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King County, Washington v. IKB Deutsche Industriebank AG


May 4, 2012




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").*fn1

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,*fn2 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.*fn3 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.


A. 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.*fn5

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.*fn6 Like banks, SIVs have both assets and liabilities.*fn7

As an SIV, Rhinebridge could only operate, raise funds, and invest those funds through its agents, such as the defendants.*fn8 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.*fn9 Rhinebridge used the proceeds from the sale of these debt securities to acquire various income-producing assets.*fn10 Rhinebridge's securities were not offered or sold to the public but only to a select group of buyers in private placements.*fn11

The notes that SIV investors purchase typically receive very high or "investment grade" ratings from Rating Agencies.*fn12 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.*fn13

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.*fn14 Over time, the market came to trust rating agencies for their integrity and unbiased approach to evaluating bonds.*fn15 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.*fn16

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."*fn17

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.*fn18

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.*fn19 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.*fn20

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.*fn21 Even though Rhinebridge held over a billion dollars worth of low-quality, mortgage-backed securities, the Senior Notes it issued were "top rated*fn22 -

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").*fn23 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.*fn24 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."*fn25 Starting on or about June 27, 2007, the Top Ratings assigned to the Senior Notes were communicated to investors; all defendants knew that investors such as the plaintiffs would view and rely upon the ratings when deciding whether or not to invest in Rhinebridge.*fn26

According to the U.S. Commercial Paper Private Placement Memorandum, the Senior Notes could not be offered to the public at large; they could only be offered and sold to Qualified Institutional Buyers, as defined in Rule 144A under the Securities Act of 1933, that are also Qualified Purchasers, as defined in Section 2(a)(51)(A) of the Investment Company Act of 1940 ("QIBs").*fn27

King County and ISL are QIBs, and - as qualified investors often do - have minimum ratings requirements for their investments.*fn28 The defendants knew this, and accordingly, the Rhinebridge U.S. Commercial Paper Placement Agency Agreement ("PAA") specified that the Senior Notes would not be issued unless they received Top Ratings.*fn29 The Senior Notes did receive Top Ratings when they were first sold to investors on or about June 27, 2007.*fn30

B. The Role of IKB and Morgan Stanley

IKB and MS were responsible for: (1) overseeing Rhinebridge's portfolio; (2) facilitating the purchase of portfolio assets; (3) conducting capital, market sensitivity and liquidity tests to monitor Rhinebridge's assets; and (4) monitoring the Senior Notes to determine whether they were supported by sufficient equity and junior notes.*fn31 Throughout the negotiation, ramp-up and launch periods, MS and IKB circulated and received drafts of virtually all of the documents concerning Rhinebridge, and set deadlines by which deal documents were to be completed and distributed to investors.*fn32 Morgan Stanley 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.*fn33

In structuring Rhinebridge, MS and IKB caused the SIV to acquire high-risk toxic assets - unbeknownst to investors, Rhinebridge held over a billion dollars worth of low-quality mortgage-backed securities, more than half of which IKB had transferred from its own balance sheet into the SIV's portfolio.*fn34 Morgan Stanley "caused"*fn35 Rhinebridge to acquire "hundreds of millions of dollars of poor quality, toxic assets" that it knew IKB was trying to "unload[]."*fn36 It "coerced"*fn37 the Rating Agencies to allow risky Home Equity Loans ("HELs") to constitute up to seventy-five percent of Liquid Eligible Assets ("LEAs")*fn38 in the SIV, where most SIVs limit HELs to fifteen to twenty percent of such assets.*fn39 It caused Rhinebridge to acquire approximately two-hundred and fifty million dollars in Countrywide securities -- a single obligor exposure approximately three times higher than the four percent limit stipulated in the SIV's operating instructions.*fn40 It knew Rhinebridge had breached its "Major Capital Loss Test"*fn41 ("Capital Test") before Rhinebridge was launched on June 27, 2007, and that its Top Ratings were false.*fn42

By virtue of their roles in creating, structuring, managing and monitoring the SIV, MS and IKB had access to confidential information regarding Rhinebridge.*fn43 Because Morgan Stanley structured and underwrote several of the SIV's underlying assets, it had intimate knowledge regarding the quality of its securitizations.*fn44 And because it had unsuccessfully attempted to sell its low-quality mortgage-backed securities on the open market, IKB had unique information regarding the demand and liquidity of those assets - assets IKB was "thrilled" that it could sell to Rhinebridge.*fn45

C. The Rating Agencies' Collaboration with MS and IKB

The Rating Agencies collaborated with IKB and MS to draft key selling documents, determine which assets the SIV could hold and what structural protections to put in place, and investigate and recommend securities for the SIV's portfolio.*fn46 The Rating Agencies had a significant ongoing role in the operation of Rhinebridge, which included (among other rights and responsibilities) the right to veto changes in management and the right to review and potentially veto any changes in how Rhinebridge obtained funding, modified its operating instructions, or changed its investment guidelines.*fn47 Regardless of their historical roles, the Rating Agencies did not merely provide ratings; rather, they were deeply entrenched in the creation and operation of Rhinebridge.*fn48

