IKB Deutsche v. McGrawHill and S&P - Credit Ratings

UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK

X : : : : : : : : : : : : : : X

IKB DEUTSCHE INDUSTRIEBANK AG, Plaintiff, vs. McGRAW HILL FINANCIAL, INC. (f/k/a THE McGRAW-HILL COMPANIES, INC. (d/b/a STANDARD & POORS RATINGS SERVICES)) and STANDARD & POORS FINANCIAL SERVICES LLC, Defendants.

Case No. 14-cv-3443 (JSR) AMENDED COMPLAINT DEMAND FOR JURY TRIAL

Case 1:14-cv-03443-JSR Document 27 Filed 07/21/14 Page 1 of 86

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TABLE OF CONTENTS

INTRODUCTION ...........................................................................................................................1 PARTIES .......................................................................................................................................18 IMPORTANT NON-PARTIES .....................................................................................................19 JURISDICTION AND VENUE ....................................................................................................22 BACKGROUND ...........................................................................................................................22 THE RATING AGENCIES ROLES ............................................................................................24

A. The Rating Agencies Historical Roles ........................................................................24

B. The Rating Agencies Helped Create and Operate Rhinebridge ...................................24

C. The Rating Agencies Received Three Times Their Usual Compensation to Provide Consulting Services and Ratings to Rhinebridge ...............28

THE FALSE AND MISLEADING CREDIT RATINGS AND OTHER STATEMENTS ..........32

A. The Credit Ratings .............................................................................................................32

B. Assurances Concerning the Purported Objectivity and Integrity of the Ratings Process ...............................................................37

THE REASONS WHY THE RATING AGENCIES KNEW THE RATINGS AND OTHER STATEMENTS WERE MATERIALLY MISLEADING ..................44

A. Due to Conflicts of Interest in the Structuring, Rating and Monitoring of Rhinebridge and Its Constituent Assets, the Ratings Were Misleading, as the Rating Agencies Knew ...............................44

B. The Rating Agencies Knew the Rhinebridge Notes Ratings Differed from Ratings of Corporate Bonds ..........................................................49

C. The Ratings Were Devoid of Any Meaningful Factual or Statistical Basis, as the Rating Agencies Knew ................................................53

D. The Rating Agencies Knew the Ratings Were False Because They Possessed, but Elected Not to Use, Updated Models That Would Better Structure and Rate Rhinebridge and Its Constituent Assets ....................................55


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E. The Rating Agencies Knew the Ratings on the

Rhinebridge Notes Were False Because They Received Non-Public Information from the Originators ...................................................58

THE RATING AGENCIES KNEW AND INTENDED THAT INVESTORS, INCLUDING IKB, WOULD RELY ON THE CREDIT RATINGS AND OTHER STATEMENTS CONCERNING THEIR OBJECTIVITY AND INDEPENDENCE ..................60 THE RHINEBRIDGE LAUNCH ..................................................................................................65 RHINEBRIDGE COLLAPSES .....................................................................................................70 COUNT I: Common Law Fraud ....................................................................................................71 COUNT II: Negligent Misrepresentation ......................................................................................74 COUNT III: Civil Conspiracy .......................................................................................................80 PRAYER FOR RELIEF ................................................................................................................82 JURY TRIAL DEMAND ..............................................................................................................82


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INTRODUCTION

1. This action arises out of the collapse of a structured investment vehicle (SIV)

known as Rhinebridge. Rhinebridge was formed in mid-2007 on the basis of the investment

grade credit ratings from the three major credit rating agencies (S&P, Moodys and Fitch (as

defined below) (together, Rating Agencies)), and then collapsed a few months later when as

Plaintiff IKB Deutsche Industriebank AG (IKB or Plaintiff) would learn only years later

those ratings proved to be false and misleading.

2. As a result of those false and misleading credit ratings, IKB has suffered hundreds

of millions of dollars of damages as detailed herein.

3. A credit rating is a term of art used in the investment industry to communicate

specific information about the strength and quality of an investment. It was at all times widely

known that the market at large, including sophisticated investors such as IKB, would and did

actually and reasonably rely on the accuracy of credit ratings and the independence of rating

agencies because of their NRSRO status (Nationally Recognized Statistical Rating

Organizations) (discussed below) and, in this case, the Rating Agencies access to non-public

information that even sophisticated investors such as IKB cannot obtain.

4. On or about June 27, 2007, Rhinebridge launched. In connection with the launch,

the Rating Agencies gave the Rhinebridge commercial paper (the Senior Notes) and capital

notes (the Capital Notes and together with the Senior Notes the Rhinebridge Notes) their

highest investment grade ratings.

5. Commercial paper is a short-term unsecured promissory note that pays a fixed

interest rate and matures in 270 days or fewer. For the past nearly half a century, almost all


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commercial paper has carried ratings from one or more rating agencies. An issuers commercial

paper rating is an independent assessment of the likelihood of timely payment of short-term debt.

Ratings are crucially important in the commercial paper market as they are used to compare risk

across issues and to guide investments. Many investors, by regulation or by choice, restrict their

holdings to high-quality commercial paper and the measure of quality used for these investment

decisions is the credit rating.

6. Rhinebridge raised money from investors, including IKB, by issuing debt

securities of varying maturities and payment priority (i.e., the Rhinebridge Notes), and then

using that money to buy various income-producing assets, such as residential mortgage-backed

securities (RMBS), commercial mortgage-backed securities (CMBS), and collateralized debt

obligations (CDOs). In simplified terms, Rhinebridge used the income from the assets held in

the SIV to satisfy its obligations to the purchasers of the Rhinebridge Notes it had issued and to

generate positive cash flow.

7. Morgan Stanley (defined below) acted as a co-arranger and a placement agent for

the Rhinebridge Notes. In that capacity, Morgan Stanley helped create and structure

Rhinebridge. An earlier SIV arranged by Morgan Stanley, managed by Cheyne Capital

Management (Cheyne), and rated by Moodys and S&P (the Cheyne SIV) served as a

roadmap for Rhinebridge.

8. In the case of Rhinebridge, IKBs subsidiary, IKB Credit Asset Management

GmBH (IKB CAM) fulfilled the role of Cheyne and managed Rhinebridge. In this role, IKB

CAM managed Rhinebridges investments in accordance with stated investment objectives and

procedures, relying on the Rating Agencies ratings of the investments that constituted the SIV.


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IKB CAM operated as an independent advisory business, with an ethical wall and segregation of

data between it and its parent, IKB. With IKB CAM on board as manager, IKB, of course, was a

prime target for the placement of the Rhinebridge Notes. As set forth below, in addition to

losing hundreds of millions of dollars as an investor in the fraudulently rated Rhinebridge Notes,

IKB also would see the going concern value of IKB CAM, a once valuable income-producing

asset of IKB, destroyed as a result of the same fraud.

9. S&P gives an A-1 rating to short-term issues and issuers that it believes have a

strong degree of safety for timely repayment of debt. Within this category, certain obligors are

designated with a plus sign (+). This indicates that the obligors capacity to meet its financial

commitments is extremely strong. S&P gives an A-2 rating to short-term issues that it believes

have a degree of safety that is satisfactory, and an A-3 rating to short-term issues that it

believes have a degree of safety that is adequate. S&P gave the Senior Notes its highest

rating of A-1+. S&P also gave the Rhinebridge structure itself its highest

issuer/counterparty rating of AAA/A-1+.

10. Moodys highest short-term rating, P-1, is given to issuers that it believes have a

superior ability to repay short-term debt obligations. Moodys gives a P-2 rating to issuers it

believes have a strong ability to repay short-term debt obligations, and a P-3 rating to issuers it

believes have an acceptable ability to repay short-term obligations. Issuers rated NP (Not

Prime) do not fall within any of the Prime rating categories. Moodys gave the Senior Notes

its highest rating of P-1.

11. Fitchs highest short-term rating, F1, indicates the strongest intrinsic capacity for

timely repayment of financial commitments. Within this category, the addition of a plus sign (+)


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denotes an exceptionally strong credit feature. Fitch gives an F2 rating where the capacity for

timely payment of financial commitments is good, and an F3 rating where the capacity is

adequate. Below F3 is a B rating, which indicates minimal capacity for timely payment, plus

heightened vulnerability to near term adverse changes in financial and economic conditions.

