearly risk free,” “safe, secure and reliable,” and possessing both a “very low probability of default” and “a high likelihood of recovery in the event of default.” 25 Starting on or about June 27, 2007, the Top Ratings assigned to the...

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