Morgan Stanley’s motion to dismiss a class action involving “built to fail” structured products has been denied as to the fraud claims against it, and the case will go forward. The plaintiffs ? a group of Singapore retail investors ? allege that Morgan Stanley committed fraud in selling them sold them $154.7 million of Pinnacle Notes. The notes, which lost almost 100 per cent of their value during the financial crisis, were linked to synthetic (i.e., derivatives-linked) collateralized debt obligations (CDOs) in 2006 and 2007.
In essence, the complaint alleges that Morgan Stanley sold class members an investment that it secretly rigged to fail and then bet against it and won, while the investors lost virtually their entire investment.
Among other things, the complaint reportedly asserts: (i) that the Pinnacle Notes were pitched as “conservative investments” when they were, in fact, “specifically designed to wipe out the … $154.7m investment” that would flow “into Morgan Stanley’s coffers;” and (ii) that “[t]he synthetic CDOs that Morgan Stanley created were not merely bets, but bets Morgan Stanley rigged, in which it placed itself on the side guaranteed to win (the ‘short’ side) and placed Plaintiffs on the side guaranteed to lose (the ‘long’ side).”
Morgan Stanley claims that it made it clear the notes were “risky” and that investors could lose their entire principal. Significantly, however, Morgan Stanley did not claim that it disclosed to investors that it selected and shorted the underlying assets.
In his Memorandum and Order, Judge Leonard Sand found: “Defendants have proffered nothing to suggest that investors were ‘placed on guard’ about anything approximating the alleged fraud, that they were ‘practically faced with the facts,’ or that they had ‘access to truth-revealing information.’ Rather, Defendants point to generalized warnings cautioning investors not to rely solely on the
offering materials and to consult outside advisors. 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.”
Thus, Morgan Stanley joins Citigroup and Goldman Sachs in the hall of shame for betraying their own clients by selling them “built to fail” structured products that they (or a more favored client) bet against.
The case is Dandong, et. al v. Pinnacle Performance Limited, et. al. United States District Court for the Southern District of New York, 10-CV-8086 (LBS).
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