The Rating Agencies were compensated for their involvement with Rhinebridge, and had significant economic incentives to provide falsely high ratings.*fn49 Each of the three Rating Agencies gave the Senior Notes the "Top Ratings" without which Rhinebridge could not have existed.*fn50 Yet these ratings were false or misleading, in part because all three Rating Agencies used information that was stale and inaccurate, and models that were outdated.*fn51

Moreover, the Rating Agencies knew that their ratings were false or misleading*fn52 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.*fn53

D. Defendants' Targeting of QIBs

The defendants knew that the Senior Notes could only be offered to QIBs and QPs,*fn54 and indeed, according to the PPM, any offer or sale of Rhinebridge-issued Senior Notes to a party other than a QP or a QIB would "BE DEEMED NULL AND VOID AB INITIO AND OF NO EFFECT."*fn55 Not only were defendants aware that many qualified investors could only invest in SIVs that received "Top Ratings," but prior to their Senior Note purchases, the plaintiffs directly informed the Rating Agencies they relied on credit ratings to make investment decisions.*fn56 Knowing that qualified investors, including the plaintiffs, were relying on the Senior Notes' ratings to decide whether or not to invest in Rhinebridge, the defendants worked closely to ensure that the Senior Notes received "Top Ratings"*fn57 - according to the PAA, receipt of the "Top Ratings" was a "condition precedent" to issuing the Senior Notes.*fn58

The Rating Agencies knew or should have known the identity of the potential Senior Notes investors,*fn59 and Morgan Stanley and IKB did know the identities of the Senior Notes investors prior to those investors' purchases of the Senior Notes.*fn60

E. The Collapse of the Rhinebridge SIV

The Senior Notes had Top Ratings from their first sale to investors on or about June 27, 2007 to their downgrade to "junk" ratings on October 18 and 19, 2007.*fn61 Thus, in less than four months, the ratings went from indicating an extremely low probability of default to indicating a near-certain likelihood of default.*fn62 The Rhinebridge SIV was forced into receivership on or about October 22, 2007, becoming perhaps the shortest-lived "Triple A" investment fund in the history of corporate finance.*fn63


A. Rule 12(b)(6) Motion to Dismiss

In deciding a motion to dismiss pursuant to Federal Rule of Civil Procedure 12(b)(6), the court "accept[s] all factual allegations in the complaint as true, and draw[s] all reasonable inferences in the plaintiff's favor."*fn64 The court evaluates the sufficiency of the complaint under the "two-pronged approach" suggested by the Supreme Court in Ashcroft v. Iqbal.*fn65 First, a court "'can choose to begin by identifying pleadings that, because they are no more than conclusions, are not entitled to the assumption of truth.'"*fn66 "Threadbare recitals of the elements of a cause of action, supported by mere conclusory statements, do not suffice" to withstand a motion to dismiss.*fn67 Second, "[w]hen there are well-pleaded factual allegations, a court should assume their veracity and then determine whether they plausibly give rise to an entitlement for relief."*fn68 To survive a Rule 12(b)(6) motion to dismiss, the allegations in the complaint must meet a standard of "plausibility."*fn69 A claim is facially plausible "when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged."*fn70 Plausibility "is not akin to a probability requirement;" rather, plausibility requires "more than a sheer possibility that a defendant has acted unlawfully."*fn71

"In considering a motion to dismiss for failure to state a claim pursuant to Rule 12(b)(6), a district court may consider the facts alleged in the complaint, documents attached to the complaint as exhibits, and documents incorporated by reference in the complaint."*fn72 However, the court may also consider a document that is not incorporated by reference, "where the complaint 'relies heavily upon its terms and effect,' thereby rendering the document 'integral' to the complaint."*fn73

B. Rule 8 Pleading Requirement

"Federal Rule of Civil Procedure 8(a)(2) requires . . . 'a short and plain statement of the claim showing that the pleader is entitled to relief.'"*fn74 To survive a Rule 12(b)(6) motion to dismiss, the allegations in the complaint must meet the standard of plausibility, as discussed above.*fn75

C. Rule 9(b) Pleading Requirement

Common law fraud claims must be pled with particularity in accordance with the requirements set forth in Rule 9(b).*fn76 Where defendants are insiders or affiliates participating in the securities offering, the Second Circuit has held "that reference to an offering memorandum satisfies 9(b)'s requirement of identifying time, place, speaker, and content of representation . . . ."*fn77


A. Negligence

Under New York law, a plaintiff asserting a claim of negligence must show that the defendant owed the plaintiff a duty of care, that the defendant breached that duty, and that the breach was the proximate cause of the harm suffered by the plaintiff.*fn78 While foreseeability and causation are generally questions of fact to be determined by juries, "the duty owed one member of society to another is a legal issue" to be decided by the courts.*fn79