Below that are C, RD and D ratings, which indicate a real possibility of default, a restricted

default, and a broad-based default, respectively. Fitch gave the Senior Notes its highest rating

of F1+.

12. Capital notes are another form of unsecured debt issued by a company. The

interest rate offered on a capital note is heavily dependent on the issuers credit rating. The

Rhinebridge Capital Notes consisted of senior, mezzanine and junior capital notes (the Senior

Capital Notes, Mezzanine Capital Notes, and Junior Capital Notes, respectively).

13. Moodys assigns long-term ratings to issuers or obligations with an original

maturity of one year or more, such as the Rhinebridge Capital Notes. Moodys highest long-

term rating, Aaa, is given to obligations judged to be of the highest quality and subject to the

lowest level of credit risk. Moodys gives an Aa rating to obligations of high quality and

very low credit risk, and an A rating to obligations judged to be upper-medium grade and

subject to low credit risk, and so on down the scale. Moodys appends numerical modifiers 1,

2, and 3 to each rating classification from Aa through Caa, with the modifier 1 indicating the

higher end of the rating category, modifier 2 the mid-range ranking, and modifier 3 in the lower

end of the rating category. Moodys gave the Senior Capital Notes its highest rating of Aaa.

Moodys also gave the Mezzanine Capital Notes a high rating of A3.


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14. The highest rating in Fitchs long-term ratings scale, AAA, indicates the

[h]ighest credit quality, lowest expectation of credit risk, exceptionally strong capacity for

payment of financial commitments, and highly unlikely to be adversely affected by foreseeable

events. The next rating, AA, indicates very high credit quality, very low credit risk, very

strong capacity for payment of financial commitments, and not significantly vulnerable to

foreseeable events. The next rating, A, indicates [h]igh credit quality, low credit risk, and

strong capacity for payment of financial commitments. Fitch gave the Senior Capital Notes

its highest AAA rating and the Mezzanine Capital Notes a high rating of A.

15. The highest rating in S&Ps long-term issue ratings scale, AAA, indicates the

obligors capacity to meet its financial commitment on the obligation is extremely strong, the

next highest rating, AA, indicates the capacity is very strong, and the next highest rating, A,

indicates the capacity is strong. S&P gave the Mezzanine Capital Notes a high rating of A.

16. In reliance on these high credit ratings, IKB initially invested $149 million in

Capital Notes when Rhinebridge launched.

17. One week after the Rhinebridge launch, the Rating Agencies rocked the market

for RMBS and related securities with a stunning announcement on July 10, 2007. On that day,

S&P announced changes in its method for rating certain types of RMBS. It also placed 612

classes of RMBS bonds on watch negative. That same day, Moodys announced the downgrade

of 399 RMBS bonds. But in the midst of this commotion, the Rating Agencies affirmed their

investment grade ratings for Rhinebridge. IKB subsequently purchased an additional $425

million of Rhinebridge Notes in reliance on such ratings.


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18. By September 2007, less than three months after the Rating Agencies issued their

false and misleading investment grade ratings, the Rating Agencies suddenly placed the

Rhinebridge Notes on watch negative. By the middle of October 2007, the Rating Agencies

downgraded the allegedly investment grade Rhinebridge Notes to junk status, leaving IKB

holding $574 million of junk securities and suffering massive losses. IKB brings this action to

recover the substantial losses it has suffered as a result of the Rating Agencies fraud and

negligent misrepresentations.

19. The Rating Agencies did not just passively rate the Rhinebridge Notes. They

played a critical role and were deeply entrenched in the creation and operation of Rhinebridge.

The Rhinebridge offering documents specified that the senior debt securities would not be issued

unless they received Top Ratings (defined below). The Rating Agencies determined, among

other things, which assets the SIV could hold and what structural protections had to be put in

place in order to achieve Top Ratings. The Rating Agencies were compensated for their

substantial role in connection with Rhinebridge, receiving three times their regular compensation

for providing ratings on other securities. IKB heavily relied on the Rating Agencies ratings to

ensure that it was investing in securities that were stable, secure and safesecurities that would

not transform from top rated to junk in a matter of months.

20. Little did IKB know that the Rating Agencies providing the essential ratings on

the Rhinebridge Notes as well as the constituent assets of the SIV were systematically providing

false and misleading ratings on such securities. The Rating Agencies systemic misconduct,

which infected both their ratings of the Rhinebridge Notes and the assets within the SIV, is now

well documented by virtue of governmental investigations and private litigations including


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suits in this very Court brought by other investors in Rhinebridge and its predecessor SIV

(Cheyne) demonstrating that the Rating Agencies intentionally issued ratings to SIVs such as

Rhinebridge, and its constituent assets, that the Rating Agencies knew were false and misleading.

21. When IKB was sued alongside the Rating Agencies in October 2009 for alleged

misconduct related to Rhinebridge, IKB did not credit the complaints allegations against it and

similarly had no reason to believe the complaints allegations against its co-defendants, the

Rating Agencies, or to disbelieve the Rating Agencies denials of wrongdoing. In any event,

these were mere allegations. Actual facts concerning the Rating Agencies misconduct did not

begin to emerge until the 2010 start of discovery, and, later, summary judgment briefing, in that

Rhinebridge-related action. Additional key facts did not emerge until 2011 through the FCIC

Report and the Senate Subcommittee Report, including documents and testimony disclosed in

those Reports relating to the Rating Agencies as detailed herein.

22. Information through which IKB obtained knowledge of the facts giving rise to its

claims against S&P (and the other Rating Agencies) was affirmatively concealed by the Rating

Agencies and did not publicly emerge prior to, at the earliest, 2010. No amount of diligence or

investigation by IKB could have uncovered such facts earlier.

23. The key facts that emerged in 2012 during summary judgment briefing in the

earlier Rhinebridge-related action include the following:

Confidential internal S&P communications lamenting the lack of default data and admitting that in rating ABS, it is obvious that we [S&P] have just stuck our preverbal [sic] finger in the air!

S&Ps highly confidential 2006 Strategic Plan for Global Structured Finance raising concerns that a bubble has developed in both residential and commercial real estate sectors and that if such a bubble bursts then a large number of rating


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downgrades may occur, which could lead to high negative rating volatility and potential skepticism of the rating.

Confidential internal S&P documents demonstrating S&Ps awareness of rampant

appraisal and underwriting fraud, rising delinquencies and [n]ightmare mortgages underlying RMBS assets such as those held by Rhinebridge.

Confidential internal S&P communications from February 2007 a few months

before the Rhinebridge launch complaining about insufficient resources to deal with the serious pressure to respond to the burgeoning poor performance of sub-prime [RMBS] deals and recognizing that such ratings are not going to hold through 2007.

S&Ps highly confidential June 2007 Board of Directors Report in which S&Ps

economic outlook, as expressed by the Chairman of the Board, was that [t]he meltdown in the subprime mortgage market will increase both foreclosures and the overhang of homes for sale.

A highly confidential S&P memorandum dated June 15, 2007 just 12 days prior to

the Rhinebridge launch entitled S&P Vulnerabilities In A Downturn, which highlights flaws in S&Ps ratings criteria, including the gap between the extent of reliance on our historical record, and the modest investment and slow pace of development of that infrastructure, and a risk that the default experience of the ratings could be understated.

S&Ps admission in a highly confidential internal presentation by its Capital Markets

Task Force that while the CDO team recognized potential weakness in RMBS ratings in 2006, which by mid-2007 could have led to notching down ratings of US RMBS going into CDOs, this was not considered given that it would imply a lack of agreement with our own internal view.

Testimony from S&Ps most senior quantitative analyst in Europe that the false

ratings on RMBS and CDOs resulted in false ratings on SIVs: [I]t is a factual statement that the ratings of those [structured investment] vehicles were inappropriate because the ratings of the underlying assets were not appropriate.

24. The public record of the Rating Agencies egregious misconduct with respect to

structured finance products such as Rhinebridge is startling.

25. Lord help our f[***]ing scam...this has to be the stupidest place I have

worked at, wrote one Standard & Poors executive. As you know, I had difficulties explaining


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HOW we got to those numbers since there is no science behind it, confessed a high-ranking

S&P analyst. If we are just going to make it up in order to rate deals, then quants [quantitative

analysts] are of precious little value, complained another senior S&P employee. Lets hope we

are all wealthy and retired by the time this house of card[s] falters, remarked another.

