Morgan Stanley, Ratings Groups Face Fraud Claims on Subprime

"Where both the rating agencies and Morgan Stanley knew that the ratings process was flawed, knew that the portfolio was not a safe, stable investment, and knew that the rating agencies could not issue an objective rating because of the effect it would have on their compensation, it may be plausibly inferred that Morgan Stanley and the rating agencies knew they were disseminating false and misleading ratings," the judge explains.

Scheindlin set an October 1 status conference in the case.

The California Public Employees' Retirement System, the nation's largest public pension fund, in July sued Moody's, S&P and Fitch Ratings over losses on Cheyne and other SIVs.

According to Bloomberg and the judge's recent remarks in her order, the rating companies worked directly with Morgan Stanley to structure the notes were compensated based on the notes receiving the desired ratings. The ratings companies were paid more than three times their normal fees, the judge said.

Morgan Stanley, as the arranger and placement agent for the notes, distributed documents to investors that included Moody's and S&P's ratings, according to the ruling.

Morgan Stanley did not issue a statement following the Sept. 3 ruling.