B. Negligent Misrepresentation

Under New York law, a plaintiff asserting a claim of negligent misrepresentation must show: that (1) the defendant had a duty, as a result of a special relationship, to give correct information; (2) the defendant made a false representation that he or she should have known was incorrect; (3) the information supplied in the representation was known by the defendant to be desired by the plaintiff for a serious purpose; (4) the plaintiff intended to rely and act upon it; and (5) the plaintiff reasonably relied on it to his or her detriment.*fn80

C. Breach of Fiduciary Duty

Under New York law, to prove a breach of fiduciary duty, "a plaintiff must demonstrate: 'breach by a fiduciary of a duty owed to plaintiff; defendant's knowing participation in the breach; and damages.'"*fn81 A fiduciary relationship exists when one party "'is under a duty to act for or to give advice for the benefit of another upon matters within the scope of the relation.'"*fn82 Further, "a fiduciary relationship must exhibit the characteristics of 'de facto control and dominance.'"*fn83

A fiduciary relationship may exist where "'one party's superior position or superior access to confidential information is so great as virtually to require the other party to repose trust and confidence in the first party,'"*fn84 or in situations "'in which influence has been acquired and abused, in which confidence has been reposed and betrayed.'"*fn85 Yet reposing trust or confidence in a party that has superior access to confidential information is not sufficient to establish a fiduciary relationship - under New York law, there is no fiduciary duty unless the trust or confidence has been accepted as well.*fn86 Further, there can be no claim for breach of fiduciary duty unless a fiduciary relationship existed prior to the transaction giving rise to the alleged wrong.*fn87

D. Aiding and Abetting

When proceeding under an aiding and abetting theory of liability under New York law, a plaintiff must show "(1) the existence of a . . . violation by the primary (as opposed to the aiding and abetting) party; (2) knowledge of this violation on the part of the aider and abettor; and (3) substantial assistance by the aider and abettor in the achievement of the primary violation."*fn88 For claims of aiding and abetting to survive a motion to dismiss, they must be pled with some level of specificity and may not consist solely of a broad, conclusory repetition of the elements of aiding and abetting.*fn89


A. Timeliness

1. Relation-back

Morgan Stanley argues that plaintiffs' negligence claims are time-barred because they were initiated more than three years after the alleged negligence and because the allegations in the original complaint did not put Morgan Stanley on notice of potential liability for its alleged negligent structuring of the SIV.*fn90 However, the First Amended Complaint did allege that Morgan Stanley structured and monitored the SIV.*fn91 Because the negligence claim "arose out of the conduct, transaction, or occurrence set out - or attempted to be set out - in the original pleading,"*fn92 and because the allegations in the First Amended Complaint alerted Morgan Stanley to the possibility of a claim based on its structuring of the SIV, the negligence claim relates back to the First Amended Complaint, and is therefore timely.

2. Leave to File the SAC Under Rule 15

Notwithstanding that I already granted plaintiffs leave to amend,*fn93 IKB argues that "Plaintiffs should not be granted leave to file the SAC under Rule 15."*fn94 The decision to allow plaintiffs leave to amend is committed to the court's "sound discretion."*fn95 I granted plaintiffs leave to file the SAC because - contrary to IKB's argument that there was a "clear legal trend against Martin Act preemption" by early 2011*fn96 - Martin Act preemption was settled law in the Second Circuit*fn97 until the New York Court of Appeals' decision in Assured Guaranty II on December 20, 2011.*fn98 Leave to amend was warranted because plaintiffs did not "sit on their rights" as IKB contends;*fn99 they requested leave to amend two days after the decision in Assured Guaranty II.*fn100

B. Negligence Claims Against All Defendants

Collectively, defendants raise a host of arguments as to why plaintiffs' negligence claims should be dismissed: (1) the negligence claims are duplicative of the negligent misrepresentation claims;*fn101 (2) negligence claims to recover purely economic losses are barred by New York's economic loss doctrine;*fn102 (3) defendants did not owe a duty to plaintiffs;*fn103 and (4) plaintiffs have not adequately pled breach or causation.*fn104 For the reasons discussed below, plaintiffs' negligence claims are not duplicative of their negligent misrepresentation claims. However, because I find that plaintiffs' negligence claims are barred by New

York's economic loss doctrine, I decline to address defendants' other arguments.

1. Duplicativeness

The Rating Agencies argue that plaintiffs' negligence claim against them challenges the same conduct at issue in plaintiffs' negligent misrepresentation claim.*fn105 This is not so. Whereas plaintiffs' negligent misrepresentation claim challenges alleged misrepresentations made by the Rating Agencies, the negligence claim arises from the Rating Agencies' role in "designing, arranging, structuring, modeling, marketing, selling and monitoring" Rhinebridge.*fn106 There are several allegations in the SAC that the Ratings Agencies - in addition to and apart from their alleged misstatements - played a role in creating and operating the Rhinebridge SIV.*fn107 Thus, the negligence claim challenges different conduct than the negligent misrepresentation claim, and it is therefore not duplicative.