26. [There is] no actual data backing the current model assumptions,

acknowledged a lead Moodys analyst on Rhinebridges predecessor. Ratings on CDOs and

SIVs are cash cows, admitted another Moodys analyst.

27. Fitch and S&P, went nuts. Everything was investment grade. It didnt really

matter, commented Moodys CEO.

28. In addition to inherent conflicts of interest arising from the system used to pay for

credit ratings, additional factors responsible for the Rating Agencies false and misleading

ratings include rating models that failed to include relevant mortgage performance data, unclear

and subjective criteria used to produce ratings, a failure to apply updated rating models to

existing rated transactions, and a failure to provide adequate staffing to perform rating and

surveillance services, despite record revenues.

29. Credit rating models are mathematical constructs that analyze a large number of

data points related to the likelihood of an asset defaulting. RMBS rating models typically use

statistical analyses of past mortgage performance data to calculate expected RMBS default rates

and losses. CDO models use assumptions to build simulations that can be used to project likely

CDO defaults and losses.

30. All three of the Rating Agencies knew their models and data were flawed and

therefore generated inflated ratings that they knew to be inaccurate.


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31. Key problems included inadequate performance data for the higher risk mortgages

flooding the mortgage markets and inadequate correlation factors. In addition, the Rating

Agencies failed to provide their ratings personnel with clear, consistent, and comprehensive

criteria to evaluate complex structured finance deals. The absence of effective criteria was

particularly problematic, because the ratings models did not conclusively determine the ratings

for particular transactions. Instead, modeling results could be altered by the subjective judgment

of analysts and their supervisors.

32. These models were also handicapped by a lack of relevant performance data for

the high risk residential mortgages supporting most RMBS and CDO securities, by a lack of

mortgage performance data in an era of stagnating or declining housing prices, by the Rating

Agencies unwillingness to devote sufficient resources to update their models, and by the failure

of the models to incorporate accurate correlation assumptions predicting how defaulting

mortgages might affect other mortgages.

33. Specifically, Fitch knew of inherent flaws in its models and rating process (which

were dependent upon housing price appreciation in spite of obvious signs to the contrary) and

that, as a result, its models would break down completely. Nevertheless, Fitch used those

faulty models to rate Rhinebridge. After assigning top ratings to Rhinebridge, Fitch published a

report blaming poor underwriting practices and fraud in the origination process for poor RMBS

performance. Months earlier, Fitch was touting the safety and security of those assets.

34. S&P and Moodys also knew that their models were flawed. According to the

April 13, 2011 report of the United States Senate Permanent Subcommittee on Investigations

(the Senate Subcommittee) examining the failures of the Rating Agencies and others:


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Additional factors responsible for the inaccurate ratings include rating models that failed to include relevant mortgage performance data, unclear and subjective criteria used to produce ratings, a failure to apply updated rating models to existing rated transactions, and a failure to provide adequate staffing to perform rating and surveillance services, despite record revenues. Compounding these problems were federal regulations that required the purchase of investment grade securities by banks and others, thereby creating pressure on the credit rating agencies to issue investment grade ratings. Still another factor were the Securities and Exchange Commissions (SEC) regulations which required use of credit ratings by Nationally Recognized Statistical Rating Organizations (NRSRO) for various purposes but, until recently, resulted in only three NRSROs, thereby limiting competition. (emphasis added) 35. Recent public disclosures indicate that S&P limited, adjusted, and delayed

updates to the ratings criteria and analytical models S&P used to assess the credit risks posed by

RMBS and CDO tranches, thereby weakening those criteria and models from what S&P analysts

believed was necessary to make them more accurate.

36. For example, the model used by S&P to rate RMBS was known as the Loan

Evaluation & Estimate Loss System (LEVELS). Despite public assurances to investors that it

regularly updated its RMBS models to reflect the changing and riskier underlying collateral,

S&P did not regularly or timely update LEVELS to incorporate relevant loan data S&P

possessed that S&P knew would make its RMBS ratings more accurate.

37. LEVELS was known for years within S&P to be flawed and inaccurate. But S&P

decided that market share was more important than ratings accuracy. For example, a senior

analyst at S&P commented in an internal e-mail to S&P executives:

When we first reviewed [proposed LEVELS] Version 6.0 results **a year ago** we saw the sub-prime and Alt-A numbers going up and that was a major point of contention which led to all the model tweaking weve done since. Version 6.0 couldve been released months ago and resources assigned elsewhere if we didnt have to massage the sub-prime and Alt-A numbers to preserve market share. (emphasis added)


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38. This same S&P director wrote in an email a month later: Screwing with criteria

to get the deal is putting the entire S&P franchise at risk its a bad idea.

39. The same is true of the model S&P used to rate CDOs, known as CDO

Evaluator. S&P recognized that the key assumptions underlying CDO Evaluator were

inaccurate and not consistent with historical data, but limited, adjusted and delayed updates to

CDO Evaluator as well in order to favor issuers and maintain and grow S&Ps market share and

profits.

40. Indeed, at one point S&P loosened correlation assumptions (a key measure of

default risk) to such a degree that it prompted a CDO analyst to question in April 2007 [d]oes

the company care about deal volume or sound credit standards?

41. Moodys also used credit rating models with data that was inadequate to predict

how high risk residential mortgages, such as subprime, interest only, and option adjustable rate

mortgages, would perform. By 2006, Moodys also knew their ratings of RMBS and CDOs were

inaccurate, revised their rating models to produce more accurate ratings, but then failed to use

the revised model to re-evaluate existing RMBS and CDO securities, delaying thousands of

rating downgrades and allowing those securities to carry inflated ratings that could mislead

investors.

42. The following instant message dialogue between two analysts at S&P exemplifies

the Rating Agencies cavalier attitude toward the false ratings they knowingly and systematically

assigned to structured finance products such as Rhinebridge:

Shah, Rahul Dilip (Structured Finance New York): btw - that deal is ridiculous Mooney, Shannon: i know right . . . model def does not capture


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half of the rish (sic) Mooney, Shannon: risk Shah, Rahul Dilip (Structured Finance New York): we should not be rating it Mooney, Shannon: we rate every deal Mooney, Shannon: it could be structured by cows and we would rate it Shah, Rahul Dilip (Structured Finance New York): but theres a lot of risk associated with it I personally dont feel comfy signing off as a committee member.

43. The Rating Agencies ratings on the Rhinebridge Notes and Rhinebridges

constituent assets were supposed to constitute fact-based opinions concerning the strength and

quality of those structured finance products. Neither IKB nor IKB CAM had any knowledge that

at the time Rhinebridge was created and IKB purchased $574 million of Rhinebridge Notes that

the Rating Agencies systems and processes for rating structured finance products, such as the

Rhinebridge Notes and its constituent assets, was in reality a scam, had no science behind it

and was nothing but a house of card[s] destined to crumble.

44. Importantly, IKB did not have any special knowledge concerning the problems

that have since been uncovered concerning the assets underlying Rhinebridge and the Rating

Agencies misconduct in rating such assets.

45. IKB never would have purchased any Rhinebridge Notes and IKB CAM never

would have agreed to perform the role of manager if they knew that the essential ratings on the

Rhinebridge Notes and the SIVs constituent assets, such as RMBS, were based on a long-

running scam that did not reflect their true risks. In the case of Rhinebridge, the house of cards


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created by the Rating Agencies scam crumbled just months after IKB acquired the Rhinebridge

Notes, resulting in catastrophic losses for IKB caused by the Rating Agencies fraud and

negligent misrepresentations.

46. With respect to the Rhinebridge Notes, the credit ratings were false and

misleading because they misstated the likelihood that Rhinebridge would collapse. The Rating

Agencies implied that they had conducted a detailed and fact-based analysis when they had not

done so and instead knowingly used outdated and obsolete models that did not capture half the

risk. The Rating Agencies motivation for employing outdated and obsolete models was to

ensure that they could rate every deal, increase their market share and, in turn, profits.

Nevertheless, the Rating Agencies falsely represented to the investors in the Rhinebridge Notes,

including IKB, that they utilized objective, independent and high quality processes and methods

to arrive at their ratings for the Rhinebridge Notes and Rhinebridges constituent assets.

