* Rating agencies rate debt, don't underwrite it
* Known market weakness won't start statute of limitations
* Execs at Moody's to testify Wednesday before U.S. panel
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By Jonathan Stempel
NEW YORK, June 1 A Manhattan federal judge said on Tuesday it is unfair to hold Moody's Investors Service and Standard & Poor's liable as "underwriters" on securities offerings needing their ratings, as he rejected fraud claims by investors on the safety of $63.4 billion of mortgage debt.
U.S. District Judge Jed Rakoff offered his assessment in an opinion detailing the reasons behind his March 31 dismissal of class-action claims against the credit rating agencies.
The judge dismissed some claims against some Merrill Lynch affiliates of Bank of America Corp (BAC.N), JPMorgan Chase & Co (JPM.N); the ABN Amro unit of Royal Bank of Scotland Group Plc (RBS.L) and C-Bass, which packaged debt underwritten by banks.
He nonetheless allowed some claims to proceed against a Merrill unit and some Merrill officials, saying the investors were not on notice that their mortgage-backed securities, rather than mortgage debt in general, were losing value, and thus triggering a one-year time limit in which to sue.
The opinion came on the eve of testimony on Wednesday about credit ratings by Moody's Chief Executive Raymond McDaniel, five other current and former Moody's officials and billionaire investor Warren Buffett before the Financial Crisis Inquiry Commission, which is examining causes of the 2008 meltdown.
Plaintiffs led by the Public Employees' Retirement System of Mississippi had accused rating agencies and several banks of misleading them about the safety of 84 mostly investment-grade offerings of residential mortgage-backed securities.
The plaintiffs said the securities they bought were in fact of a much lower quality and, after being downgraded to "junk" status in April 2008, were worth much less than they paid.
In his opinion, Rakoff rejected the contention that rating agencies should be treated effectively as underwriters because their ratings were "necessary" to distribute the securities.
"There is nothing in the complaint to suggest that the ratings agencies participated in the relevant 'undertaking' -- that of purchasing the securities ... from the issuer with a view to their resale," he wrote.
Rakoff also dismissed claims on the 65 of the 84 offerings that the named plaintiffs did not actually buy, saying it would be too late to add plaintiffs to the lawsuit who did.
Moody's is a unit of Moody's Corp (MCO.N) and S&P is a unit of McGraw-Hill Cos Inc MHP.N. They have been widely criticized for fueling the crisis by assigning high ratings for too long and then downgrading them too fast.
"This opinion is significant in two respects," said Carla Walworth, a partner at Paul, Hastings, Janofsky & Walker LLP in New York who represented C-Bass, whose full name is Credit-Based Asset Servicing & Securitization LLC.
"First, the judge takes a strict and I think well-supported view on who can be strictly liable for misrepresentation on these MBS offerings," she said. "He's not going to open the door to let investors sue every party that might be involved.
"Second, even though there was a lot of information in the market calling into question the viability of the investments, that unless investors are put on notice as to actual fraud in the making of their very investments, it is not enough to put them on notice that they have a claim."
Moody's spokesman Michael Adler and S&P spokesman Frank Briamonte said they were pleased with Rakoff's opinion. Bank of America spokesman Bill Halldin and RBS spokesman Michael Geller declined to comment. Representatives of the plaintiff and JPMorgan did not immediately return requests for comment.
Berkshire Hathaway Inc (BRKa.N)(BRKb.N), which Buffett runs, had a 13 percent stake in Moody's as of March 31, down from nearly 20 percent less than a year earlier.
The case is Public Employees' Retirement System of Mississippi et al v. Merrill Lynch & Co et al, U.S. District Court, Southern District of New York, No. 08-10841. (Reporting by Jonathan Stempel; editing by Lisa Von Ahn and Andre Grenon)