2. New York's Economic Loss Doctrine

Under New York's "economic loss" rule, a plaintiff cannot recover in tort for purely economic losses caused by a defendant's negligence.*fn108 In 532

Madison Avenue Gourmet Foods, Inc. v. Finlandia Center, Inc., the New York Court of Appeals cautioned that the "economic loss rule" has no application outside of the product-liability context.*fn109 And yet, in practice the principle has been applied broadly, and has been referred to interchangeably as the "economic loss rule" and the "economic loss doctrine."*fn110 The approach taken in Finlandia is instructive - rather than apply a "rule" barring plaintiffs from recovering for purely economic losses, the Court of Appeals conducted a duty analysis and determined that "plaintiffs' negligence claims based on economic loss alone fall beyond the scope of the duty owed them by defendants."*fn111 It is this focused duty analysis - this policy-driven scrutiny of whether a defendant had a duty to protect a plaintiff against purely economic losses - that can best be termed "the economic loss doctrine." In Hydro Investors, Inc. v. Trafalgar Power Inc., the Second Circuit explained the rationale behind the doctrine:

[The economic loss rule's] continuing role is based on the recognition that "[r]elying solely on foreseeability to define the extent of liability [in cases involving economic loss], while generally effective, could result in some instances in liability so great that, as a matter of policy, courts would be reluctant to impose it." To prevent such open-ended liability, courts have applied the economic loss rule to prevent the recovery of damages that are inappropriate because they actually lie in the nature of breach of contract as opposed to tort.*fn112

Thus the economic loss doctrine serves two purposes: (1) it "protect[s] defendants from disproportionate, and potentially limitless, liability";*fn113 and (2) it disentangles contract and tort law by restricting plaintiffs who suffer economic losses to the benefits of their bargains.*fn114

Plaintiffs argue that the economic loss doctrine does not apply where an action in contract is unavailable, and that because I dismissed contract claims under facts very similar to those here,*fn115 the doctrine does not bar plaintiffs' negligence claims. This argument misunderstands the economic loss doctrine - the unavailability of a contract remedy does not automatically trigger an exception to the rule.*fn116 Indeed, the doctrine may apply even when there is no contract at all between the parties.*fn117 Rather, the presence of a contract or a financial transaction that is "in the nature of contract"*fn118 can be a strong indicator that a plaintiff was not owed a legal duty separate and apart from obligations bargained for and subsumed within the transaction.*fn119

While plaintiffs have not alleged the existence of any contract between them and either Rhinebridge or the defendants, an analysis of the conduct that plaintiffs' negligence claim challenges - defendants' creation, structuring and operation of the Rhinebridge SIV - demonstrates why it would be inappropriate to allow plaintiffs to recover in negligence for their economic losses. Notes issued by an SIV are financial products - they carry an expected return, a level of risk, and a price which is supposed to reflect those factors. If a seller of a financial product misleads buyers about the level of risk or expected return, then actions may lie in breach of contract, fraud, negligent misrepresentation, breach of fiduciary duty, etc. Such products, however, cannot be negligently structured - even a low-quality financial product with a high level of risk and low expected return would have an appropriate price, albeit a low one. As a matter of law, creators and structurers of investment vehicles - even risky or "low quality" ones - do not have a duty of care to protect investors against economic losses. The economic loss doctrine serves to disentangle inappropriate negligence liability such as that alleged by the plaintiffs from sustainable causes of action stemming from flaws in the transaction or defects in the information disclosed.

Plaintiffs argue that even if the economic loss rule were to apply, the rule allows recovery for economic loss where the defendant had a professional responsibility to the plaintiffs.*fn120 This exception stems from the fact that malpractice is a subcategory of negligence,*fn121 and it exists to prevent the economic loss doctrine from barring recovery in many types of malpractice actions.*fn122 The exception has been read narrowly to apply to professionals that might be liable for malpractice - such as attorneys, engineers, accountants, or architects.*fn123 Even were plaintiffs correct that defendants are "professionals," the exception to the economic loss doctrine is only triggered when the defendant either had a contract with or provided professional services directly to the plaintiff.*fn124 Because plaintiffs have failed to allege that defendants owed them a professional responsibility to structure the Rhinebridge SIV in a certain fashion, their negligence claim is barred by the economic loss doctrine.

