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

UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK

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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 Rhineland
1
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).

18

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 NR
2
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

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 internal controls to ensure the objectivity and
integrity of its ratings.
b. Section 2.2.1 states: Fitch shall not forbear or refrain from taking a rating
action based on the potential effect (economic, political or otherwise) of the rating action
on Fitch, an issuer, an investor, a subscriber or other market participant.
c. Section 2.2.3 states: The determination of a rating shall be influenced
only by factors known to the relevant rating committee and believed by it to be relevant
to such rating.

44

d. Section 2.2.4 states: The rating or rating action Fitch assigns to an issuer
or security shall not be affected by the existence of or potential for a business relationship
between Fitch (or its affiliates or shareholders) and the issuer (or its affiliates) or any
other party, or the non-existence of such a relationship.
139. Upon information and belief, Fitch made similar representations on its public
website concerning the Code of Conduct in place during the period of IKBs involvement with
Rhinebridge.
140. In addition to the Rhinebridge credit ratings themselves, these statements by each
of the Rating Agencies concerning the objectivity, independence and integrity of the rating
process and methodology employed with respect to the Rhinebridge credit ratings were also
false, as the Rating Agencies knew, for the reasons set forth below.
THE REASONS WHY THE RATING AGENCIES KNEW THE RATINGS
AND OTHER STATEMENTS WERE MATERIALLY MISLEADING

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

141. As noted, it was a condition to the sale of the Rhinebridge Notes that they receive
top investment grade ratings. A rating must be independent to have any value. The ratings in
this case were not independent.
142. IKB placed its trust in the credit ratings largely because the Rating Agencies were
supposed to be independent and unbiased agencies.
143. Serious conflicts of interest at the Rating Agencies have since been revealed.
Such conflicts of interest undermined the credibility of the ratings structures and surveillance of
Rhinebridge and, in particular, its constituent structured finance assets.

45

144. On April 13, 2011, the Senate Subcommittee explained that one significant cause
of inaccurate credit ratings issued by Moodys and S&P was the inherent conflict of interest
arising from the system used to pay for credit ratings:
Credit rating agencies were paid by the Wall Street firms that sought their ratings
and profited from the financial products being rated. The rating companies were
dependent upon those Wall Street firms to bring them business and were
vulnerable to threats that the firms would take their business elsewhere if they did
not get the ratings they wanted. Rating standards weakened as each credit
rating agency competed to provide the most favorable rating to win business
and greater market share. The result was a race to the bottom.

(emphasis added). The same inherent conflicts existed at Fitch.

145. The Senate Subcommittee further explained:
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.

146. The Senate Subcommittee summed it up its assessment of the false assurances the
Rating Agencies provided the investing public about their independence, objectivity and ability
to manage conflicts of interest as follows:
The credit rating agencies assured Congress and the investing public that they
could manage these conflicts, but the evidence indicates that the drive for
market share and increasing revenues, ratings shopping, and investment bank
pressures have undermined the ratings process and the quality of the ratings
themselves. Multiple former Moodys and S&P employees told the
Subcommittee that, in the years leading up to the financial crisis, gaining market
share, increasing revenues, and pleasing investment bankers bringing business to

46

the firm assumed a higher priority than issuing accurate RMBS and CDO credit
ratings. (emphasis added)

147. Admissions by former employees of the Rating Agencies confirm that the Rating
Agencies knew their ratings on investment pools such as Rhinebridge were false, as reported by
Bloomberg:
I knew it was wrong at the time, said a former S&P Managing Director;

It was either that or skip the business. That wasnt my mandate. My mandate was
to find a way. Find the way.

Another former S&P Managing Director commented, [S&P] thought they had
discovered a machine for making money that would spread the risks so far that
nobody would ever get hurt.

148. As set forth in the Financial Crisis Inquiry Report (FCIC Report) issued by the
U.S. Governments Financial Crisis Inquiry Commission in January 2011, the rating agencies
placed market share and profit considerations above the quality and integrity of their ratings.
The FCIC Reports conclusions are particularly damning with respect to Moodys:
The former managing director Jerome Fons, who was responsible for assembling an
internal history of Moodys, agreed: The main problem was . . . that the firm became so
focused, particularly the structured area, on revenues, on market share, and the
ambitions of Brian Clarkson, that they willingly looked the other way, traded the firms
reputation for short-term profits.

More evidence of Moodys emphasis on market share was provided by an email that
circulated in the fall of 2007, in the midst of significant downgrades in the structured
finance market. Group Managing Director of U.S. Derivatives Yuri Yoshizawa asked her
teams managing directors to explain a market share decrease from 98% to 94%.

Richard Michalek, a former Moodys vice president and senior credit officer, testified to
the FCIC, The threat of losing business to a competitor, even if not realized, absolutely
tilted the balance away from an independent arbiter of risk towards a captive facilitator
of risk transfer.

Former managing director Fons suggested that Moodys was complaisant when it should
have been principled: [Moodys] knew that they were being bullied into caving in to

47

bank pressure from the investment banks and originators of these things. . . . Moodys
allow[ed] itself to be bullied. And, you know, they willingly played the game . . . .

The external pressure was summed up in Kimballs October 2007 memorandum:
Analysts and [managing directors] are continually pitched by bankers, issuers,
investors all with reasonable argumentswhose views can color credit judgment,
sometimes improving it, other times degrading it (we drink the kool-aid). Coupled with
strong internal emphasis on market share & margin focus, this does constitute a risk
to ratings quality.

The Commission concludes that the credit rating agencies abysmally failed in their
central mission to provide quality ratings on securities for the benefit of investors.
They did not heed many warning signs indicating significant problems in the housing and
mortgage sector. Moodys, the Commissions case study in this area, continued issuing
ratings on mortgage-related securities, using its outdated analytical models, rather than
making the necessary adjustments. The business model under which firms issuing
securities paid for their ratings seriously undermined the quality and integrity of those
ratings; the rating agencies placed market share and profit considerations above the
quality and integrity of their ratings.

149. Statements by industry insiders indicate the Rating Agencies were paid nearly
three times the amount to rate Rhinebridge as they would have received to rate a traditional
corporate debt obligation. Among other reasons they were paid substantially more to rate
Rhinebridge is because they helped structure that is, create the product. The Rating
Agencies structuring activities and attendant pay for performance compensation undermined
the credibility of their ratings to such a significant degree as to make those ratings false and
misleading.
150. The loosening of ratings standards is exemplified by a now infamous instant
message conversation between two S&P analysts describing S&Ps rating of an investment
similar to Rhinebridge and its constituent securities. In response to one analysts comment that a
deal is ridiculous and [S&P] should not be rating it, the other agrees that the model
def[initely] does not capture half of the ris[k], but laments that [S&P] rates every deal and it