47. The Rating Agencies knew that their models did not capture the real credit risks

and that their falsely inflated ratings would induce investors, such as IKB in the case of

Rhinebridge, to purchase securities exponentially riskier than the ratings indicated. Simply put,

the Rating Agencies chose market share and profits over providing truthful ratingsa choice

that cost IKB hundreds of millions of dollars with respect to the Rhinebridge Notes.

48. Additionally, the Rating Agencies knew the credit ratings they assigned to

Rhinebridge were false and misleading because they were aware that the data they input into

their models was stale and inaccurate as, for example, it did not reflect the Rating Agencies

concern with the state of the RMBS market and expectation of increased delinquency rates in the

mortgages underlying the RMBS in Rhinebridge. Moreover, all three Rating Agencies knew that


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their ratings were false and misleading because the ratings they assigned differed materially from

the equivalent ratings assigned to safe, stable corporate bonds. They also knew based on their

receipt of non-public information (including highly detailed, loan-by-loan data unavailable to

IKB) that the underlying assets of the Rhinebridge SIV were undeserving of the high ratings

they received. And they knew they could not issue an objective rating utilizing accurate and

current data because of the effect it would have on their compensation.

49. The Rating Agencies scam has not gone unnoticed by regulators. The

Department of Justice of the United States of America (DOJ) last year sued S&P for falsely

representing that its credit ratings of RMBS and CDO tranches (the same type of investments

supporting the Rhinebridge structure) were objective, independent, uninfluenced by any conflicts

of interest that might compromise S&Ps analytic judgment, and reflected S&Ps true current

opinion regarding the credit risks the rated RMBS and CDO tranches posed to investors.

50. State Attorneys General have also brought suit. Democratic Senator Richard

Blumenthal of Connecticut, who as then-attorney general brought the cases against S&P and

Moodys in 2010, said he found rampant abuse across the credit rating industry. The difference

is one of degree and scale rather than essential modus operandi, Blumenthal said in an

interview.

51. Far from utilizing rating processes and models that reflected the Rating Agencies

true current opinion regarding credit risks, the Rating Agencies limited, adjusted, and delayed

updates to the ratings criteria and analytical models used to assess the credit risks posed by

RMBS and CDO tranches, thereby weakening those criteria and models from what the Rating

Agencies believed was necessary to make them more accurate.


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52. Knowing that the credit risks of such constituent assets were increasing, were

expected to continue to increase, and were anticipated to result in negative rating actions, the

Rating Agencies knowingly disregarded the true extent of the credit risks associated with those

assets in issuing and/or confirming their ratings, which the Rating Agencies knew did not

accurately reflect those assets true current credit risks.

53. Because the Rating Agencies unreasonably structured the assets that comprised

Rhinebridge, the high ratings assigned to the Rhinebridge Notes were necessarily false and

misleading. An SIV is by definition only as strong as the assets it holds. The Rating Agencies

lowered their standards and used false and unreasonable data to stamp out Triple A ratings on

mortgage-backed securities in a constant pursuit of greater market share and higher profits. They

received triple their usual fees for rating products like Rhinebridge, and double-dipped on fees

because Rhinebridge and other SIVs acquired billions of dollars worth of the Rating Agencies

other rated products.

54. Ultimately, the Rating Agencies had the motive and opportunity to push the

boundaries and communicate false and misleading ratings to investors, including IKB. They

viewed ratings on structured financial products and CDOs and SIVs as cash cows and

compromised the quality of their ratings in pursuit of profits.

55. As an investor acquiring Rhinebridge Notes, IKB reasonably relied on the credit

ratings assigned to them. For example, in the months leading up to the Rhinebridge launch, IKB

was reviewing its investment strategy and guidelines in light of developments in the U.S.

housing market. IKB was highly reliant upon the credit ratings assigned by the Rating Agencies,


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and was focused on investments in papers of the highest quality, as reflected by receipt of the

highest credit ratings.

56. In reliance upon these false and misleading credit ratings and additional

misrepresentations concerning the objectivity, independence, quality and integrity of their credit

rating process and methodology, IKB invested $574 million in Rhinebridge Notes, including

Rhinebridge commercial paper and Capital Notes.

57. IKB CAM also reasonably relied on the credit ratings in managing the

Rhinebridge portfolio and identifying rated securities as potential investments for Rhinebridge,

and the Rhinebridge Notes as potential investments for IKB. Among other criteria IKB CAM

had to observe in selecting investments for potential inclusion in Rhinebridges investment

portfolio, the management agreement required that the potential investment be rated at least A-

by S&P, A- by Fitch, and A3 by Moodys or, in the case of commercial paper, A-1 by S&P, P-1

by Moodys, and F1 by Fitch.

58. IKBs asset management business was a valuable income-producing asset. In

December 2006, IKB CAM was created to continue this function.

59. As of March 31, 2007, gross assets under management totaled approximately

17,387 billion with 12,057 billion in respect of Rhineland1 and about 5,33 billion in respect

of IKB AG (all as converted from USD into EUR as of March 31, 2007).

60. Neither IKB nor IKB CAM knew that the ratings assigned to Rhinebridge and its

constituent assets were false. Neither knowledge of the underlying securities held by

1 Rhineland refers to the asset-backed commercial paper conduit Rhineland Funding Capital Corp. (launched in 2002, with advisory services transferred from IKB to IKB CAM in December 2006).


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Rhinebridge nor any amount of research or due diligence by IKB or IKB CAM could have

uncovered that the credit ratings assigned by the Rating Agencies to Rhinebridge and its

constituent assets were false and misleading.

61. IKB did not have access to the same non-public information (including detailed,

loan-by-loan data) possessed by the Rating Agencies.

62. When the true quality and value of Rhinebridge and its constituent assets became

known, Rhinebridge was forced into receivership and the Rhinebridge Notes immediately

collapsed in value.

63. For these and other reasons set forth herein, the Rating Agencies recklessly or

deceptively created and rated the Rhinebridge Notes as well as the constituent assets of

Rhinebridge. As a consequence, IKB has suffered hundreds of millions of dollars of damages

stemming from its Rhinebridge investment and the destruction of its asset management business.

PARTIES

64. Plaintiff IKB Deutsche Industriebank AG (IKB or Plaintiff) is a commercial

bank incorporated in Germany, with a main office at Wilhelm-Botzkes-Strasse 1, 40474

Dusseldorf, Germany. IKB acquired highly-rated Rhinebridge commercial paper and Capital

Notes and actually and reasonably relied on such credit ratings in purchasing both those rated

securities and Rhinebridges unrated debt instruments.

65. Defendant McGraw Hill Financial, Inc. (f/k/a The McGraw-Hill Companies, Inc.

(d/b/a Standard & Poors Ratings Services)) and its affiliates, including its wholly-owned and

controlled business division Standard & Poors Ratings Services (collectively, McGraw Hill

and together with S&P LLC (defined below), S&P), provides credit market services and


19

products. S&P structured, rated and was supposed to monitor Rhinebridge and approximately

100% of its constituent assets. S&P also disseminated false and misleading statements

concerning its rating process via its Code of Conduct and other public statements. S&P is a New

York corporation, with its principal place of business in New York; in particular, in this District.

66. Defendant Standard & Poors Financial Services LLC (S&P LLC) is a wholly

owned subsidiary of Defendant McGraw Hill Financial, Inc., and is a Delaware limited liability

company with its principal place of business in New York. S&P LLC was formed effective

January 1, 2009 as part of an internal reorganization to house in a separate subsidiary certain

rating businesses previously operating as divisions of McGraw Hill.

67. S&P, Moodys (defined below) and Fitch (defined below) are collectively

referred to herein as the Rating Agencies.

68. Among other things, the Rating Agencies were involved in the structuring, rating

and monitoring of the Rhinebridge Notes and the assets backing those notes. The Rating

Agencies received substantial success fees for helping launch Rhinebridge, as well as fees that

increased in tandem with its growth and fees from the assets acquired by Rhinebridge. The

Rating Agencies substantial remuneration was drawn from the proceeds of the Rhinebridge

Notes issuance, and their ongoing fees were paid out of income owed to investors in the

Rhinebridge Notes.

IMPORTANT NON-PARTIES

69. Non-party Fitch Ratings, Inc. (f/k/a Fitch, Inc.) (Fitch) provides credit market

services and products. Fitch structured, rated and was supposed to monitor Rhinebridge and

approximately 30% of its constituent assets. Fitch also disseminated false and misleading


20

statements concerning its rating process via its Code of Conduct and other public statements.