C. Negligent Misrepresentation

1. The Economic Loss Doctrine

Although "[n]egligent misrepresentation is a type of fraud,"*fn125 the economic loss doctrine may nonetheless bar negligent misrepresentation claims. Where the parties have a contract governing their relationship, the analytical approach is the same: the economic loss rule may apply unless the defendant had a legal duty - separate and apart from any contractual obligations - to protect the plaintiff from purely economic losses.*fn126 Where, as here, the parties are not in contractual privity, the duty analysis at the heart of the economic loss doctrine is subsumed by the determination of whether the parties had a relationship that barred the defendant from making any negligent misrepresentations to the plaintiff.*fn127

2. Actionability of Credit Ratings

In Abu Dhabi, I rejected the argument that credit ratings are not actionable as misrepresentations in New York.*fn128 Morgan Stanley and the Rating Agencies now argue that, as predictive opinions about future events, credit ratings are only actionable "when they misrepresent the speaker's genuine opinion (i.e., when fraudulent), they cannot be actionable in a negligence context."*fn129 Yet under New York negligent misrepresentation law, "even statements of opinion are actionable if they are made in bad faith or are not supported by the available evidence."*fn130 Many of the cases which defendants cite for the proposition that credit ratings are not actionable deal with Sections 11 and 12 of the Securities Act of 1933.*fn131 Although cases interpreting Section 10(b) of the Securities Act are helpful to federal courts applying New York law,*fn132 the same is not true for

Sections 11 and 12.*fn133 Similarly, defendants cite several cases applying the common law of other states,*fn134 but they are inapposite because they do not apply New York law. Maverick Fund, L.D.C. v. Comverse Technology, Inc. - one of the few cases cited by defendants that deals with New York negligent misrepresentation law - distinguishes between statements predicting future events, which are not actionable in negligent misrepresentation in New York, and statements of opinion, which may be.*fn135 The other cases that defendants cite only hold that certain types of opinions - as opposed to opinions in general - are not actionable in New York.*fn136 As such, I again hold that plaintiffs "have sufficiently alleged that the ratings issued by the Rating Agencies on the Rated Notes are actionable misstatements."*fn137

3. Special Relationship with the Rating Agencies

Under New York law, "[w]hether the nature and caliber of the relationship between the parties is such that the injured party's reliance on a negligent misrepresentation is justified generally raises an issue of fact."*fn138 The

New York Court of Appealsfurther directs the fact-finder to consider:

[W]hether the person making the representation held or appeared to hold unique or special expertise; whether a special relationship of trust or confidence existed between the parties; and whether the speaker was aware of the use to which the information would be put and supplied it for that purpose.*fn139

Thus, there can be no negligent misrepresentation without some form of "special relationship" between the parties.*fn140 At the motion to dismiss stage, "a 'sparsely pled' special relationship of trust or confidence is not fatal to a claim for negligent misrepresentation where 'the complaint emphatically alleges the other two factors enunciated in Kimmell [v. Schaefer].'"*fn141 Plaintiffs have sufficiently alleged that the Rating Agencies possessed unique or specialized expertise,*fn142 and that the Rating Agencies knew and intended that their ratings would be used by investors in deciding whether or not to invest in Rhinebridge.*fn143

In the absence of actual contractual privity, plaintiffs alleging a special relationship sufficient to give rise to a duty face a "heavy burden,"*fn144 and must establish that the relationship was so close as to be "privity-like."*fn145 Still, "a determination of whether a special relationship exists is highly fact-specific and 'generally not susceptible to resolution at the pleadings stage.'"*fn146

In Credit Alliance Corp. v. Arthur Andersen & Co., the New York Court of Appeals elaborated on the "special relationship" standard:

(1) the accountants must have been aware that the financial reports were to be used for a particular purpose or purposes; (2) in the furtherance of which a known party or parties was intended to rely; and (3) there must have been some conduct on the part of the accountants linking them to that party or parties, which evinces the accountants' understanding of that party or parties' reliance.*fn147

Although Credit Alliance discussed accountants, the Credit Alliance test has been applied broadly.*fn148 Plaintiffs have sufficiently alleged that the Rating Agencies knew their statements would be used for a particular purpose - to evaluate the quality of the assets in the SIV. The Rating Agencies argue that: (1) the second prong of the Credit Alliance test has not been met because plaintiffs were not "known parties" but rather unknown amidst a large pool of potential investors; and

(2) the third prong of the Credit Alliance test has not been met because there was no "linking conduct" between the Rating Agencies and the plaintiffs. The Rating Agencies are wrong on both counts.