48

could be structured by cows and we would rate it.
151. In a December 15, 2006 e-mail, an S&P analytical manager in the same group as
these two analysts wrote to a senior analytical manager that the Rating Agencies continue to
create an even bigger monster the CDO market. Lets hope were all wealthy and retired by
the time this house of cards falters.
152. The loosening of ratings criteria due to market share considerations was evident at
Moodys also. In a presentation to Moodys Board of Directors in October 2007, CEO Raymond
McDaniel (McDaniel) told the Board: The real problem is not that the market . . .
underweights ratings quality but rather that, in some sectors, it actually penalizes quality . . . . It
turns out that ratings quality has surprisingly few friends . . . .
153. As McDaniel noted, this degradation of ratings quality was not limited to
Moodys: What happened in 04 and 05 with respect to subordinated tranches is that our
competition, Fitch and S&P, went nuts. Everything was investment grade. It didnt really
matter.
154. Suffice it to say, Moodys did not asterisk their ratings of Rhinebridge debt and
did not explain that S&P and Fitch went nuts in rating Rhinebridge and its constituent assets,
upon which the safety and security of Rhinebridge as an investment depended.
155. Due to the Rating Agencies easing of credit rating criteria, the Rating Agencies
made the Rhinebridge Notes and the constituent assets of the SIV appear to be far less risky than
they really were. This easing of credit rating criteria and the true risk of Rhinebridge contradicts
the high credit ratings at issue in this case.
156. For these same reasons, the Rating Agencies knew that their public assurances

49

concerning the objectivity, independence, quality and integrity of their ratings process and
methodology employed in rating the Rhinebridge Notes were false and misleading.
B. The Rating Agencies Knew the Rhinebridge Notes
Ratings Differed from Ratings of Corporate Bonds

157. In August 2004, Moodys started using a new credit-rating model. The formula
allowed securities firms to sell more top-rated, nonprime mortgage-backed bonds than ever
before. A week later, S&P moved to ease its credit rating methods because of the threat of losing
deals to Moodys. According to Moodys, Fitch similarly went nuts. The overrated securities
that were the byproduct of the Rating Agencies loosening of their ratings standards to the point
of being nuts, of course, was what formed the majority of the assets in Rhinebridge.
158. With respect to credit ratings on the Rhinebridge Notes, the high ratings represent
that the Rhinebridge Notes had the same default probability and loss severity (should default
occur) as corporate bonds with the same ratings. Rhinebridges ratings differ from corporate
bond ratings in several important ways that render Rhinebridges high ratings false and
misleading.
159. For example, in order to provide ratings for the Rhinebridge Notes, which were
backed by numerous underlying assets, the Rating Agencies had to make assumptions about how
frequently those assets would default together, or in tandem. The apparent safety of the
Rhinebridge Notes depended significantly on the degree of diversity of these underlying credits.
A highly diverse group of credits is unlikely to default at the same time. Conversely, a highly
correlated group of credits is likely to default at the same time. This relationship among various
credits is also called correlation.
160. The high ratings of the Rhinebridge Notes reflected the assumption by the Rating

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Agencies about the correlation of Rhinebridges constituent securities. As noted, a lower
correlation assumption reflected greater safety for the Rhinebridge Notes, because, if the
correlation of defaults is low, it is less likely that a large number of the underlying assets will
default at the same time. By making unreasonably low correlation assumptions, the Rating
Agencies were able to conclude that the Rhinebridge Notes deserved high ratings. These
correlation assumptions were unreasonable and false, and were not based on reasonable data.
Unlike the correlation assumptions the Rating Agencies use for rating other instruments, such as
corporate bonds, the correlation assumptions used for Rhinebridge were mere speculation.
161. The Rating Agencies also made unreasonable and false assumptions concerning
housing price appreciation that was not based on reasonable data, and actually contradicted data
in their possession. For example, 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 knowingly
used those faulty models to produce top ratings in Rhinebridge that it could not reasonably
believe to be true.
162. Further, the Rating Agencies knew but failed to appropriately rate the
Rhinebridge Notes given the lending practices that had been used to generate the underlying
mortgages, including stated income loans where the stated income was unreasonably high as
compared to the stated job title. These were referred to in the industry as liar loans. The
nonprime mortgage-backed securities in Rhinebridge included mortgages based on artificially
inflated appraisals and loans to nonprime borrowers with silent seconds, where the down
payment was in reality another loan. These lending improprieties dramatically increased the

51

probability of delinquencies, defaults, foreclosures and, ultimately, losses.
163. For example, in an internal e-mail in August 2006, an S&P employee observed:
[T]here has been rampant appraisal and underwriting fraud in the industry for quite some time
as pressure has mounted to feed the origination machine. In September 2006, another S&P
employee wrote: I think it is telling us that underwriting fraud, appraisal fraud, and the general
appetite for new product among originators is resulting in loans being made that should not be
made. A colleague responded that the head of the S&P Surveillance Group told me that
broken down to loan level what she is seeing in losses is as bad as high 40s--low 50 percent. I
would love to be able to publish a commentary with this data but maybe too much of a powder
keg. (emphasis added).
164. As set forth in the FCIC Report, Moodys was well aware of factors that rendered
its models and ratings inaccurate:
Moodys did not sufficiently account for the deterioration in underwriting standards or a
dramatic decline in home prices.

Even as housing prices rose to unprecedented levels, Moodys never adjusted the
scenarios to put greater weight on the possibility of a decline. According to Siegel [a
former Moodys team managing director involved in developing the model], in 2005,
Moodys position was that there was not a . . . national housing bubble.

Moodys did not, however, sufficiently account for the deteriorating quality of the
loans being securitized. Fons described this problem to the FCIC: I sat on this high level
Structured Credit committee, which youd think would be dealing with such issues [of
declining mortgage-underwriting standards], and never once was it raised to this group
or put on our agenda that the decline in quality that was going into pools, the impact
possibly on ratings, other things. . . . We talked about everything but, you know, the
elephant sitting on the table.

Moodys, the Commissions case study in this area, relied on flawed and outdated
models to issue erroneous ratings on mortgage-related securities, failed to perform
meaningful due diligence on the assets underlying the securities, and continued to rely
on those models even after it became obvious that the models were wrong.

52

In plainer English, Witt [formerly one of Moodys team managing directors for the CDO
unit] said, Moodys didnt have a good model on which to estimate correlations between
mortgage-backed securitiesso they made them up.

In June 2005, Moodys updated its approach for estimating default correlation, but it
based the new model on trends from the previous 20 years, a period when housing prices
were rising and mortgage delinquencies were very lowand a period in which
nontraditional mortgage products had been a very small niche. Then, Moodys modified
this optimistic set of empirical assumptions with ad hoc adjustments . . . . Using these
methods, Moodys estimated that two mortgage- backed securities would be less closely
correlated than two securities backed by other consumer credit assets, such as credit
card or auto loans.

There was a clear failure of corporate governance at Moodys, which did not ensure
the quality of its ratings on tens of thousands of mortgage-backed securities and CDOs.

