CA sues Morgan Stanley over public pension funds

12 Apr, 2016 by James Poulos

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The State of California has sued investment bank Morgan Stanley, filing a complaint in San Francisco Superior Court, seeking redress for what officials said was massive harm to its public-sector workers.

“Public employees in California, including peace officers, firefighters, teachers, and other public servants, suffered major losses as a result of Morgan Stanley’s residential mortgage-backed securities, in which high-risk home loans were purchased from subprime lenders, bundled together and sold for billions of dollars to investors,” the complaint alleges, according to CBS San Francisco.

Lack of disclosure

The complaint depicts Morgan Stanley as doling out bad deals out of “fear that transparency would be ‘a relationship killer,’ hampering a lucrative business with the companies taking on the risky debt,” Bloomberg noted. “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.”

In a statement, the office of California Attorney General Kamala Harris singled out the state’s large twin public pension funds as suffering particularly large losses. “The California Public Employees Retirement System (CalPERS) and the California State Teachers Retirement System (CalSTRS) — two of the nation’s largest institutional investors — lost hundred of millions of dollars on these Morgan Stanley investments,” the statement read. “CalPERS provides retirement security and health plans to more than 1.6 million California firefighters, peace officers, and other public employees. CalSTRS provides retirement, disability, and survivor benefits for over 850,000 of California’s pre-kindergarten through community college educators and their families.”

Swinging for the fences

Blaming “a culture of greed and deception,” Harris accused the bank of obscuring the investment risk posed by “toxic residential mortgage-backed securities and ‘structured investment vehicles’ it marketed from 2004 to 2007, sometimes encouraging credit rating agencies to award unjustifiably high ratings,” as Reuters reported. Seeking to maximize compensation, “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,” according to Bloomberg, plus a court order barring similar misrepresentations in the future.

The lawsuit reflected a hope that Morgan Stanley might also be vulnerable to an approach successfully taken in the past toward ratings agencies accused of their own misdeeds. “CalPERS had previously recovered hundreds of millions of dollars in settlements with agencies such as McGraw Hill Financial Inc’s Standard & Poor’s and Moody’s Corp’s Moody’s Investors Service over alleged inflated ratings,” as the wire service noted. In previous lawsuits, officials had pegged the combined losses facing the funds at over $1 billion, according to the Sacramento Bee, with the lion’s share falling on CalPERS.

A vigorous defense

Despite the length of time that has elapsed since the 2008 financial crisis, investment banks have still not put the past behind them in court. Confronted with the prospect of a substantial surrender of funds and the establishment of unfavorable precedent, the bank promised to defend itself vigorously in court. “Harris is seeking $700 million in penalties against Morgan Stanley, plus damages of more than $600 million,” the Los Angeles Times reported, citing Attorney General office spokeswoman Rachele Huennekens. Mark Lake, a Morgan Stanley spokesman, told the Times the bank does “not believe this case has merit. The securities at issue were marketed and sold to sophisticated institutional investors, and their performance has been consistent with the sector as a whole.”

The fight came at a moment when Morgan Stanley and the state of California have been working hand in hand on another big-ticket issue of central concern to state officials: new water bonds. “California’s Infrastructure and Economic Development Bank will issue $414.2 million of clean water state revolving fund revenue bonds as green bonds through lead manager Morgan Stanley,” as Reuters observed.