Because they were members of a select group of qualified investors, plaintiffs were known parties towards whom the Rating Agencies targeted their alleged misrepresentations, and thus the "known party" prong of the Credit Alliance test has been met.*fn149 The Rating Agencies rely on Sykes v. RFD Third Ave 1 Associates, LLC, in which the New York Court of Appeals used broad language in holding that potential purchasers of apartments in a condominium building were not "known parties" to the engineering firm that designed the building's heating, ventilation and air conditioning system.*fn150 Yet Sykes should not be read to require that the defendant know the identity of each particular plaintiff; rather, plaintiffs are a "known party" if they are members of a "settled and particularized class,"*fn151 as opposed to an "indeterminate class."*fn152 Whereas the pool of potential purchasers of apartments in a condominium building is an "indeterminate class," the select group of qualified investors towards which the Rating Agencies targeted their alleged misrepresentation is a "settled and particularized class."*fn153 Further, plaintiffs were known parties to the Rating Agencies because - prior to their purchase of the Senior Notes - plaintiffs directly informed the Ratings Agencies that they rely on credit ratings in making investment decisions.*fn154

Similarly, "linking conduct" is present such that the third prong of the Credit Alliance test is satisfied. In LaSalle National Bank v. Duff & Phelps Credit Rating Co., under facts mirroring those present here, Judge Whitman Knapp found "linking conduct" between Duff & Phelps Credit Rating Co. ("Duff & Phelps") - a ratings agency - and a select group of qualified investors.*fn155 To meet the "linking conduct" prong of the Credit Alliance test, the LaSalle National Bank plaintiffs alleged - as the plaintiffs do here - that the "primary if not exclusive end and aim" of the rating was to market an investment product to plaintiffs, and that the rating was shaped to meet plaintiffs' needs.*fn156 The Rating Agencies argue that the facts in LaSalle National Bank are distinguishable - whereas in LaSalle National Bank, six out of the twenty-six plaintiffs had direct phone contact with Duff & Phelps, here the Rating Agencies had no direct contact with any of the plaintiffs prior to their investment in the SIV.*fn157 This distinction is of no moment, however, as Judge Knapp declined to dismiss the negligence claims of the plaintiffs who had no direct contact with Duff & Phelps.*fn158 Rather, Judge Knapp viewed the contact with the six plaintiffs as indicative of Duff & Phelps' awareness that its ratings would be given to a select group of qualified investors.*fn159 Here, not only have plaintiffs alleged that the Rating Agencies were aware their ratings would be given to a select group of qualified investors, but plaintiffs also alleged that the Rating Agencies issued their ratings with the end and aim of inducing that limited group of investors to invest in Rhinebridge.*fn160 The Rating Agencies cite Securities Investment Protection Corp. v. BDO Seidman, LLP for the proposition that "end and aim" allegations are insufficient to allege "linking conduct."*fn161 But unlike in BDO Seidman, there are additional indicia of "linking conduct" here: plaintiffs have alleged that the Rating Agencies' ratings were prepared for the benefit of the plaintiffs, were sent to the plaintiffs, were read by the plaintiffs and, as a result, placed the plaintiffs in a relationship significantly different from anyone else in the investing public at large.*fn162

All three prongs of the Credit Alliance test have been met: the Rating Agencies (1) intended that their ratings would be used to evaluate the SIV; (2) intended that the plaintiffs - members of a select group of qualified investors - would rely on their ratings to evaluate the SIV; and (3) prepared their ratings with the end and aim of inducing investors such as the plaintiffs to invest in the SIV. Because there was a privity-like "special relationship"*fn163 between the plaintiffs and the Rating Agencies, the Rating Agencies' motion to dismiss the negligent misrepresentation claims is denied.*fn164

4. Special Relationship with Morgan Stanley and IKB

Similarly, plaintiffs have satisfied the three prongs of the Credit Alliance test and sufficiently alleged a "special relationship" with both IKB and MS.*fn165 Under the first prong, plaintiffs have sufficiently alleged that MS and IKB knew the credit ratings would be used by investors to decide whether or not to purchase the Senior Notes.*fn166 Further, MS and IKB made Top Ratings a condition precedent to issuance of the Senior Notes because they knew that QIBs such as the plaintiffs - legally, the only potential purchasers of the Senior Notes - require Top Ratings.*fn167

The second prong of the Credit Alliance test is met, as IKB and MS created the Senior Notes for QIBs, a limited and known group of potential investors.*fn168 MS and IKB knew about QIBs' investment requirements, and structured Rhinebridge accordingly.*fn169 Although MS and IKB may not have remembered or known the specific identities of all of the QIBs, "[k]nowledge of the identity of each particular plaintiff is not necessary."*fn170 Moreover, the SAC specifically alleges that "Morgan Stanley and IKB knew the identities of the Senior Notes investors prior to those investors' purchases of the Senior Notes."*fn171

Although the SAC does provide some factual support for this allegation, IKB contends that the allegation is false and contradicted by underlying documents.*fn172

Whether or not IKB actually knew the identity of the Senior Notes investors prior to their purchases of the Senior Notes is a factual question; for the purpose of deciding this motion to dismiss, I must accept plaintiffs' allegation as true.

The third prong of the Credit Alliance test is met in that IKB and MS created and structured Rhinebridge, worked with the Rating Agencies to ensure that the Rated Notes received falsely-high ratings, and communicated those inaccurate ratings to a select group of qualified investors including the plaintiffs.