165. In addition, not long after assigning top ratings to Rhinebridge, Fitch published a
report blaming poor underwriting practices and fraud in the origination process for poor RMBS
performance. According to the report, Fitch had a look behind the curtain at loan-level
information that IKB and other investors did not enjoy, and the results were startling. Fitchs
analysts conducted an independent analysis of these files with the benefit of the full origination
and servicing files. The result of the analysis was disconcerting at best, as there was the
appearance of fraud or misrepresentation in almost every file.
166. Despite this knowledge of the heightened risk of the very same asset class
underlying the Rhinebridge SIV, Fitch was touting the safety and security of those same assets
and the Rhinebridge Notes (on which they were based) just months earlier.
167. The credit ratings on Rhinebridges constituent securities were consequently not
indicative of the riskiness of these securities, and the ratings on the Rhinebridge Notes were
similarly misleading and the Rating Agencies knew it. The Rating Agencies knew the real risks
but misled IKB with investment grade ratings and assurances about the integrity of their rating

53

process. When the real risks were exposed, Rhinebridge lost its funding ability and collapsed.
168. Fitch was additionally negligent and/or reckless in its policy of adopting S&Ps
and Moodys ratings of the assets underlying Rhinebridge.
169. Unlike S&P and Moodys, which would lower or notch down the rating for a
transaction if it was rated by Fitch but not them, in Rhinebridge Fitch simply used the lower of
S&P or Moodys rating if both rated the transaction, or the same rating if one of them rated a
transaction that Fitch did not rate.
170. Again, S&P and Moodys structured and rated approximately 100% of
Rhinebridges constituent securities, while Fitch rated 30% of these securities. Given these facts
and the Rating Agencies receipt of material non-public information from the mortgage
originators whose loans were underlying Rhinebridge, the Rating Agencies knew the low-quality
assets held by Rhinebridge rendered the Rhinebridge Notes high ratings false and misleading.
171. This non-public information (including detailed, loan-by-loan data) was not
available to IKB and was one of the main reasons why IKB relied on the Rating Agencies
ratings.
172. In addition to this qualitative information, the Rating Agencies received
quantitative information that contradicted the Rhinebridge ratings, as discussed below.
methodology were false and misleading.
C. The Ratings Were Devoid of Any Meaningful
Factual or Statistical Basis, as the Rating Agencies Knew

174. The Rating Agencies knew but failed to account for major changes in the types of

54

assets included in Rhinebridge. Because Rhinebridges ratings were based on inaccurate data,
the ratings were false and misleading.
175. For example, the Rating Agencies used models based on historical information
preceding 2000 that had no relevance to rating Rhinebridge. This information did not reflect the
true state of the mortgage market during the relevant period because from the period 2001
through 2005: (i) the percentage of subprime mortgage loans tripled; (ii) the combined LTV
(or loan-to-value) ratio of loans in excess of 90% tripled; (iii) limited documentation loans (or
liar loans) nearly quadrupled; (iv) interest only and option adjustable rate mortgages
quintupled; (v) piggy back or second-lien mortgages doubled; (vi) the amount of equity U.S.
homeowners stripped out of their homes tripled; (vii) the volume of loans originated for second
homes more than tripled; (viii) the percentage of loans including silent seconds a nearly
non-existent phenomenon a few years prior to the issuance of the Senior Notes - experienced
over a 16,000% increase; and (ix) the volume of nontraditional mortgages more than quintupled.
176. The exotic mortgage products characterizing the U.S. marketplace after 2000
performed poorly relative to the performance required by their models, and the Rating Agencies
knew it. Each month the Rating Agencies received product information and performance data on
billions of dollars in U.S. loans. Under the contractual terms of hundreds of billions of dollars
worth of mortgage-backed securities they rate, the Rating Agencies are provided such product
information. Thus, when the Rating Agencies provided top ratings on the Rhinebridge Notes,
they knew that their historical data no longer reflected market realities and that mortgage credit
quality was rapidly deteriorating.

55

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

178. Despite the fact that the decrease in lending standards and increase in exotic
mortgage products rendered the Rating Agencies pre-2000 loan performance data obsolete and
irrelevant to rating the Rhinebridge Notes, and the fact that more current and accurate
information was available during the relevant time, the Rating Agencies did not update their
models to reflect these changes.
179. According to Frank Raiter the Managing Director and Head of Residential
Mortgage-Backed Securities Ratings at S&P from March 1995 to April 2005 S&P had
developed models that accounted for the new type of mortgage products available after 2000.
These models better captured the changes in the post-2000 mortgage landscape and were
therefore better at determining default risks posed by these new mortgages. However, S&P did
not implement these models due to their cost and because improving the model would not add to
S&Ps revenues.
180. As Raiter explained, the unfortunate consequences of continuing to use outdated
versions of the rating model included the failure to capture changes in performance of the new
subprime products and the unprecedented number of AAA downgrades and subsequent
collapse of prices in the RMBS market. Former President of S&P, Deven Sharma (Sharma),
agreed, noting: It is by now clear that a number of the assumptions we used in preparing our

56

ratings on mortgage-backed securities issued between the last quarter of 2005 and the middle of
2007 did not work.
181. The use of outmoded models and inaccurate information was not limited to S&P.
In fact, Moodys did not update its key assumptions for rating structured finance CDOs until
December of 2008when, among other changes, Moodys increased the average assumed asset
correlations by a factor of roughly two to three times the previous levels.
182. Executives at Moodys also acknowledged a lack of investment in Moodys rating
models and the failure of Moodys rating models to capture the decrease in lending standards. In
a confidential presentation to Moodys Board of Directors, McDaniel, CEO of Moodys, noted
that underfunding can put ratings accuracy at risk. He acknowledged that Moodys Mortgage
Model (M3) needs investment. McDaniel also acknowledged that Moodys models did not
sufficiently capture the changed mortgage landscape. Brian Clarkson - the former President and
Chief Operating Officer of Moodys also recognized Moodys failure to incorporate decreased
lending standards into their ratings, stating: We should have done a better job monitoring that
[decrease in underwriting standards].
183. The Rating Agencies models were dependent on housing price appreciation.
This is clear from their downgrading of billions of dollars in mortgage-backed securities in lock-
step. Moodys also declared that S&P and Fitch went nuts in rating such securities in the first
instance.
184. Fitch made a similar admissions in a private telephone conversation with an
investor in March 2007:
We were on the March 22 [,2007] call with Fitch regarding the sub-prime
securitization markets difficulties. In their talk, they were highly confident

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regarding their models and their ratings. My associate asked several questions.
What are the key drivers of your rating model? They responded, FICO scores
and home price appreciation (HPA) of low single digit (LSD) or mid single digit
(MSD), as HPA has been for the past 50 years. My associate then asked, What if
HPA was flat for an extended period of time? They responded that their model
would start to break down. He then asked, What if HPA were to decline I% to
2% for an extended period of time? They responded that their models would
break down completely. He then asked, With 2% depreciation, how far up the
ratings scale would it harm? They responded that it might go as high as the AA
or AAA tranches.

185. The Rating Agencies continued to stamp top ratings on securities like the
Rhinebridge Notes and its constituent assets in 2007, after prices had already declined.
186. This fact is demonstrated by S&Ps statement on August 28, 2007, that [t]he
year-over-year decline reported in the 2nd quarter of 2007 for the National Home Price Index is
the lowest point in its reported history, which dates back to January 1987.
187. Moodys own managing directors, who apparently did not work in the
structured finance group, posed the following questions:
Who is going to accept responsibility within Moodys for the lack of
oversight of [the] structured ratings group.

