* Investors sued over Cheyne debt vehicle
* Fraud claims against Morgan Stanley tossed out
* Morgan Stanley still faces aiding and abetting claims
* Judge may drop negligent misrepresentation claims
By Basil Katz
Aug 17 A Manhattan federal judge on Friday refused to dismiss a lawsuit seeking to hold credit rating agencies responsible for misleading investors about the safety of a risky debt vehicle that they rated.
U.S. District Judge Shira Scheindlin denied a bid by Moody's Investors Service and Standard & Poor's to dismiss the claims, saying a jury could reasonably infer the agencies acted fraudulently over their activities regarding the Cheyne structured investment vehicle.
Friday's 89-page opinion also dismissed substantive fraud claims against Morgan Stanley, which marketed the SIV, but let stand claims the bank aided and abetted the alleged wrongdoing.
"Morgan Stanley not only substantially assisted the rating agencies in perpetrating a fraud, but actively encouraged them to do so," the opinion said.
"Plaintiffs have offered evidence suggesting that despite misgivings, Morgan Stanley manipulated the Cheyne SIV modeling process to create the ratings it desired," the opinion said. The bank "can be liable for aiding and abetting fraud, but not fraud."
Morgan Stanley spokeswoman Mary Claire Delaney declined to comment.
In court papers, the rating agencies and the bank have argued that there was no wrongdoing and that the ratings constitute independent opinions by the agencies.
The Abu Dhabi Commercial Bank, King County in Washington state, and a group of other investors had sued over losses they claimed to suffer when Cheyne went bankrupt in August 2007.
The plaintiffs are seeking unspecified damages. The plaintiffs say that by the time Cheyne collapsed it was worth about $9 billion.
Friday's opinion kept in place 12 of the investors' claims and tossed out three.
"We are pleased that the court dismissed several claims against Standard & Poor's," said spokesman Edward Sweeney. S&P is a unit of McGraw-Hill Cos. "We expect to prevail at trial on the fraud claims."
Representatives for Moody's, a unit of Moody's Corp, did not immediately return requests for comment.
The judge ruled that the "plaintiffs have also offered sufficient evidence from which a reasonable jury could infer that the rating agencies did not believe the ratings when they issued them."
The opinion quoted from an online conversation between S&P employees in which one analyst tells another that "that deal is ridiculous."
Daniel Drosman, a lawyer for the plaintiffs, said they were "pleased that the court, after examining the evidence, has recognized the validity of our fraud claims against Morgan Stanley and the rating agencies."
The judge also ordered the plaintiffs to file briefs by the end of the month demonstrating why their negligent misrepresentation claims against the rating agencies should stay in place in light of a recent federal appeals court decision.
Sweeney, the S&P spokesman, said the agency believes those claims should be tossed out.
The case is Abu Dhabi Commercial Bank et al v. Morgan Stanley & Co et al, U.S. District Court, Southern District of New York, No. 08-cv-07508.