Fitch is a Delaware corporation, with its principal place of business in New York; in particular,

in this District. For purposes of this complaint, Fitch is an unnamed co-conspirator and joint

tortfeasor vis--vis S&P and Moodys.

70. Non-party Moodys Investors Service, Inc. (Moodys) provides credit market

services and products. Moodys structured, rated and was supposed to monitor Rhinebridge and

approximately 100% of its constituent assets. The ratings Moodys assigned to the Rhinebridge

Notes were issued in rating action releases bearing the trade name Moodys Investors Service,

an integrated business segment operating through a global network of offices, and a copyright

specifically identifying Moodys Investors Service, Inc. Moodys also disseminated false and

misleading statements concerning its rating process via its Code of Professional Conduct and

other public statements. Moodys is a Delaware corporation with its principal place of business

in New York; in particular, in this District. For purposes of this complaint, Moodys is an

unnamed co-conspirator and joint tortfeasor vis--vis S&P and Fitch.

71. Non-party Moodys Investors Service, Ltd., a United Kingdom entity and affiliate

of Moodys Investors Service, Inc., was part of the Moodys integrated credit rating business

segment that issued the ratings on the Rhinebridge Notes. This business segment operated under

the trade name Moodys Investors Service through a global network of offices and business

affiliations. Indeed, Moodys stated goal is to integrate the decision-making process on a

global basis, to facilitate worldwide ratings consistency. Upon information and belief, at all

times relevant herein, Moodys Investors Service, Ltd. acted in concert with Moodys as a co-

conspirator and joint tortfeasor in pursuit of a common plan to commit the ratings fraud alleged


21

herein. In addition, at all times relevant herein, Moodys Investors Service, Ltd. acted as a co-

conspirator and joint tortfeasor vis--vis S&P and Fitch, acting in concert with S&P and Fitch in

pursuit of a common plan to commit the ratings fraud alleged herein.

72. Non-party IKB Credit Asset Management GmbH (IKB CAM) was a wholly

owned subsidiary of IKB AG. Prior to the Rhinebridge launch, as of March 31, 2007, IKB

CAMs gross assets under management totaled approximately 17,387 billion with 12,057

billion in respect of Rhineland and about 5,33 billion in respect of IKB AG (all as converted

from USD into EUR as of March 31, 2007). Rhinebridge was the flagship vehicle in IKB

CAMs expansion into asset-backed securities asset management.

73. For the Rhinebridge portfolio and for IKB AGs balance sheet, IKB CAM

implemented what it believed to be a conservative investment approach, selecting only high-

grade, highly-rated asset-backed securities. IKB CAM reasonably relied on such credit ratings in

recommending such investments. IKB CAM also utilized two sophisticated managers,

Blackrock and Standish Mellon, to select assets for the Rhinebridge portfolio. IKBs asset

management business was a valuable income-producing asset. Due to the Rating Agencies

fraud, the going concern value of IKB CAM was destroyed.

74. Non-party Morgan Stanley & Co. Incorporated and Morgan Stanley & Co.

International Limited and their affiliates (together, Morgan Stanley) is an investment banking

and global financial services corporation headquartered in New York City. Morgan Stanley

serves diversified groups of corporations, governments, financial institutions, and individuals,

and acted as a Co-Arranger and a placement agent for the Rhinebridge Notes. In that capacity,

Morgan Stanley helped create and structure Rhinebridge.


22

JURISDICTION AND VENUE

75. This Court has jurisdiction over the subject matter of this action pursuant to 28

U.S.C. 1332(a)(2) because Plaintiff and Defendants are citizens of a State and citizens of a

foreign state, and the matter in controversy exceeds $75,000, exclusive of interest and costs.

Plaintiff IKB is a citizen of Germany. Defendants are citizens of the State of New York.

76. Venue is proper in this District because Defendants headquarters is located in

this District and Defendants made false statements that gave rise to the violations of law alleged

herein and a substantial part of the events and omissions that gave rise to the claims asserted

herein occurred in this District.

77. In addition, venue is proper in this District because hundreds of millions of dollars

in mortgage-backed securities backing the Rhinebridge Notes were underwritten in this District.

Approximately 82% of the securities included in Rhinebridge were originated in the United

States by various lenders. Upon information and belief, the overwhelming majority of the

information concerning the low-quality assets included in Rhinebridge and the sources of the

unreasonable and false data inputs used to create the credit ratings complained of herein will be

found in this District and elsewhere in the United States.

BACKGROUND

78. An SIV is a special purpose entity that borrows money by issuing short- and

medium-term debt and then uses that money to buy longer-term securities, including mortgage

bonds and other asset-backed securities. An SIV is sometimes called a conduit, because it

raises short-term funds and channels those funds into longer-term assets. An SIVs business

model resembles that of a bank because it seeks to earn a spread between the interest rate at


23

which it borrows and the interest rate at which it lends. And like a bank, an SIV has both assets

and liabilities.

79. An SIV typically has three categories of liabilities: commercial paper, medium-

term notes, and other medium-term debt, often called capital notes. The commercial paper and

medium term notes are senior in priority to the capital notes, which bear the first loss if an SIVs

assets decline in value.

80. An SIVs assets typically include investment grade rated or high quality asset-

backed securities (ABS), RMBS, and CDOs. ABS investments typically entitle investors to

principal and interest drawn from pools of student loans, credit cards, or auto loans. The term is

sometimes used more broadly to include RMBS. RMBS are backed by a variety of residential

mortgages. CDOs invest in ABS and RMBS and are similar to SIVs. SIVs typically are

designed to invest in high-grade and highly rated assets in these investment categories.

81. The liabilities or bonds (notes) issued by SIVs typically receive very high or

investment grade ratings from credit rating agencies.

82. These ratings are derived in large measure from the quality of the assets backing

the structure. The credit quality of an SIVs assets is extremely important to the credit quality

and resulting market value of the securities issued by the SIV. Structural features such as credit

enhancement are used to create an SIVs investment grade securities, as well. Credit

enhancement can take a number of forms, but is often accomplished through structural

subordination. For example, investors in Rhinebridge were supposedly protected by

subordinated series or tranches of junior liabilities. The sole equity of SIVs in general, and

Rhinebridge in particular, consists of a thin slice of unrated notes and nominal equity.


24

83. Rhinebridges securities were not offered or sold to the public but only to a select

group of buyers in private placements.

THE RATING AGENCIES ROLES

A. The Rating Agencies Historical Roles

84. Historically, the Rating Agencies were conservative institutions, more like

governmental entities or publishers than market actors. The Rating Agencies often liken

themselves to reporters. That is because in the past they provided unsolicited opinions on the

creditworthiness of corporations and had a subscription-based business model. Their evaluations

were often derived from publicly available information such as filings with the SEC.

85. Over time, the Rating Agencies earned the trust of the marketplace for their

integrity and unbiased approach to evaluating bonds. Similarly, in 1975 the SEC provided the

Rating Agencies a special status of nationally recognized statistical rating organization or

NRSRO to help ensure the integrity of the ratings process. According to the SEC, the single

most important factor 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 a company hinges on the rating

organizations independence from the companies it rates.

B. The Rating Agencies Helped Create and Operate Rhinebridge

86. In this particular case, the Rating Agencies did not perform their historical

functions and just passively rate the Rhinebridge Notes. Instead, the Rating Agencies were

actively involved in the creation and ongoing operation of Rhinebridge.

87. For example, the Rating Agencies helped determine how much capital was


25

needed beneath the Senior Notes in order to support the Top Ratings. The Rating Agencies

agreed that support of approximately 16% (of the entire capital structure) from junior notes and

nominal equity was sufficient to support the Top Ratings.

88. The process of determining the amount of capital needed to support the

Rhinebridge Notes in order to achieve high ratings is called sizing. Sizing is directly related to

the quality and value of assets held by Rhinebridge. The Rating Agencies used data regarding

the probability of default, the amount of money returned to investors in the event of default (or

recovery) for each asset in Rhinebridge, and data concerning the relationships among assets

included in Rhinebridge (called correlation). These inputs are based upon the performance of

other ratings and data provided by the Rating Agencies.