Multi-notch downgrades in Structured Finance (SIVs and others) what
exactly were the reasons for that and what are lessons? Doesnt an Aaa also
imply a certain low migration [transition downward from one rating to
another] risk?

Really no discussion of why the structured group refused to change their
ratings in the face of overwhelming evidence that they were wrong."


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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

189. As the Rating Agencies well knew, Rhinebridges investment portfolio included
many securities derived from mortgages originated by mortgage lenders under extremely
dubious circumstances. Whether the mortgage loans were categorized as prime or nonprime'
borrowers, many of the mortgages were granted in amounts not justified by the borrowers
income. Many borrowers were qualified under stated income applications (usually reserved for
self-employed individuals who could not provide Form W-2s) even though such borrowers were
wage earners. Many borrowers qualified under pay-option adjustable rate mortgages (ARMs)
which would, after the initial teaser period, adjust to such high payment amounts that it would be
impossible for the borrowers to make the payments. Rhinebridges weak assets contradicted the
high ratings.
190. The credit ratings on Rhinebridges constituent assets were not indicative of the
riskiness of these securities, and the ratings on the Rhinebridge Notes were consequently
misleading. When the real risks were exposed, Rhinebridge lost its funding ability and
collapsed.
191. The Rating Agencies knew that the mortgage-backed assets supporting
Rhinebridge were shoddy, because the Rating Agencies had access to non-public information
about the collateral underlying Rhinebridge from their involvement in rating the originators of
the mortgages purchased by Rhinebridge. Because the Rating Agencies are exempt from SEC
Regulation FD (Fair Disclosure), they have access to such non-public information. Such non-
public information (including detailed, loan-by-loan data) was not available to IKB.

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192. For example, mere months after rating the Rhinebridge Notes, Fitch published a
report stating that evidence in the loan files of a sampling of 2006 Fitch-rated subprime RMBS
found the appearance of fraud or misrepresentation in almost every file. Fitch and the other
Rating Agencies were aware of or consciously disregarded these and similar issues
undermining the top ratings at the time they assigned such top ratings to the Rhinebridge Notes
and the assets comprising the Rhinebridge SIV.
193. If the Rating Agencies had disclosed such material non-public information in their
possession, Rhinebridge could not have issued the Rhinebridge Notes. Indeed, without their
ratings, the overwhelming majority of securities supporting Rhinebridge would not have even
been eligible for issuance on a shelf takedown basis under the SEC rules. The reason the SEC
permits securities such as the residential mortgage-backed securities backing Rhinebridge to be
issued on Form S-3 which involves less oversight by the SEC than in a typical registration is
because of the very low risk such securities represent to the investment community as a result of
the high-quality, low- risk nature of securities that receive investment grade ratings.
194. As set forth above, as a result of their roles in structuring, rating and monitoring
Rhinebridge, the Rating Agencies occupied superior positions, had access to confidential, non-
public information, and possessed unique and special knowledge regarding Rhinebridge that
IKB did not possess, requiring IKB to justifiably repose trust and confidence in the Rating
Agencies representations. IKB did not have access to the models, criteria, data and assumptions
that the Rating Agencies used to rate the Rhinebridge Notes and Rhinebridges constituent
assets.

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THE RATING AGENCIES KNEW AND INTENDED THAT INVESTORS, INCLUDING
IKB, WOULD RELY ON THE CREDIT RATINGS AND OTHER STATEMENTS
CONCERNING THEIR OBJECTIVITY AND INDEPENDENCE

196. The end aim of the credit ratings was to entice qualified investors, such as IKB,
into purchasing Rhinebridge Notes.
197. The Rating Agencies published pre-sale reports and new issue reports
disseminating the Rhinebridge credit ratings to qualified investors.
198. Like IKB, such qualified investors often had minimum ratings requirements for
their investments. As Senator Carl Levin explained during the April 23, 2010 Hearing on
Financial Crisis Causes:
A variety of U.S. laws and regulations rely on credit ratings to gauge risk . . .
. Some investors, like pension funds, are barred from holding below investment-
grade assets. Because so many statutes and regulations reference ratings,
issuers of securities and other financial instruments work hard to obtain
favorable credit ratings to ensure more investors can buy their products.

Over the last 10 years, Wall Street has engineered ever more complex
financial instruments for sale to investors. Because these so-called structured
finance products are so hard to understand, investors often place heavy
reliance on credit ratings to determine whether they can or should buy
them.

199. On April 13, 2011, the Senate Subcommittee further explained:
Because so many federal and state statutes and regulations require the
purchase of investment grade ratings, issuers of securities and other
instruments work hard to obtain favorable credit ratings to ensure
regulated financial institutions can buy their products. As a result, those
legal requirements not only increased the demand for investment grade
ratings, but also created pressure on credit rating agencies to issue top
ratings in order to make the rated products eligible for purchase by

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regulated financial institutions. The legal requirements also generated
more work and greater profits for the credit rating agencies.

200. Moreover, IKB directly informed the Rating Agencies prior their purchase that
they relied on credit ratings in making investment decisions. Thus, the Rating Agencies knew
that investors, including IKB, were relying on the Rhinebridge Notes credit ratings to make
investment decisions.
201. IKBs investment strategy was reliant upon, among other factors, the credit
ratings assigned by the Rating Agencies, and was focused on investments in debt instruments of
the highest quality, as reflected by receipt of the highest credit ratings.
202. The Rating Agencies also knew that investors such as IKB were relying on their
statements concerning the objectivity, independence, quality and integrity of their ratings process
in making investment decisions. That is why the Rating Agencies touted such statements as
core principles of the utmost importance and made them available on their public websites
for all to see.
203. The Rating Agencies also knew that investors such as IKB necessarily relied on
their credit ratings in deciding to invest in structured finance products because of the Rating
Agencies superior access to non-public information. As Moodys CEO McDaniel told the
SEC on April 15, 2009:
Unlike in the corporate market, where investors and other market
participants can reasonably develop their own informed opinions based on
publicly available information, in the structured finance market, there is
insufficient public information to do so . . . .

In the absence of sufficient data, investors are unable to conduct their own
analysis and develop their own independent views about potential or existing
investments.


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204. McDaniel further admitted that the lack of current information regarding
structured finance products and the underlying pools of assets can hinder the efforts of secondary
market purchasers to make informed investment decisions, making investors reliance on credit
ratings even more necessary.
205. Similarly, in his October 22, 2008 testimony to the Senate, Fons, the former
Managing Director of Credit Policy at Moodys, explained that investors such as IKB were not
privy to the same information as the Rating Agencies and, thus, had to rely heavily on credit
ratings to make investment decisions:
Market participants relied heavily on the rating agencies when
purchasing subprime related assets for at least three reasons. First,
subprime RMBS and their offshoots [such as the Rhinebridge SIV] offer little
transparency around the composition and characteristics of the underlying
loan collateral. Potential investors are not privy to the information that
would allow them to understand clearly the quality of the loan pool. Loan-
by-loan data, the highest level of detail, is generally not available to
investors. Second, the complexity of the securitization process requires
extremely sophisticated systems and technical competence to properly assess
risk at the tranche level. Third, rating agencies had a reputation, earned over
nearly one century, of being honest arbiters of risk.

