(CN) - A federal judge in Manhattan rejected investors' bid to expand their fraud class action against Morgan Stanley and two credit rating agencies, accusing them of hyping and overrating a complex investment vehicle linked to the subprime mortgage mess.
Abu Dhabi Commercial Bank and other investors claimed the bank, Moody's Investment Service and The McGraw-Hill Companies masked the risk of the Cheyne Structured Investment Vehicle, which went bankrupt in August 2007.
The plaintiffs said structured investment vehicles (SIV) "have been at the heart of the recent U.S. credit crisis."
Cheyne's investors were hit hard after the vehicle's assets plummeted in 2007. Many lost most or all of their investments, according to the lawsuit.
U.S. District Judge Shira A. Scheindlin rejected investors' bid to throw non-fraud claims in the mix.
The ruling is expected to draw attention from other investors and pension funds, who seek to hold banks and credit raters responsible for steering investors toward SIVs and similar complex investments, which would have been "virtually unmarketable without high credit ratings," the plaintiffs' said in their amended complaint.
SIV's are funds that invest in long-term, high-yield securities with money that they raise by selling lower-yielding, short-term securities. They're often invested in asset-backed securities, or corporate debt.
"At their core, SIV's are a mechanism for banks to offload exposure to these risky asset backed securities," according to the plaintiffs.
The market for SIV's dried up after the subprime mortgage crisis.
The plaintiffs said Morgan Stanley misled investors by hyping Cheyne as a high-quality investment, and the rating agencies improperly assigned it a high rating.
The judge dismissed all claims against the Bank of New York Mellon last month, but left the door open in the current ruling by not dismissing them with prejudice.
She decided that discovery could reveal new facts to bolster the plaintiffs' claims that BoNY aided and abetted Morgan Stanley and the rating agencies in the alleged fraud.
Judge Scheindlin dismissed numerous claims against Morgan Stanley, including breach of fiduciary duty and unjust enrichment, in last month's ruling, but gave the plaintiffs a chance to amend their complaint.
Scheindlin said she rejected the inclusion of the additional claims because the plaintiffs' amended complaint "added no new facts and made no attempt to cure the deficiencies outlined by this Court." But the bank and rating agencies must still defend against the fraud claims.
"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 ratings agencies knew they were disseminating false and misleading ratings," Scheindlin wrote in her opinion last month.