89. The inputs are entered into models used by the Rating Agencies to determine the

losses that would accrue to the Rhinebridge Notes in the event that Rhinebridge was required to

sell its assets to pay back investors.

90. The model then determines the amount of capital needed to support the high

ratings of the Rhinebridge Notes. This activity of determining the quantum of capital necessary

to support the assigned investment grade ratings was done at the inception of Rhinebridge and on

an ongoing basis with the Rating Agencies instructions and approval.

91. These models, however, generated false and misleading ratings in part because

the Rating Agencies used inaccurate and stale information to create Rhinebridges constituent

assets, and compounded this problem by failing to monitor and update the information regarding

these constituent assets after they were first created. One professor of finance explained to

Bloomberg that [t]his type of model is totally out of touch with the underlying economic


26

reality.

92. Nobel Prize winning economist, Joseph Stiglitz, was even more blunt in an

interview with Bloomberg: The greed of Wall Street knows no bounds . . . [t]hey cheated on

their models. But even without the cheating, their models were bad.

93. While the Rating Agencies processes for creating Rhinebridge and its constituent

assets were out of touch with economic reality, the personal financial benefits that accrued to the

Rating Agencies by unreasonably failing to consider that reality are unmistakable. In

Rhinebridge alone, Moodys and S&P rated and helped structure approximately 100% of the

assets comprising Rhinebridge, while Fitch rated and helped structure approximately 30% of

those assets. The Rating Agencies thus double-dipped on large fees for rating and structuring the

securities acquired by Rhinebridge and the securities issued by Rhinebridge.

94. The Rating Agencies actually provided or approved instructions governing types

and volumes of assets Rhinebridge could acquire. These instructions were also based upon

credit ratings. The quality of assets included in Rhinebridge was crucial to investors in the

Rhinebridge Notes because their investment depended directly upon those assets for the service

of interest and return of principal. Given the importance of credit quality to the success of any

SIV, SIVs like Rhinebridge are only supposed to invest in assets of the highest credit quality. In

reality, however, the fraudulently inflated ratings misrepresented the credit quality of

Rhinebridges assets and masked the fact that Rhinebridge held mostly low-quality mortgage-

backed securities.

95. The Rating Agencies played other roles as well. The Rating Agencies had

ongoing involvement in operating Rhinebridge:


27

(a) Rhinebridge had to monitor and hedge against risks associated with

the level of funding provided by its constituent assets consistent with the Rating Agencies

instructions;

(b) Rhinebridge was required to get the Rating Agencies approval before

making changes to its operating instructions;

(c) The Rating Agencies had the right to veto any changes in the

management of Rhinebridge;

(d) The Rating Agencies provided instructions on how to maintain the

Top Ratings and maintained veto rights over any changes thereto;

(e) The Rating Agencies had veto rights over changes in the parties who

provided administrative services to Rhinebridge;

(f) The Rating Agencies provided the criteria and had veto rights over any

changes to nearly every aspect of the manner in which Rhinebridge obtained funding;

(g) The Rating Agencies had a right to immediate notice of any changes in

Rhinebridges operating conditions;

(h) The Rating Agencies had veto rights over any investment while

Rhinebridge was supposed to operate in more conservative modes;

(i) The Rating Agencies approval was required before Rhinebridge could

loan out any constituent assets or enter into related agreements;

(j) The Rating Agencies approval was required before Rhinebridge could

make any changes to its investment guidelines; and


28

(k) The Rating Agencies had the right to review and approve certain

insurance or derivative contracts Rhinebridge could execute.

96. Importantly, because the primary source of funding was commercial paper and

medium-term notes, which are short-term liabilities, the Rating Agencies had to monitor

Rhinebridges capital frequently.

97. In short, whatever their historical roles, in addition to providing credit ratings, the

Rating Agencies were deeply entrenched in the creation and operation of Rhinebridge.

98. Without the Top Ratings, Rhinebridge would not have existed and could not

have operated. Indeed, once the Rating Agencies were forced to drop their fraudulently inflated

ratings, Rhinebridges access to funding was cut off and Rhinebridge collapsed. As a result, IKB

suffered hundreds of millions of dollars in damages.

C. The Rating Agencies Received Three Times Their Usual Compensation to Provide Consulting Services and Ratings to Rhinebridge

99. According to Rhinebridges Private Placement Memorandum, there were $16

million in upfront costs (paid out of the proceeds of investors capital) to be shared among a

number of parties. On information and belief, the Rating Agencies were paid fees of

approximately ten or more basis points of Rhinebridges stated market value when the

transaction closed or was funded on or about June 27, 2007. Reflective of the Rating

Agencies substantial role in creating and operating Rhinebridge, these fees are three times

higher than the Rating Agencies compensation for rating traditional municipal or corporate

bonds. With an approximate (and false) initial portfolio value of $1.8 billion, the Rating

Agencies would have been paid $1.8 million in success fees.


29

100. The Rating Agencies were also paid ongoing fees following the June 27, 2007

closing.

101. The Rating Agencies had powerful economic incentives to provide false ratings

and conspired to do so. A substantial portion of the Rating Agencies fees were linked to the

size and market values of the assets held by Rhinebridge. In addition, the Rating Agencies

received their success fees only in the event that the transaction closed with the desired Top

Ratings. The offering materials set forth the high ratings that the Rhinebridge Notes were to

receive, and did receive, upon issuance. Importantly, the ratings were to be equivalent ratings

from, depending on the instrument, at least two and in most cases all three of the Rating

Agencies. The Rating Agencies acted in concert to artificially inflate the ratings on the

Rhinebridge Notes, without which the entire structure would have unraveled.

102. The Rating Agencies, equipped with their intentionally obsolete models and stale

data, had every incentive to ignore the risks they knew regarding the assets, such as RMBS, in

Rhinebridge in order to ensure Rhinebridge received Top Ratings so the Rating Agencies

could collect their fees while investors, such as IKB, were left holding investment grade

securities that the Rating Agencies knew were junk (and in fact were compelled to admit

exactly that just a few months after Rhinebridge launched).

103. The millions of dollars in fees paid to the Rating Agencies were taken out of

IKBs and other investors investment capital.

104. In addition, the Rating Agencies enjoyed double-dipping fees because

Rhinebridges operating instructions (which the Rating Agencies helped design) required


30

Rhinebridge to acquire other securities that had been rated and structured by the Rating

Agencies.

105. In fact, Moodys and S&P rated approximately 100% of Rhinebridges

constituent assets, while Fitch rated approximately 30% of these assets.

106. The Rating Agencies revenue growth during the relevant period was driven by

the creation of SIVs like Rhinebridge and other structured finance securities.

107. The Rating Agencies were highly compensated for undertaking this new business

venture of consulting, structuring and monitoring special purpose investment funds like

Rhinebridge.

108. For example, from 2004 to 2007, Moodys and S&P produced a record number of

ratings and a record amount of revenues in structured finance, primarily because of RMBS and

CDO ratings.

109. A 2008 submission by S&P to the SEC indicates, for example, that from 2004 to

2007, S&P issued more than 5,500 RMBS ratings and more than 835 mortgage related CDO

ratings. The number of ratings S&P issued increased each year, going from approximately 700

RMBS ratings in 2002, to more than 1,600 in 2006. S&Ps mortgage related CDO ratings

increased tenfold, going from 34 in 2002, to over 340 in 2006.

110. Moodys experienced similar growth. According to a 2008 submission by

Moodys to the SEC, from 2004 to 2007, Moodys issued over 4,000 RMBS ratings and over

870 CDO ratings. Moodys also increased the ratings it issued each year, going from

approximately 540 RMBS and 45 CDO ratings in 2002, to more than 1,200 RMBS and 360 CDO

ratings in 2006.


31

111. The Rating Agencies charged substantial fees to rate a product. To obtain an

RMBS or CDO rating during the height of the market, for example, S&P charged issuers

generally from $40,000 to $135,000 to rate tranches of an RMBS and from $30,000 to $750,000

to rate the tranches of a CDO. Surveillance fees, which may be imposed at the initial rating or

annually, ranged generally from $5,000 to $50,000 for these mortgage-backed securities.

112. Revenues increased dramatically over time as well. On May 31, 2007, an article

published by Bloomberg reported that for Fitch, for the fiscal year ended on September 30, 2006,

the rating of structured finance securities accounted for 51% of total revenue of $480.5 million.