206. This highly-detailed, loan-by-loan data was available to each of the Rating
Agencies, but not to IKB. For example, a 2007 report by Fitch confirms that Fitch had access to
and, as part of the report, reviewed the full origination and servicing files for loans underlying
various 2006 Fitch-rated subprime RMBS.
207. As a result of their knowledge of IKBs reliance on the credit ratings and the
Rating Agencies superior knowledge of Rhinebridge and the loan-level data corresponding to
Rhinebridges constituent assets, the Rating Agencies maintained a special relationship with
IKB.

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208. Moreover, IKB had direct contact and communications with the Rating
Agencies. For example, pursuant to the Management Agreement, the Manager (IKBs wholly-
owned subsidiary, IKB CAM) undertook to act as the agent of the issuer in dealing with the
Rating Agencies, including applying for and maintaining Top Ratings for each of the Senior
Notes and the then current ratings assigned to the Capital Notes. The Manager was also required
to distribute monthly investment reports to the Rating Agencies, and to test for compliance of the
investment portfolio with certain investment parameters and notify the Rating Agencies of any
breach of the investment parameter tests.
209. In addition, IKBs Head of Research had meetings and communications with the
Rating Agencies during which IKB had an opportunity to communicate its views, research
findings, and concerns (including concerns about high sub-prime delinquencies and the impact
on house prices) and hear how the Rating Agencies were evaluating and modeling such
developments.
210. As the pre-sale reports reflect, part of the disclosure made to the Rating Agencies
was of all legal documentation, e.g., contracts and other agreements among the participants,
relating to Rhinebridge. Indeed, pursuant to their engagement letters with IKB, each of the
Rating Agencies had to be paid an additional fee for further review of the legal documentation,
should there be any material change in their terms.
211. As a result of their review, the Rating Agencies knew that IKB committed to
make a substantial investment in the bottom tranches of the Rhinebridge capital structure. One
of the agreements related to Rhinebridge was the engagement letter whereby IKB retained
Morgan Stanley to act as its investment advisor and structurer for the transaction. In that letter,

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IKB contracts to purchase a minimum of 40% of the Junior Capital Notes and 25% of the
Mezzanine Capital Notes of Rhinebridge. Of course, as the letter reflects, one of the Key
Conditions of the purchase was the Rating Agencies confirmation and issuance of the high
ratings detailed herein.
212. The Rating Agencies were not simply aware of IKBs commitment to invest in
Rhinebridge, they touted it. In its April 5, 2007 pre-sale report, Fitch listed as a key feature of
Rhinebridge that IKB AG is a significant sponsor of Rhinebridge Plc, with a strong co-
investment commitment in the capital notes.
213. The pre-sale reports of each of the Rating Agencies also reveal their
understanding that IKB not only committed to invest in Rhinebridge, but to invest in the lower
tranches of the structure. This is because it was in large measure IKBs investment in these
Capital Notes that provided the subordination i.e., protective capital cushion for the higher
rated notes that were essential to the SIVs launch. Indeed, in its June 8, 2007 pre-sale report,
Moodys highlights the provision of this subordination as one of the chief mitigants to the
credit risk of the Senior Notes.
214. The obvious consequence of the fact that its Capital Note investment was
providing protection to Senior Notes was that, as the Rating Agencies each understood, IKB was
at the greatest risk of loss should the credit ratings be false.
215. The pre-sale reports also reflect the Rating Agencies knowledge that the
Rhinebridge transaction was part of IKBs efforts to expand its existing investment advisory and
asset management business. The pre-sale reports refer to the experience of the manager, which
was IKB Credit Asset Management, London Branch. IKB CAM was a newly-established group

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subsidiary. Previously, IKB had successfully managed the Rhineland ABCP conduit for some
five years as of the launch of Rhinebridge. The Rating Agencies were well aware that in
addition to its capital, IKB was risking the future of its investment advisory and asset
management line of business on the success of Rhinebridge.
THE RHINEBRIDGE LAUNCH
216. With structuring expertise provided by Morgan Stanley and asset selection
expertise provided by Blackrock and Standish Mellon (with respect to the underlying RMBS)
and IKB CAM (with respect to the underlying CDOs), the Rhinebridge structure took shape.
217. As part of the ramp up, certain RMBS assets were purchased by IKB in advance
of the launch of Rhinebridge specifically for inclusion in the Rhinebridge portfolio. If
Rhinebridge never launched, IKB would have retained these highly rated securities. However,
given that the carrying costs (i.e., capital reserve required under applicable regulations) would
have been higher than the yield, IKB would have sold the assets.
218. Originally set to launch on March 31, 2007, Morgan Stanley was unable to place
the Capital Notes in time and the launch was delayed.
219. The market was tightening during this period. Only those who could see behind
the curtainoriginators, banks purchasing the loans and securitizing them, and the Rating
Agencies who had access to loan-level informationunderstood that the RMBS market was in
trouble. IKB understood the market was tightening, but believed this was a market event driven
by liquidity, not a credit event driven by bad loans. They relied on the Rating Agencies and their
superior access to information unavailable to IKB to provide a truthful assessment of credit risk.

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220. As each Rating Agency knew, the Rhinebridge vehicle would not launch if they
declined to issue top ratings on, in particular, the Rhinebridge commercial paper. This was true
as a legal matter, as reflected in IKBs engagement letter with Morgan Stanley. It was also true,
as the Rating Agencies knew, as a commercial matter. The economic model of the SIV was that
it would generate higher returns on long-term assets that it purchased with money borrowed
through the commercial paper market at a lower return. That is, the SIVs profitability was
limited by the difference, or spread, between the return Rhinebridge received on its long-term
investments (like RMBS), and the return it had to pay the purchasers of commercial paper. In
order to pay a viably low return on the commercial paper, that paper had to have top ratings.
221. The Rhinebridge offering memoranda state that the rated Rhinebridge Notes will
receive and, in fact, did receive top ratings upon issuance. As the Rating Agencies knew,
without their top ratings, the issuers funding costs would likely increase, and it might be
impossible to refinance outstanding notes or make payments on others. In other words, the
Rhinebridge Notes would be unmarketable and the entire structure would unravel, eviscerating
the Rating Agencies success fees and lucrative monitoring fees.
222. Understanding all of this, the Rating Agencies entered into a corrupt agreement to
artificially inflate the credit ratings for the Rhinebridge Notes. Each Rating Agency issued its
pre-sale report shortly before the launch of Rhinebridge, stating their anticipation that they would
issue such top ratings on the commercial paper: Fitch on April 5, S&P on April 13, and Moodys
on June 8, 2007. The statement by each Rating Agency in the pre-sale reports that the vehicles
securities merited the ratings set forth therein was false when made. None of the Rating
Agencies honestly believed that Rhinebridge or its securities actually merited the ratings each

