Photo: Diego M. Radzinschi/ALM

Lawyers for Reed Smith on Tuesday urged a Manhattan state court to dismiss a $500 million malpractice suit over the firm's work for a pair of Bear Stearns investment funds on a financial crisis-era lawsuit against the major credit rating agencies.

Represented by Reid Collins & Tsai, liquidators for the now defunct Cayman Islands-based funds sued Reed Smith in January, alleging that the firm missed key statute of limitations deadlines in connection with a fraud lawsuit against Standard & Poor's, Moody's and Fitch Ratings that could have been worth a billion dollars.

The funds suffered losses on investments made ahead of the financial crisis. They had previously raised and fed capital to so-called master funds at Bear Stearns, which then invested heavily in risky residential mortgage backed securities and collateralized debt obligations, according to the suit.

The malpractice suit alleges that Reed Smith analyzed a potential ratings agency lawsuit as early as 2011. But the firm allegedly failed to inform its clients until 2013—and by then, the relevant six-year statute of limitations had expired because the securities involved were purchased in 2006 and 2007, the suit said.

“In total, Reed Smith's haphazard representation of the Bear Stearns funds caused the funds to lose claims worth over a billion dollars—claims against defendants who unquestionably committed the fraud that gave rise to those claims and had the financial wherewithal to pay the full amount of the judgment the Bear Stearns funds would have obtained,” the complaint said.

On Tuesday, Reed Smith's outside lawyers at Gibson, Dunn & Crutcher filed a brief pushing for two of the feeder funds' claims, one for malpractice and another for breach of contract, to be tossed. The complaint also included a breach of fiduciary duty claim, but in a footnote, Reed Smith's brief said the firm would address that claim in a different court response in the future, but stressed that the firm believes that the fiduciary duty count has “fatal flaws.”

In substance, Reed Smith's brief supporting the partial motion to dismiss expands on the firm's initial response when contacted for comment in January, after the complaint was filed. The firm's outside lawyer, Gibson Dunn's Kevin Rosen, said in a January statement that despite Reed Smith's analysis of a potential ratings agency suit in 2011, such litigation was not viable at that point for several reasons.

Expanding on that claim, Tuesday's brief argues that the feeder funds didn't have the money to pursue a ratings agency case in 2011, and that similar financial crisis-related litigation against the ratings houses didn't gain much traction in the court system until later.

The brief also said the funds wouldn't have had direct standing to bring that case. The standing issue arose because, technically, the master funds purchased the securities. For the feeder funds to pursue the ratings houses, they would have needed to enter an agreement in which they purchased an assignment of the master funds' claims.

“It is beyond speculation to allege that despite these dire straits, plaintiffs would have miraculously found some unknown source of funding not only to purchase the assignment from the master funds, but also to underwrite multimillion-dollar litigation against the rating agencies and/or underwriters on a theory of liability that largely had been rejected by courts at that time,”

Reid Collins & Tsai's William Reid IV, who represents the feeder funds, said in an interview Tuesday that Reed Smith's response to the malpractice suit includes “rank speculation” about the funds' ability to bring a lawsuit before the statute of limitations ran out. The firm, he said, is attempting to shift blame for missing key deadlines to Reed Smith's former clients, when in reality it was the firm's responsibility to keep track of those deadlines and to keep its clients apprised.

Reid also said, “Each and every one of the defenses posed by Reed Smith is a fact issue that a jury should consider.”