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Burnt S’pore Investors Get Their Day in US Sun

11/03/2011 | The Singapore Business Times
by Grace Leong

A group of Singapore investors of Morgan Stanley’s failed Pinnacle Notes have scored a major legal victory after a US federal judge ruled that their class action lawsuit can proceed in New York.

According to the suit, the Singapore investors of Pinnacle Performance Ltd series 1,2,3,5,6,7,9 and 10 notes accused Morgan Stanley of engaging in ‘undisclosed self-dealing’ when they allegedly created and approved products that were ‘designed to fail’ so that every dollar the investors lost was gained by the bank.

Also significant was the New York federal court’s ruling that ‘generalised warnings of risk and of the possibility of adverse interests’ between Morgan Stanley and the Pinnacle Notes investors were not sufficient to protect the US investment bank against all allegations of fraud.

In denying Morgan Stanley’s motion to dismiss the investors’ fraud claims, US District Judge Leonard Sand said: ‘While there is little doubt that the cautionary language warned plaintiffs that (Pinnacle) Notes carried some risk, it is inadequate to have put the reasonable investor on notice of the alleged fraud.’

‘Even a sophisticated investor armed with a bevy of accountants, financial advisers, and lawyers could not have known that Morgan Stanley would select inherently risky underlying assets and short them,’ Judge Sand said in the ruling issued this week in US District Court for the Southern District of New York.

That finding is pivotal because it allows the issue to be examined at trial of whether the issuers and arrangers of such products should have legal immunity through such boilerplate clauses that are typically buried in many investment products sold here, particularly complex derivatives, and which are usually very hard to understand.

Judge Sand granted Morgan Stanley’s motion to dismiss the investors’ claims of negligent misrepresentation, breach of fiduciary duty, unjust enrichment, aiding and abetting negligent misrepresentation, and aiding and abetting breach of fiduciary duty.

But lawyers for the investors consider those to be subsidiary claims that are not likely to materially affect the case as their core fraud claims weren’t dismissed.

Daniel Hume, a lawyer representing the Singapore investors and partner of the New York law firm of Kirby McInerney LLP, said that his clients were pleased with the federal court’s ruling. ‘Given the substantial amounts lost and the serious nature of the allegations, plaintiffs deserve their day in court and Judge (Sand) now has allowed them that,’ he told BT.

Morgan Stanley declined to comment on the ruling.

The suit alleged that Morgan Stanley placed US$154.7 million of the investors’ funds in synthetic CDOs (collateralised debt obligations) of its making, where the bank itself was allegedly a counterparty on underlying swap agreements. These underlying assets were then allegedly collateralised by subprime mortgages and Icelandic banks that failed. When those assets went belly up, all the money allegedly went to the bank in New York, the suit said.

In his ruling, Judge Sand said that the investors have ‘pled sufficient facts to raise the suspicion that MS International (a Morgan Stanley affiliate) had no intention of selecting anything apart from the synthetic CDOs created by MS Capital as the underlying assets’.

‘The language indicating the possibility of decline cannot be used to shield Morgan Stanley from plaintiffs’ allegations that MS Capital had ‘custom-built (the CDOs) to intensify the normal risk of principal loss’.

‘In particular, plaintiffs have alleged that despite ample evidence of a worsening subprime crisis in late 2007, MS Capital increased the percentage of companies susceptible to a housing downturn in the CDO REs.’ ‘May decline’ is a misstatement when, assuming plaintiffs are correct, the CDOs would almost certainly decline, Judge Sand said.

In ruling that the case can proceed in New York, Judge Sand found that the Monetary Authority of Singapore’s dispute resolution process ‘only covers claims by investors against independent distributors, who aren’t defendants or even essential to the case’.

Thus, MAS is unlikely to ‘entertain plaintiffs’ claims against Morgan Stanley or its affiliates - claims . . .that are at the very heart of the complaint’, Judge Sand found.

That makes the investors’ recourse through US courts the only apparent option. Despite Morgan Stanley’s arguments that the dispute is centred on activities that allegedly occurred in Singapore and that the independent distributors in Singapore are essential to the case, Judge Sand disagreed, finding that the distributors ‘didn’t create the CDOs but merely sold it’.

‘We do not see - nor have the defendants told us - why the independent distributors’ statements would be material to rebutting plaintiffs’ claims.’

Furthermore, Judge Sand found that even if the case were to proceed in Singapore, Singaporean courts could not subpoena former employees of Morgan Stanley and MS Capital.

‘Having found that most of the activity alleged to be fraudulent occurred not in Singapore but in New York (and to a lesser extent in London), we find that the availability of evidence and witnesses - not to mention issues of expense and convenience - favour plaintiffs’ choice of a New York forum,’ Judge Sand ruled.