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claimed it was prepared to issue, but knew that the Rhinebridge Notes had to receive high ratings
from at least two, and in most cases, all three of the Rating Agencies for the launch to be
successful.
223. The Rhinebridge SIV launched on June 27, 2007.
224. Each Rating Agency issued false final ratings on the Rhinebridge transaction and
securities on or shortly after the launch. In reliance on the false ratings, and in order to enhance
the vehicles overall chances for success, which were predicated on the false ratings, IKB
invested in the subordinated Capital Notes on the day of the launch. At this time, IKB invested
$149 million, consisting of a purchase of $12 million of Junior Capital Notes, $77 million of
Mezzanine Capital Notes, and $60 million of Senior Capital Notes.
225. Had the Rating Agencies not issued the false final ratings, the transaction would
have been immediately unwound and IKB would have recovered its $149 million.
226. The launch on June 27, 2007 proceeded as planned. Rhinebridge took in IKBs
Capital Notes investment (and investments in Capital Notes from certain other institutional
investors) and also sold its first rounds of commercial paper. It thus funded itself for the
purchase of the asset portfolio of purportedly super high grade assets prepared for it, which were
to generate the returns to support the entire structure.
227. Approximately 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.

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228. Thus, a mere thirteen days after issuing the final top ratings to Rhinebridge,
whose portfolio consisted overwhelmingly of RMBS, the Rating Agencies announced their
repudiation of their prior methodology for rating these types of assets.
229. The announcements created confusion throughout the asset-backed securities
markets.
230. As a result of these announcements, the market prices for assets comprised of
subprime mortgage loans entered a phase of great volatility, and a generally downward slide.
This price pressure began to affect Rhinebridge, which was a mark to market vehicle. Because
of Rhinebridges strict requirements to maintain certain levels of capital subordination to support
the ratings on the commercial paper (a requirement dictated by the Rating Agencies), it had to
consider and eventually to begin asset sales to maintain the proper capital ratio. That is, by
virtue of the revelation of Rating Agencies stunning reversal on RMBS, Rhinebridge was faced
with having to sell off the long-term assets that generated the returns that made the vehicle
viable.
231. In light of the market turmoil created by the Rating Agencies, by August 2007,
IKB began considering options with regard to dealing with Rhinebridge. The key question for
IKB at this time was whether Rhinebridge continued to be viable long term and, if so, how best
to see it through this period.
232. A number of actions and statements by the Rating Agencies during this period
persuaded IKB that it should commit to further support Rhinebridge. First, of the many
hundreds of bonds either downgraded or placed on credit watch in the July 10 announcement,
none of them were held by Rhinebridge. At the same time, as a requirement of maintaining the

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false ratings, IKB CAM and QSR (the SIVs administrator) provided substantial reports on
prices, assets and cash flows for Rhinebridge to the Rating Agencies every week (and sometimes
more often). This monitoring program was dictated by the Rating Agencies. Yet, through the
first week of August, the Rating Agencies did not change their ratings.
233. Moreover, on July 20, 2007, Moodys issued a report entitled, SIVs: An Oasis
of Calm in the Sup-Prime Maelstrom, in which it touted SIVs as particularly safe in the current
volatile market. Rhinebridge was an SIV.
234. In reliance on the Rating Agencies maintenance of their high ratings and touting
SIVs as particularly safe in this market, IKB purchased another $110 million of Rhinebridge
Junior Capital Notes in order to provide further liquidity and capital support to the vehicle. This
brought IKBs investment in the vehicle in reliance on the Rating Agencies false ratings to $259
million.
235. The market turmoil continued. IKB CAM worked diligently to navigate this
period. It made careful asset sales, typically at prices over 90% of par. However, Rhinebridge
needed additional funding to continue to move forward and attract investors.
236. Thus, IKB was again faced with the question of whether to extend further support
to Rhinebridge. It decided to do so, not only in light of the prior statements and conduct of the
Rating Agencies, but also on the fact that, in the midst of this market crisis of their creation, the
Rating Agencies reaffirmed their ratings. On August 9, 2007 Moodys stated that it was
reaffirming Top Ratings for Rhinebridge commercial paper. On August 14, 2007, S&P issued a
report stating that it was maintaining its ratings on 30 SIVs, including Rhinebridge.

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237. Notably, the Rating Agencies engagement letters provided lucrative fees for
continued coverage of Rhinebridge. They would receive these additional fees each year that
Rhinebridge continued to be in existence.
238. In reliance on the reaffirmation of the false ratings, and the other above actions
and statements of the Rating Agencies, on August 15, 2007, IKB purchased $295 million of
Rhinebridge commercial paper.
239. None of the Rating Agencies changed the rating of any Rhinebridge securities,
including the commercial paper, in the month of August 2007. In reliance upon the maintenance
of those false ratings, as well as the other statements and actions of the Rating Agencies, and in
an attempt to mitigate any damage to its investment advisory/asset management business, IKB
made a final investment of $20 million in Rhinebridge commercial paper, on August 31, 2007.
RHINEBRIDGE COLLAPSES
240. Less than two weeks later, Fitch downgraded all Rhinebridge securities, and
Moodys and S&P placed Rhinebridge on watch negative.
241. Rhinebridge defaulted on Senior Notes payments on or about October 18, 2007.
Moodys and S&P downgraded the Senior Notes to junk status on October 18 and October 19,
2007, respectively. Fitch downgraded the Senior Notes to junk on October 19, 2007.
242. In what is perhaps the shortest-lived Triple A company in the history of
corporate finance, Rhinebridge was launched in an initial private offering on or about June 27,
2007 propped up by the Rating Agencies false and misleading investment grade ratings and
was officially in receivership less than four months later on or about October 22, 2007.

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243. As a result, IKBs Capital Notes were completely wiped out, IKB suffered
substantial losses on its investment in Rhinebridge commercial paper, and IKBs profitable,
income-producing asset management business was destroyed.
COUNT I
Common Law Fraud

244. Plaintiff repeats and realleges the allegations set forth in the preceding
paragraphs, inclusive, as if fully set forth herein.
245. This count is against S&P, for joint and several liability for all losses alleged
herein.
246. S&P made materially false and misleading representations and omissions
concerning the credit quality of the Rhinebridge Notes and the assets comprising the Rhinebridge
SIV. In addition to the Rhinebridge Notes themselves, 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. For the reasons set forth with particularity
above, the credit ratings the Rating Agencies assigned to the assets underlying Rhinebridge were
not indicative of the riskiness of these securities and S&P knew it.
247. Specifically, the Top Ratings and other investment grade ratings given to
Rhinebridge and its constituent assets were false and misleading. These false and misleading
ratings were communicated to and relied upon by IKB and IKB CAM.
248. The Rating Agencies collaborated in creating and disseminating the false and
misleading ratings.