Morgan Stanley argues that it cannot be liable for negligent misrepresentation because it has not made any statement. Based on the group pleading doctrine, I rejected this argument when I denied Morgan Stanley's motion to dismiss plaintiffs' fraud claim.*fn173 MS argues that the group pleading doctrine has no applicability to negligent misrepresentation and breach of fiduciary duty claims,*fn174 but cites no controlling authority for this proposition.*fn175 While it is settled that "[t]he group pleading doctrine is an exception to the requirement that the fraudulent acts of each defendant be identified separately in the complaint,"*fn176

this does not imply that the group pleading doctrine applies only to fraud claims; rather, it applies whenever Rule 9(b) applies, which is whenever the alleged conduct of defendants is fraudulent in nature. Because negligent misrepresentation is a type of fraud,*fn177 the group pleading doctrine does apply to negligent misrepresentation claims. Further, the group pleading doctrine applies to breach of fiduciary duty claims that are rooted in fraud, as is the case here.*fn178 Thus, because plaintiffs' negligent misrepresentation and breach of fiduciary duty claims allege fraudulent conduct, the group pleading doctrine applies, and plaintiffs' failure to allege a statement made by Morgan Stanley is not fatal to their negligent misrepresentation claim.*fn179

5. Plaintiffs' Reliance on the Ratings

IKB argues that there can be no special relationship between plaintiffs and IKB due to: (1) plaintiffs' sophistication as QIBs;*fn180 and (2) the PPM's disclaimers that plaintiffs should conduct their own investment analysis and that IKB only accepted responsibility for a narrow category of representations in the document.*fn181 A defendant's awareness of or intention to induce plaintiff's reliance may be relevant to the "special relationship" analysis.*fn182 However, the sophistication of plaintiffs, the existence of disclaimers, and a defendant's possession of unique or special expertise are generally only relevant to whether or not a plaintiff reasonably relied on statements made by the defendant.*fn183 Justifiable reliance has little to do with the Credit Alliance test, and is a separate element of a negligent misrepresentation claim.*fn184

In Abu Dhabi, under very similar facts, I held that plaintiffs sufficiently alleged justifiable reliance on credit ratings.*fn185 Although there, as here, the offering documents contained disclaimers of liability and warnings that investors should conduct their own investigation, I found that plaintiffs could prove that their reliance was justified given their lack of access to the information upon which the ratings were based.*fn186 I see no reason to deviate from that ruling here.

D. Breach of Fiduciary Duty

1. Concession of Fiduciary Duty

Plaintiffs argue that, while testifying before Congress, the Rating Agencies conceded that they owe a fiduciary responsibility to investors.*fn187 In the SAC, plaintiffs selectively quote from the October 22, 2008 Hearing on Credit Rating Agencies and the Financial Crisis as follows:

Senator Speier: "Who do you owe a fiduciary duty to, the issuer or the investor?

Fitch: "I feel quite responsible to provide our best opinion to investors . . . ."

Moody's: "[W]e must be responsible to the investor."

S&P: "Responsibility to the investor is the most critical thing for us."*fn188

These out-of-context and vague statements by the Rating Agencies that they feel a responsibility to investors do not constitute a concession that they have a fiduciary duty to all investors, let alone the plaintiffs.*fn189

2. Disclaimers of Fiduciary Duty

MS and IKB argue that they had no fiduciary duty to plaintiffs given their lack of contact with the plaintiffs and the existence of disclaimers in the PPM.*fn190 Contractual disclaimers of fiduciary duty are enforceable in New York,*fn191 but only when explicit.*fn192 Here, the "disclaimers" on which IKB and MS rely are not sufficiently explicit, as they make no reference to a fiduciary duty.*fn193

3. Existence of a Fiduciary Relationship

It is settled in New York that a fiduciary relationship exists "'when confidence is reposed on one side and there is resulting superiority and influence on the other.'"*fn194 Plaintiffs argue that such a relationship was created through the Rating Agencies' superior access to confidential information about Rhinebridge and the fact that, as NRSROs, the Rating Agencies held themselves out to investors as independent and reliable issuers of credit ratings.*fn195 While "[a]scertaining the existence of a fiduciary relationship 'inevitably requires a fact-specific inquiry,'"*fn196 a breach of fiduciary duty claim requires a closer relationship than the "special relationship" necessary for a negligent misrepresentation claim.*fn197 Because fiduciary relationships are "personal and context-specific,"*fn198 before a court can "infer and superimpose" a fiduciary duty, "the contract and relationship of the parties must be plumbed."*fn199

