Banking giant accused of false subprime pitch

by 05 Apr 2016

California sued Morgan Stanley over claims it misrepresented “complex investments” sold to the state’s employee pension funds, including the type of subprime mortgage-backed securities that led to the global financial crisis.

Attorney General Kamala Harris alleges that Morgan Stanley violated at least three California laws by “concealing or understating the risks of intricate investments involving large numbers of underlying loans and other assets.”

Harris accuses the bank of bundling high-risk loans from subprime lenders -- some directly funded by Morgan Stanley -- and selling them to investors without disclosing its own concerns about the poor quality of the debt. The behavior was explained by the bank’s fear that transparency would be “a relationship killer,” hampering a lucrative business with the companies taking on the risky debt, according to the complaint filed Friday in San Francisco state court.

“We do not believe this case has merit and intend to defend it vigorously,” Mark Lake, a Morgan Stanley spokesman, said in a statement. “The securities at issue were marketed and sold to sophisticated institutional investors and their performance has been consistent with the sector as a whole. It is also worth noting that the alleged victim in this case elected not to pursue its own lawsuit against the firm.”

Latest Jab
The case against Morgan Stanley is the latest jab in Harris’s fight for compensation after the 2008 mortgage crisis crippled the global economy. In 2014, she secured $369 million for the state out of a national $25 billion foreclosures settlement. A year later, Harris, a Democrat, declared her candidacy for the U.S. Senate seat held by Barbara Boxer, who is retiring in 2017.

According to Harris, Morgan Stanley pooled billions of dollars of debt, including home loans and mortgage-backed securities, from 2004 to 2007 and sold them to investors, including the state’s retirement funds. The bank entered the structured investment vehicles market in 2004 serving as “arranger, lead dealer and structurer” to help Cheyne Capital Management Ltd. issue the SIV notes that included the consolidated debt.

‘Probably Retire’
Morgan Stanley misrepresented the quality of the investments in its own offering documents by failing to disclose that the lenders had issued debt exceeding the value of the properties acquired, while some loans were already delinquent, according to the complaint. The document cites a Morgan Stanley employee as stating, “Someone could probably retire by shorting these upcoming deals” and that “someone needs to benefit from this mess.”

The California Public Employees Retirement System, Calpers, and the California State Teachers Retirement System, or Calstrs, lost hundreds of millions of dollars on Cheyne’s SIVs without understanding the risk of the debt, according to the complaint. Calpers, the nation’s largest pension fund, covers more than 1.6 million firefighters, police officers and other public employees and retirees. The teachers fund covers more than 850,000.

Saxon Capital Inc., a residential mortgage lender acquired by Morgan Stanley in December 2006, was used as one the bank’s primary tools for offloading bad debt, according to the complaint. The bank and Saxon Capital’s due diligence managers “waived in” loans they knew should have been left out of securities, Harris said.

Overall, the two state funds lost billions of dollars after buying subprime debt. The case against Morgan Stanley is the state’s latest suit aimed at recovering losses for the funds. This year, both Standard & Poor’s and Moody’s Investors Services Inc. agreed to settle claims in California for a combined $255 million.

Triple Damages
In the case against Morgan Stanley, California seeks to triple the damages sustained by the pension funds, plus penalties of $2,500 for each violation of the state’s business code, along with other compensation and a court order barring future misrepresentations.

“Calpers applauds the Attorney General for her continued efforts to hold financial institutions accountable for their nefarious actions,” said Megan White, a spokesman for the pension fund. “We look forward to her success in restoring to Calpers the money that rightfully belongs to our members and employers.”

Bloomberg News


Is TILA-RESPA a good or bad thing long term?