Moodys gross revenues from RMBS and CDO ratings more than tripled in five years, from over

$61 million in 2002, to over $260 million in 2006. S&Ps revenue increased even more. In

2002, S&Ps gross revenue for RMBS and mortgage related CDO ratings was over $64 million

and increased to over $265 million in 2006. In that same period, revenues from S&Ps structured

finance group tripled from about $184 million in 2002 to over $561 million in 2007. In 2002,

structured finance ratings contributed 36% to S&Ps bottom line; in 2007, they made up 49% of

all S&P revenues from ratings.

113. In addition, from 2000 to 2007, operating margins at the Rating Agencies

averaged 53%. Altogether, revenues from the three leading credit rating agencies more than

doubled from nearly $3 billion in 2002 to over $6 billion in 2007.


32

THE FALSE AND MISLEADING CREDIT RATINGS AND OTHER STATEMENTS

A. The Credit Ratings

114. The ratings assigned to any bond communicate specific information to investors

about the assets backing their bonds (notes). In this case, the Senior Notes received Top

Ratings, defined in the Private Placement Memorandum as follows:

Top Rated or Top Ratings means, in the case of S&P, AAA for notes with original term maturities exceeding 364 days and A-1+ for commercial paper, in the case of Fitch, AAA for notes with original maturities exceeding 364 days and F1+ for commercial paper, and, in the case of Moodys, Aaa for notes with original maturities exceeding 364 days and P-l for commercial paper.

115. As to each Rating Agency, the Top Ratings constituted the highest ratings that

could be given to an investment.

116. The ratings at issue in this case are standard terms of art in the investment

industry and communicate specific, positive information about the strength and quality of an

investment.

117. At all relevant times, the Rating Agencies knew how these terms of art were used

in the investment industry. The Rating Agencies describe the short-term and long-term Top

Ratings assigned to Rhinebridges Senior Notes in the following way:

Moodys: P-1: Issuers (or supporting institutions) rated Prime-1 have a superior ability to repay short-term debt obligations.

* * *

Aaa: Obligations rated Aaa are judged to be of the highest quality, with minimal credit risk.

S&P: A-1[+]: An obligor rated A-1 has STRONG capacity

to meet its financial commitments. It is rated in the


33

highest category by Standard & Poors. Within this category, certain obligors are designated with a plus sign (+). This indicates that the obligors capacity to meet its financial commitments is EXTREMELY STRONG.

* * *

AAA: An obligation rated AAA has the highest rating assigned by Standard & Poors. The obligors capacity to meet its financial commitment on the obligation is extremely strong.

Fitch: F1[+]: Highest credit quality. Indicates the strongest

capacity for timely payment of financial commitments; may have an added + to denote any exceptionally strong credit feature.

* * *

AAA: Highest credit quality. AAA ratings denote the lowest expectation of credit risk. They are assigned only in case of exceptionally strong capacity for payment of financial commitments. This capacity is highly unlikely to be adversely affected by foreseeable events.

118. Not only the Senior Notes enjoyed Top Ratings. Even a portion of the other

Rhinebridge Notes purchased by IKB, the Senior Capital Notes, received Top Ratings. And

other Rhinebridge Notes purchased by IKB received very high investment grade ratings as

well, signaling strong capacity to meet financial commitments and low credit risk. These ratings

were all false and misleading. IKB reasonably relied on the falsely inflated ratings assigned to

the entire Rhinebridge structure, including with respect to the unrated notes, the safety and

security of which was dependent upon the false ratings assigned to the more senior tranches.

119. The following chart lists the Rhinebridge Notes acquired by IKB and the original

credit ratings assigned to them, before they were downgraded to junk:


34

Asset/Tranche Name Original Rating Moodys

Original Rating Fitch

Original Rating S&P

Rhinebridge Commercial Paper

P-1 F1+ A-1+

RHNBR 07-1JCN A NR2 NR NR RHNBR 07-1MNC A A3 A A RHNBR 07-1SCN A Aaa AAA NR RHNBR 07-2MCN A A3 A A RHNBR 07-3JCN A NR NR NR RHNBR 07-3MCN A A3 A A RHNBR 07-3SCN A Aaa AAA NR RHNBR 07-4MCN A A3 A A RHNBR 07-4SCN A Aaa AAA NR RHNBR 07-5MCN A A3 A A RHNBR 07-5MCN A A3 A A RHNBR 07-5SCN A Aaa AAA NR RHNBR 07-6MCN A A3 A A RHNBR 07-6SCN A Aaa AAA NR

120. In addition to the foregoing qualitative information, credit ratings communicate

quantitative information, and the Rating Agencies knew it. In June of 2007, for example,

Moodys explained in a Special Comment on Short-Term Corporate and Structured Finance

Transition Rates that:

Structured finance short-term rating transition rates are reported here for the first time, using the same definition of default and methodology for measuring rating transition rates as used for our corporate ratings. The data set consists primarily of asset-backed commercial paper ratings; however, all other short term structured finance ratings are included in the sample, including those of structured investment vehicles (SIVs), collateralized debt obligations (CDOs), and money market tranches of term asset-backed (ABS), residential mortgage-backed (RMBS), and commercial-mortgage-backed transactions (CMBS).

o Since 1983, 1,689 distinct ABCP programs or tranches of ABS, CDO, CMBS, and RMBS transactions have been assigned short-term ratings.

o No obligation carrying a short-term rating has ever defaulted in the

structured finance market. 2 For purposes of this chart, NR means not rated.


35

About 3.8% of all P-1 rated short-term corporate ratings were downgraded within one year, compared to about 0.6% of P-1-rated short-term structured finance ratings.

(Footnote omitted.)

121. In brief, the Rating Agencies conveyed to investors that the credit ratings assigned

to SIVs like Rhinebridge and similar CDO and ABS securities were even stronger than

comparable corporate bond ratings. Nothing could have been further from the truth.

122. The information communicated by high investment grade credit ratings is

important because an SIVs success depends directly on the credit quality of the assets it

acquires. SIV investors are willing to invest in large part because of the high credit ratings

assigned to SIVs. These ratings are largely a reflection of the high ratings assigned to the assets

acquired by SIVs. Indeed, without such high credit ratings, Rhinebridge would not have existed.

Rhinebridges Private Placement Memorandum acknowledges this fact by noting that any

downgrade in assets held by Rhinebridge is likely to have an adverse effect on the market

value of the Senior Notes.

123. The Rating Agencies communicated to investors that the Rhinebridge Notes had

Top Ratings or other high, investment grade ratings. As noted, these ratings are terms of art in

the investment industry and mean:

(a) the Rhinebridge Notes were nearly risk free;

(b) the Rhinebridge Notes were as safe, secure and reliable as high quality

corporate or government bonds;

(c) the Rhinebridge Notes had an extremely low probability of

transitioning to junk status;


36

(d) the Rhinebridge Notes had a very low probability of default;

(e) the Rhinebridge Notes had a reasonably high likelihood of a high

recovery in the event of default;

(f) the Rhinebridge Notes had been rated by an objective, independent

third-party whose impartiality was not impaired by any significant conflicts of interest, such

as the payment of triple-sized fees for structuring and closing Rhinebridge;

(g) the Rhinebridge Notes had been rated on the basis of current, accurate

and complete data and analysis, as well as reasonable and true models and assumptions, not

mere guess work and speculation; and

(h) the low rates of return offered by the Rhinebridge Notes were

appropriate and reflected the true level of risk associated with the Rhinebridge Notes.

124. The false ratings were communicated to IKB and others starting on or about June

27, 2007, when the Rhinebridge Notes were first sold to investors and were repeated each time a

Rhinebridge Note was offered or sold to an investor until October 18 and 19, 2007, when the

Rhinebridge Notes were downgraded to their accurate junk ratings by the Rating Agencies.

125. The false ratings were communicated to a narrow group of private investors,

including IKB, by various means including in transactions exempt from registration under the

United States securities laws. Indeed, the Rhinebridge Notes could be offered and sold only to

this limited group of qualified investors.

126. On information and belief, each Rating Agency knew at all times that IKB would

and did reasonably rely on the false ratings before making a decision to invest in Rhinebridge


37

and that IKB CAM would do the same, as asset manager, in recommending such investments for

IKBs balance sheet and for the Rhinebridge portfolio itself.