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249. In addition to the ratings themselves, S&P made additional materially false and
misleading representations and omissions concerning the objectivity, independence, integrity and
quality of their ratings process and methods. These false and misleading statements were
communicated to and relied upon by IKB and IKB CAM.
250. S&P created and disseminated the false and misleading statements by way of the
ratings to IKB and IKB CAM through various private information services, including
Bloomberg, and confirmed through private placement memoranda.
251. S&P created and disseminated the false and misleading statements concerning the
objectivity, independence, quality and integrity of its ratings process and methods, including its
commitment to conduct ongoing surveillance to ensure the continued accuracy of its ratings,
through public statements and by making them freely available to the public on its public
websites, including in the form of written Codes of Conduct.
252. The ratings, Codes of Conduct, and the reasons why they are false and misleading
are set forth with particularity above.
253. S&P knew or recklessly disregarded the false and misleading nature of its
representations and omissions. The bases for S&Ps knowledge or reckless disregard are set
forth with particularity above.
254. S&P made the materially misleading statements and omissions for the purpose of
inducing IKB to buy and retain the Rhinebridge Notes, and inducing IKB CAM to recommend
such investments for IKBs balance sheet and other S&P-rated assets for the Rhinebridge
portfolio itself.

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255. IKB reasonably and justifiably relied on S&Ps materially misleading statements
and omissions as they went to the core of IKBs investment decisions regarding the Rhinebridge
Notes namely, the attendant amount and nature of risk associated with the Rhinebridge Notes
and the determination of whether the respective rates of return associated with the Rhinebridge
Notes adequately compensated investors for such risks, and also the credibility of the ratings
process. The Rhinebridge Notes would have been unmarketable and would not have issued or
even existed but for the Rating Agencies misleading statements and omissions.
256. IKB CAM also reasonably and justifiably relied on such misleading statements
and omissions as they went to the core of IKB CAMs recommendation of purportedly safe and
secure investments for IKBs balance sheet and the Rhinebridge portfolio itself.
257. S&Ps misrepresentations and omissions went to the credit quality of the
Rhinebridge Notes and the underlying collateral assets. When the truth regarding these assets
was revealed just months after S&Ps misrepresentations, Rhinebridge collapsed and was forced
into receivership.
258. The Rating Agencies undertook to structure and rate billions of dollars in
Rhinebridge Notes for sale to investors. Having elected to make representations to investors in
order to structure, rate, and sell Rhinebridge Notes to them, S&P owed such investors a duty to
disclose all material information, including adverse information.
259. The Rating Agencies were in possession of material non-public information
concerning the quality and value of the Rhinebridge Notes, including information concerning the
quality and value of the assets held by Rhinebridge. S&P owed investors a duty to disclose that

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information, including but not limited to the facts that the low quality assets could not support
the Top Ratings or other investment grade ratings ascribed to the Rhinebridge Notes.
260. S&P was in a superior position to IKB due to its receipt of material non-public
information (including detailed, loan-by-loan data) from the originators of the assets constituting
Rhinebridge.
261. IKB has been injured as a result of S&Ps fraudulent conduct and
misrepresentations and omissions, including losses on its investment in the Rhinebridge Notes,
and destruction of its valuable, income-producing asset management business, in an amount to
be determined at trial.
COUNT II
Negligent Misrepresentation

263. This count, plead in the alternative to Count I, is against S&P for joint and several
liability for all losses alleged herein.
264. S&P negligently made materially false and misleading representations and
omissions concerning the credit quality of the Rhinebridge Notes and the assets comprising the
Rhinebridge SIV. In addition to the Rhinebridge Notes themselves, 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. For the reasons set forth with
particularity above, the credit ratings S&P assigned to the assets underlying Rhinebridge were
not indicative of the riskiness of these securities and S&P should have known it.

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265. Specifically, the Top Ratings and other investment grade ratings given to
Rhinebridge and its constituent assets were false and misleading. These false and misleading
ratings were communicated to and relied upon by IKB and IKB CAM.
266. In addition to the ratings themselves, S&P negligently made additional materially
false and misleading representations and omissions concerning the objectivity, independence,
integrity and quality of its ratings process and methods. These false and misleading statements
were communicated to and relied upon by IKB and IKB CAM.
267. S&P negligently created and disseminated the false and misleading statements by
way of the ratings to IKB and IKB CAM through various private information services, including
Bloomberg, and confirmed through private placement memoranda.
268. S&P negligently created and disseminated the false and misleading statements
concerning the objectivity, independence, quality and integrity of its ratings process and
methods, including their commitment to conduct ongoing surveillance to ensure the continued
accuracy of its ratings, through public statements and by making them freely available to the
public on its public websites, including in the form of written Codes of Conduct.
269. As described herein, S&P had a duty, as a result of a contractual (pursuant to the
engagement letters discussed above) and special relationship, to give correct information. S&P
failed to exercise its duty of care when making these statements.
270. As a result of its knowledge of IKBs reliance on the credit ratings and superior
knowledge of Rhinebridge and the loan-level data corresponding to Rhinebridges constituent
assets, S&P maintained a special relationship with IKB.

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271. Moreover, IKB had direct contact and communications with the Rating
Agencies. For example, pursuant to the Management Agreement, the Manager (IKBs wholly-
owned subsidiary, IKB CAM) acted as agent of the issuer in dealing with the Rating Agencies,
including applying for and maintaining Top Ratings for each of the Senior Notes and the then
current ratings assigned to the Capital Notes. The Manager was also required to distribute
monthly investment reports to the Rating Agencies, and to test for compliance of the investment
portfolio with certain investment parameters and notify the Rating Agencies of any breach of the
investment parameter tests. In addition, representatives of IKB communicated with the Rating
Agencies during the relevant period (including at ABS industry conferences), exchanging views
and research findings, and discussing how the Rating Agencies were evaluating and modeling
developments.
272. The negligent misrepresentations concerning the credit quality of the Rhinebridge
Notes, and the objectivity, independence, quality and integrity of the ratings process, were
intended to induce IKBs reliance, and S&P knew at all times that IKB, to whom the false and
misleading credit ratings and other misrepresentations were made, would and did rely upon their
misrepresentations and omissions in evaluating the Rhinebridge Notes.
273. S&P knew and intended that IKB a member of a select group of qualified
investors would rely on their ratings, and statements concerning the objectivity and
independence of their ratings process, for a serious purposeto evaluate an investment in
Rhinebridge.
274. S&P also knew and intended that IKB CAM in its unique role as investment
manager would rely on the ratings, and statements concerning the objectivity and independence