Although plaintiffs sufficiently alleged the existence of a relationship with defendants sufficient to state a cause of action for negligent misrepresentation, the relationship between the parties is too attenuated to give rise to a fiduciary duty.*fn200 Classic examples of fiduciary relationships include trustee-beneficiary, guardian-ward, principal-agent, and attorney-client relationships.*fn201 These relationships all include "an unusually high degree of care,"*fn202 to the point where one party "'is under a duty to act for or to give advice for the benefit of another upon matters within the scope of the relation.'"*fn203 This is generally not the case for commercial relationships in which the parties have had no direct dealings with one another.*fn204 To hold that the Rating Agencies had a fiduciary duty to plaintiffs would be to hold that, whenever rating agencies issue ratings based on confidential information, they have a fiduciary duty to all potential investors who are likely to rely on that rating. Likewise, to hold that MS and IKB had a fiduciary relationship with plaintiffs prior to plaintiffs' purchase of the Senior Notes would be to hold that the creators and arrangers of structured finance vehicles have a fiduciary duty to all potential investors. New York does not recognize so broad a fiduciary duty - a fiduciary relationship does not arise from a party's superior knowledge about an investment product,*fn205 nor does it arise in a business transaction between an investor and a company soliciting investors.*fn206 Thus, defendants' motions to dismiss plaintiffs' breach of fiduciary duty claims are granted.

E. Aiding and Abetting

There is no cause of action for aiding and abetting negligence or negligent misrepresentation in New York. In In re Bayou Hedge Funds Investment Litigation, Judge Colleen McMahon pointed out that few states recognize aiding and abetting liability for a third party's negligence, and - after noting that there were no examples of New York courts allowing such claims to proceed - dismissed a claim for aiding and abetting negligence.*fn207 For this reason, plaintiffs' claims of aiding and abetting negligence and negligent misrepresentation are dismissed.

New York does recognize a cause of action for aiding and abetting breach of fiduciary duty where: (1) one breached a fiduciary duty owed to another; (2) the defendant knowingly induced or participated in the breach; and (3) the plaintiff suffered damage as a result of the breach.*fn208 However, there can be no aiding and abetting claim without the existence of a violation by a primary (as opposed to aiding and abetting) party.*fn209 Thus, because I dismissed plaintiffs' breach of fiduciary duty claims, plaintiffs' aiding and abetting breach of fiduciary duty claims are likewise dismissed.

F. Sufficiency of Allegations Pertaining to Fitch

In a separate brief, defendant rating agency Fitch argues that the SAC fails to "plead facts particular to Fitch sufficient to sustain these new claims."*fn210

Fitch made - and I rejected - this argument when I denied Fitch's motion to dismiss plaintiffs' fraud claims. Nonetheless, Fitch offers two reasons it believes a different result is warranted here: (1) because discovery has begun on plaintiffs' fraud claims, plaintiffs cannot bring new common law claims against Fitch without more allegations particular to Fitch;*fn211 and (2) my prior holding is inconsistent with the decision of Judge James O. Browning of the district court in New Mexico in Genesee County Employees' Retirement System v. Thornburg Mortgage Securities Trust 2006-3.*fn212 Fitch is wrong on both counts.

Fitch offers no support for the proposition that once discovery has begun on some claims, newly added claims face a heightened pleading standard.

And indeed, no such support exists. Rule 12(b)(6) demands that I "accept all factual allegations in the complaint as true, and draw all reasonable inferences in the plaintiff's favor." At no point in the discovery process does Rule 12(b)(6) permit me to make a negative inference from facts that are absent from the complaint. That plaintiffs refer to Fitch, S&P and Moody's collectively as the "Rating Agencies" does not make the allegations in the SAC any less particular. Although plaintiffs do have "an obligation to 'make clear exactly who is alleged to have done what to whom,'"*fn213 plaintiffs are not required to copy and paste their allegations for each rating agency. It is sufficient to define the three rating agency defendants collectively as the "Rating Agencies" - as plaintiffs did*fn214 - and then use that collective term in all allegations that apply equally to those three defendants.

Fitch's reliance on Genesee County is similarly unavailing. Whereas Judge Browning held that the allegations against Fitch in Genesee County were insufficient because they "lead only to the conclusion that [Fitch's credit] ratings 'were honestly held when formed but simply turn[ed] out later to be inaccurate,' or that Fitch 'could have formed "better" opinions,'"*fn215 I have already held that "plaintiffs have adequately pled that (1) Fitch did not 'genuinely and reasonably believe' the ratings it issued or that (2) those rating were 'without bais in fact' -- i.e., that they did not 'hold the opinions expressed by the ratings.'"*fn216 I see no reason to reconsider that ruling.


For the foregoing reasons, defendants' motions to dismiss are granted in part and denied in part: plaintiffs' claims for negligence, breach of fiduciary duty, and aiding and abetting are dismissed; defendants' motions to dismiss plaintiffs' claims of negligent misrepresentation are denied. The Clerk of the Court is directed to close this otion (Docket Nos. 212, 216, and 219). A status conference is scheduled for May 29, 2012 at 4:30pm.


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