127. On information and belief, each Rating Agency knew at all times that such

information would be communicated directly to IKB through, inter alia, a commonly used

investment platform provided by Bloomberg and confirmed via Private Placement Memoranda

and other written materials concerning Rhinebridge.

128. The foregoing beliefs are based upon, inter alia, the fact that the investment grade

ratings were a critical investment characteristic of the Rhinebridge Notes and it was common

industry practice both to communicate and to rely upon this information, as set forth above.

129. The investment grade ratings were false, as the Rating Agencies knew, for the

reasons set forth below.

B. Assurances Concerning the Purported Objectivity and Integrity of the Ratings Process 130. In addition to the ratings themselves, the Rating Agencies made other materially

false and misleading statements intended to reassure investors, including IKB, that its credit

ratings, including those for the sort of RMBS and CDOs contained in the Rhinebridge portfolio,

were objective and independent, and that the conflict of interest inherent in the Rating Agencies

being selected and retained by the issuers whose RMBS and CDOs they rated, and the resulting

incentives to favor issuers in order to maintain and increase market share and profits, would not

influence those ratings.

131. For example, in September 2004, S&P gathered and restated established policies

and procedures that are relevant to the rating and surveillance processes of Ratings Services in a

Code of Practices and Procedures that S&P made freely available to the public on [S&Ps]


38

public website. In its Code of Practices and Procedures, S&P made several representations

regarding its ratings objectivity, independence, and freedom from influence from any conflicts

of interest.

a. In the Introduction, S&P states that its mission has always remained the

same to provide high-quality, objective, independent, and rigorous analytical

information to the marketplace and that S&P endeavors to conduct the rating and

surveillance processes in a manner that is transparent and credible and that also

ensures that the integrity and independence of the ratings and surveillance processes

are not compromised by conflicts of interest, abuse of confidential information or

other undue influence.

b. Section 3.11 states: Conflicts of interest or other undue influences if not

managed properly could undermine Ratings Services independence, objectivity and

credibility. Ratings Services is aware of the significant role it plays in the global

securities markets and understands the publics concern about conflicts of interest and

how such conflicts may affect the rating and surveillance processes. Ratings Services

endeavors to avoid conflicts of interest and, where this is not possible, has established

policies and procedures to address conflicts of interest through a combination of

internal controls and disclosure.

c. Section 3.1.2 states: In all analytic processes, Ratings Services must

preserve the objectivity, integrity and independence of its ratings. In particular, the

fact that Ratings Services receives a fee from the issuer must not be a factor in the

decision to rate an issuer or in the analysis and the rating opinion.


39

d. Section 3.14 states: Ratings services criteria and methodology shall be

determined solely by [S&Ps] Analytics Policy Board and Analysts.

e. Section 3.1.5 states: Ratings assigned by Ratings Services shall not be

affected by an existing or a potential business relationship between Rating Services

(or any Non-Ratings Business) and the issuer or any other party, or the non-existence

of such a relationship.

132. S&P reaffirmed and further codified its representations regarding its ratings

objectivity, independence, and freedom from influence by any conflicts of interest in October

2005, when S&P adopted and published on its website its Code of Conduct. The Code of

Conduct assured investors that S&P endeavors to conduct the rating and surveillance processes

in a manner that is transparent and credible and that also ensures that the integrity and

independence of such processes are not compromised by conflicts of interest, abuse of

confidential information, or other undue influences.

133. S&Ps Code of Conduct made several representations about the manner in which

S&P maintained its objectivity and independence and avoided conflicts of interests posed by its

relationships with issuers. These representations remained part of the Code of Conduct when

S&P updated and reissued it in June 2007. In particular:

a. The Introduction states that it was S&Ps mission to provide high-

quality, objective, independent, and rigorous analytical information to the marketplace.

In order to achieve this mission, Ratings Services strives for analytic excellence at all

times, evaluates its rating criteria, methodologies and procedures on a regular basis, and


40

modifies or enhances them as necessary to respond to the needs of the global capital

markets.

b. Section 2.1 states: Ratings Services shall not forbear from taking a Rating

Action, if appropriate, based on the potential effect (economic, political, or otherwise) of

the Rating Action on Ratings Services, an issuer, an investor, or other market

participant.

c. Section 2.2 states: Ratings Services and its Analysts shall use care and

analytic judgment to maintain both the substance and appearance of independence and

objectivity.

d. Section 2.4 states: Ratings assigned by Ratings Services to an issuer or

issue shall not be affected by the existence of, or potential for, a business relationship

between Ratings Services (or any Non-Ratings Business) and the issuer (or its affiliates)

or any other party, or the non-existence of such a relationship.

134. Moodys adopted its own Code of Professional Conduct in June 2005 (the

Moodys Code), which was made available to the public on Moodys website. It too contained

numerous representations concerning the purported integrity, objectivity and transparency of

Moodys credit rating process. Moodys made the following representations in its April 2006

Report on the Moodys Code:

a. The Introduction states: Moodys Code sets forth the overall policies

through which we seek to further our objective to protect the integrity, objectivity and

transparency of our credit rating process.We also believe that greater transparency


41

around what we do and how we do it will enhance the market understanding of, and

confidence in, our Credit Ratings.

b. Section II states: Through the implementation of the Moodys Code, we

seek to protect the quality, integrity and independence of the ratings process, to ensure

that investors and Issuers are treated fairly, to safeguard confidential information

produced by Moodys Analysts or provided to us by Issuers, and to provide transparent

disclosure about our rating methodologies, policies and practices and overall track record.

We believe that this will enhance market understanding of and confidence in Moodys

Credit Rating.

c. Section II.A states: The quality and integrity of the processes by which

we develop our Credit Ratings are of utmost importance to us. We have developed

policies, practices and procedures over time to govern the rating process and promote

quality and integrity in that process.

d. Section II.A.4 states: Moodys arrives at and maintains our published

Credit Ratings through a process that involves robust analysis of the Issuer or obligation

to be rated, following by rating committee deliberation and voting.

e. Section II.B states: In 2005, Moodys derived approximately 87% of our

revenue from Issuer payments for Credit Ratings . . . . [W]e recognize that this business

model entails potential conflicts of interest that could impact the independence and

objectivity of our rating process . . . .To maintain our objectivity and independence, and

to protect the integrity of our Credit Ratings and rating process, we have adopted policies


42

and procedures at a company level as well as at the level of the individual rating and the

Employee . . . .

135. The currently available version of the Moodys Code makes the following

representations:

a. Section 1.12: Moodys and its Employees will deal fairly and honestly

with Issuers, Investors, other market participants, and the public.

b. Section 2.1: Moodys will not forbear or refrain from taking a Credit

Rating action based on the potential effect (economic, political or

otherwise) of the action on Moodys, an Issuer, an Investor, or other

market participants.

c. Section 2.2: Moodys and its Analysts will use care and professional

judgment to maintain both the substance and appearance of independence

and objectivity.

d. Section 2.3: The determination of a Credit Rating will be influenced only

by factors relevant to the credit assessment.

e. Section 2.4: The Credit Rating Moodys assigns to an Issuer, debt or debt-

like obligation will not be affected by the existence of, or potential for, a

business relationship between Moodys (or its affiliates) and the Issuer (or

its affiliates), or any other party, or the non-existence of any such

relationship.

136. Upon information and belief, Moodys made similar representations on its public

website concerning the Code of Conduct in place during the period of IKBs involvement with


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Rhinebridge.

137. Fitchs public website declares: Throughout Fitch Ratings history, it has

established and implemented policies, procedures, and internal controls in order to ensure the

objectivity and integrity of its ratings. The policies that comprise Fitchs Code of Ethics describe

our current policies and procedures germane to our commitment to following the core values that

drive the way we conduct our business objectivity, integrity, and transparency.

138. The current version of the Fitch Code of Conduct, which is available on its public

website, contains numerous representations concerning the purported integrity, objectivity and

transparency of Fitchs credit rating process. For example:

a. The Introduction states: Fitch is dedicated to several core principles

objectivity, independence, integrity and transparency. Investor confidence in Fitchs

ratings and research is difficult to win, and easy to lose, and Fitchs continued success is

dependent on that confidence.Throughout its history, Fitch has established and

implemented policies, procedures and int

IKB Deutsche v. McGrawHill and S&P - Credit Ratings

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