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Morgan Stanley Must Face Lawsuit Over Failed Debt

11/03/2011 | Reuters
A federal judge ordered Morgan Stanley to defend against a lawsuit by Singapore investors that accused it of selling them risky debt that was designed to fail.

U.S. District Judge Leonard Sand rejected Morgan Stanley’s bid to dismiss claims by 18 investors that the bank committed fraud and showed bad faith in the 2006 and 2007 sale of notes $154.7 million of notes issued by Cayman Islands-registered Pinnacle Performance Ltd.

He said Morgan Stanley was not shielded from the lawsuit by warnings in the offering materials that the notes could lose value, and even fall to zero, as the investors said they did.

“Defendants point to generalized warnings cautioning investors not to rely solely on the offering materials,” the Manhattan judge wrote on Monday. “But even a sophisticated investor armed with a bevy of accountants, financial advisors, and lawyers could not have known that Morgan Stanley would select inherently risky underlying assets and short them.”

Sand dismissed several other claims.

Morgan Stanley spokeswoman Mary Claire Delaney declined to comment. Daniel Hume, a lawyer for the plaintiffs, said he was pleased with the decision.

The October 2010 lawsuit seeks class-action status, and is one of many accusing banks of misleading investors into buying seemingly safe securities backed by risky debt, even as other investors or the banks themselves were “shorting” them.

Since July 2010, Goldman Sachs Group Inc, Citigroup Inc and JPMorgan Chase & Co have agreed to pay nearly $1 billion combined to settle Securities & Exchange Commission lawsuits over such offerings. Citigroup’s $285 million accord has not yet won court approval.

In the Morgan Stanley case, the Singapore investors accused the bank of marketing the Pinnacle notes as “conservative,” and designed to keep principal safe.

But they said Morgan Stanley instead invested their funds into synthetic collateralized debt obligations of their own making, linked to risky companies including subprime mortgage lenders and Icelandic banks.

They said the bank was a counterparty in an arrangement designed to let it gain one dollar for each dollar they lost. “Morgan Stanley designed the synthetic CDOs to fail,” the complaint said. “It placed itself on the side guaranteed to win (the “short” side) and placed plaintiffs and the class on the side guaranteed to lose (the “long” side).”

The case is Dandong et al v. Pinnacle Performance Ltd et al, U.S. District Court, Southern District of New York, No. 10-08086.

For the plaintiffs: Daniel Hume, Ira Press and Andrew McNeela of Kirby McInerney. For Pinnacle Performance Limited and Morgan Stanley: Bruce Angiolillo, Jonathan Youngwood and Andrew Cattell of Simpson Thacher & Bartlett.

(Reporting by Jonathan Stempel)