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of their ratings process, for a serious purpose--to evaluate and recommend an investment in
Rhinebridge.
275. S&P prepared its Rhinebridge ratings and statements concerning the objectivity
and independence of its ratings process with the end aim of inducing investors such as IKB to
invest in Rhinebridge, and IKB CAM to recommend investments in Rhinebridge.
276. IKB intended to, and did, reasonably and justifiably rely and act upon the
information supplied by S&Ps representations. Because IKB could not evaluate non-public
information possessed only by the Rating Agencies (including the loan files for the mortgage
loans underlying the assets comprising the Rhinebridge portfolio), and because IKB could not
examine the underwriting quality or services practices on a loan-by-loan basis, IKB was heavily
reliant on the Rating Agencies unique and special knowledge regarding the underlying mortgage
loans in determining whether to make its investments in the Rhinebridge Notes. For the same
reasons, IKB CAM was heavily reliant on the Rating Agencies unique and special knowledge in
determining whether to recommend investments in the Rhinebridge Notes.
277. IKB and IKB CAM justifiably relied upon these materially false and misleading
statements and omissions as they went to the core of IKBs investment decision and IKB CAMs
investment recommendation decision, respectively, regarding the Rhinebridge Notes namely,
the attendant amount and nature of risk associated with the Rhinebridge Notes, and the
determination of whether the respective rates of return associated with the Rhinebridge Notes
adequately compensated IKB for such risk, and also the credibility of the ratings process. The
Rhinebridge Notes would have been unmarketable and would not have issued but for S&Ps

78

misleading statements and omissions concerning the quality of the Rhinebridge SIV, the ratings
on the Rhinebridge Notes, and the integrity of the ratings process.
278. IKB and IKB CAM reasonably relied on the information supplied by the Rating
Agencies representations to their detriment.
279. The Rating Agencies had a duty of care to accurately and completely represent all
material facts to IKB because, inter alia:
a. The Rating Agencies could readily foresee that their failure to exercise
due care in structuring, rating, and monitoring the Rhinebridge SIV could cause injury to
IKB;
b. The Rating Agencies were insiders of the Rhinebridge SIV, which issued
the Rhinebridge Notes IKB purchased;
c. The Rating Agencies knew that the Rhinebridge Notes could be marketed
and sold only to a select group of readily identifiable QIBs as defined in Rule 144 of the
1933 Act and QPs as defined in the 1940 Act and foreign purchasers who meet
equivalent requirements;
d. The Rating Agencies had unique and special knowledge, occupied a
superior position to IKB and had superior access to confidential information regarding
the Rhinebridge Notes, requiring IKB to repose trust and confidence in them;
e. The Rating Agencies established the model and inputs used to structure
and rate the Rhinebridge SIV;
f. The Rating Agencies knew or should have known that IKB was a
prospective Rhinebridge Note investor and that IKB CAM was Manager;

79

g. The Rating Agencies owed investors such as IKB a fiduciary duty as
alleged herein;
h. The Rating Agencies made an undertaking to monitor the Rhinebridge
SIV and provide updates to reflect material changes affecting the Rhinebridge Notes; and
i. The Rating Agencies are NRSROs and along with the special privileges
that follow from this designation (including monopoly-like market control), owe a
statutory duty to IKB to base their ratings on current and accurate information.
280. Further, IKB relied on the Rating Agencies because, during the relevant time
period, they were understood, inter alia, to have:
a. Provided objective, independent, unbiased analyses and services;
b. Provided ratings that were supported by facts and based on reality, as
opposed to ratings with no factual basis that were based on inaccurate and false
information, exceptions and assumptions that, if disclosed properly, would have made
it possible for IKB to understand the real risks posed to its investments;
c. Accounted for the difference between key characteristics of corporate
bonds and structured finance bonds, and accounted for those differences in their ratings
methodologies and practices;
d. Applied reasonably consistent methodologies and used reasonable
assumptions, including a reasonable correlation assumption, and models in their ratings;
e. Verified information concerning Rhinebridges constituent securities;

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f. Applied sound processes and practices for monitoring the constituent
securities of Rhinebridge, which they were obligated to do on an ongoing basis for
Rhinebridge; and
g. Held no serious doubts about the validity of their own rating
methodologies and practices in respect of structured finance securities.
281. Had IKB known the true facts concerning the credit ratings assigned to
Rhinebridge and its constituent assets, and the lack of objectivity and integrity in the ratings
process employed by S&P, IKB would not have invested in and supported Rhinebridge and IKB
CAM would have pursued other investment opportunities as well.
282. By reason of the foregoing, S&P is liable to IKB for negligent misrepresentation.
283. IKB has been injured as a result of S&Ps negligent misrepresentations, including
losses on its investment in the Rhinebridge Notes, and destruction of its valuable, income-
producing asset management business, in an amount to be determined at trial.
COUNT III
Civil Conspiracy

285. This count is for civil conspiracy to commit fraud, brought against S&P for joint
and several liability for all losses alleged herein
286. As alleged herein, the Rating Agencies committed underlying frauds in
connection with rating the Rhinebridge Notes and its underlying assets.

81

287. The Rating Agencies entered into a corrupt agreement to artificially inflate credit
ratings assigned to structured products such as the Rhinebridge Notes and its underlying assets.
The Rhinebridge offering memoranda stated that the rated Rhinebridge Notes would receive
and they did receive high ratings from at least two, and in most cases, all three of the Rating
Agencies, without which the Rhinebridge Notes would have been unmarketable and the entire
structure would have unraveled.
288. The Rating Agencies each committed numerous overt acts in furtherance of that
agreement, as detailed above, including by structuring Rhinebridge so that it would appear to
support top ratings, and then issuing, in tandem, the falsely inflated ratings without which
Rhinebridge could not exist, and by actively concealing their misconduct, including by making
false or misleading public statements about the objectivity, independence, quality and integrity of
their credit rating process and methodology.
289. The Rating Agencies intentionally took these and other overt acts described above
to further the corrupt agreement between the Rating Agencies and to carry out a common plan to
execute a fraud on investors such as IKB, and to benefit the Rating Agencies.
290. Each Rating Agency was at all relevant times fully aware of the conspiracy and
substantially furthered it as set forth above.
291. As a direct and proximate result of the Rating Agencies conspiracy, IKB invested
in the Rhinebridge Notes and suffered massive losses, in an amount to be determined at trial.
292. In addition, because the Rating Agencies fraud was willful and wanton, and
because, by their acts, they knowingly affected the general public, including but not limited to all

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persons in the investment community that rely on credit ratings in making investment decisions,
Plaintiff is entitled to recover punitive damages.
PRAYER FOR RELIEF
WHEREFORE, IKB prays for relief and judgment, as follows:
An award of damages in favor of IKB against S&P, jointly and severally, for all damages
sustained as a result of the Rating Agencies wrongdoing, in an amount to be proven at trial, but
including at a minimum:
A. IKBs monetary losses in connection with its investment in the Rhinebridge
Notes, including loss of market value and loss of principal and interest payments;
B. IKBs monetary losses in connection with the destruction of its profitable,
income-producing asset management business;
C. Plaintiffs attorneys fees and costs;
D. Punitive damages;
E. Prejudgment interest at the maximum legal rate; and
F. Such other and further relief as the Court may deem just and proper.
JURY TRIAL DEMAND
Plaintiff hereby demands a trial by jury on all issues so triable.


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Dated: New York, New York
July 11, 2014

WOLLMUTH MAHER & DEUTSCH LLP

By: /s/ Jeffrey Coviello
David H. Wollmuth (dwollmuth@wmd-law.com)
Jeffrey Coviello (jcoviello@wmd-law.com)
500 Fifth Avenue
New York, New York 10110
(212) 382-3300

Attorneys for Plaintiff IKB Deutsche Industriebank
AG


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

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