Morgan Stanley Wins Dismissal of Libertas CDO Suit by Virgin Islands Pension

Morgan Stanley has won the dismissal of a Virgin Islands government pension fund lawsuit accusing the bank of defrauding investors of $1.2 billion of risky mortgage debt that it expected to fail.

(October 3, 2011) — Morgan Stanley has won the dismissal of a Virgin Islands pension fund’s lawsuit over a collateralized debt obligation (CDO).

US District Judge Barbara Jones in Manhattan dismissed the investor complaint.

In 2009, the Employees’ Retirement System of the Government of the Virgin Islands claimed that the bank defrauded investors by collaborating with ratings companies to give the CDO an undeserved AAA rating while it was simultaneously short-selling nearly all of the assets underlying the notes. Bloomberg reported. The complaint alleged that the bank was therefore motivated to defraud investors with positive ratings, aware the CDO assets were suffering from an increase in delinquencies and were riskier than the ratings indicated.

Additionally, the lawsuit claimed that the CDOs were backed by securities issued by subprime lenders, including bankrupt New Century Financial Corp. and Option One Mortgage Corp.

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The lawsuit by the pension against Morgan Stanley is one of many examples of accusations against financial institutions following the 2008 economic crisis. Last year, the US Securities and Exchange Commission (SEC) accused Goldman Sachs of fraud in failing to disclose conflicts in mortgage securities, which they alleged cost investors more than $1 billion and fueled the worst financial crisis since the Great Depression.

The SEC’s complaint, filed in the US District Court for the Southern District of New York, stated that Goldman failed to disclose that one of its clients — Paulson & Co. — helped create and then bet against subprime mortgage securities that the New York-based firm sold to investors. The suit claimed that Paulson & Co., one of the world’s largest hedge funds run by the billionaire John Paulson, paid Goldman about $15 million for structuring the deals in 2007.

In July 2010, Goldman agreed to pay $550 million to settle charges by the SEC over the Abacus 2007-AC1 CDO.

More recently, the SEC announced in June that JP Morgan will pay $153 million to settle charges of allegedly selling $1.1 billion in mortgage-backed securities that were designed to fail. The US regulator asserted that as the housing market crumbled in March and April 2007, JP Morgan executives urged the marketing of Squared CDO 2007-1, a synthetic CDO linked to a collection of residential mortgages, without informing investors that a hedge fund — Magnetar Capital — helped select the assets in the CDO portfolio and had a short position in more than half of those assets. Consequently, the hedge fund was positioned to benefit if the CDO assets it was selecting for the portfolio defaulted.

“J.P Morgan marketed highly-complex CDO investments to investors with promises that the mortgage assets underlying the CDO would be selected by an independent manager looking out for investor interests,” Robert Khuzami, the SEC’s director of the division of enforcement, said in a statement. “What JP Morgan failed to tell investors was that a prominent hedge fund that would financially profit from the failure of CDO portfolio assets heavily influenced the CDO portfolio selection. With today’s settlement, harmed investors receive a full return of the losses they suffered.”

The SEC release stated: “The SEC alleges that by the time the deal closed in May 2007, Magnetar held a $600 million short position that dwarfed its $8.9 million long position. In an internal e-mail, a J.P. Morgan employee noted, ‘We all know [Magnetar] wants to print as many deals as possible before everything completely falls apart.'”

To contact the <em>aiCIO</em> editor of this story: Paula Vasan at <a href='mailto:pvasan@assetinternational.com'>pvasan@assetinternational.com</a>; 646-308-2742

(October 3, 2011) — Yale University’s endowment — run by David Swensen — earned a 21.9% investment return for the fiscal year ended June 30, beating Harvard University’s 21.4% return.

The 21.9% return for the university is a major improvement from the endowment’s performance in fiscal year 2010, when the university posted an 8.9% return. As of the fiscal year ended June 30, its value rose to $19.4 billion, making it one of the richest in the world. Despite the positive news, the fund remains below its 2007 peak valuation of $22.9 billion. “While real assets provide protection against inflation, which may prove beneficial in today’s highly uncertain global economy, in weak economic environments real assets tend to produce poor returns,” the university said in a statement last year.

According to the New Haven, Connecticut-based school, foreign stocks and private equity investment drove the gains. While the university’s foreign stock portfolio jumped 40.7%, its private equity portfolio gained 30.3%, the university said. The success of private equity has also been detailed in a recent academic research paper that showed that returns on private equity have surpassed the public market over the long-term. “It’s surprising how good private equity has been,” Steven Kaplan, one of the authors of the academic working paper, told aiCIO late last month. “For every dollar you put into private equity, at the end of the day, you have 20% more than if you left that money in public markets. Over a 5-year to 6-year period, that translates to 3% to 4% more a year in investment return.”

During the last 10 years, the average return for college and university endowments was 6.2%.

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“We were very pleased to learn of the endowment’s gain of nearly 22% during the 2010–’11 year,” Provost Peter Salovey said in an email to the university newspaper, the Yale Daily News. “The Investments Office has done exceptionally well over the past 10 and 20 years, despite some very difficult years.”

Yale’s CIO Swensen is largely to credit for the fund’s success, as he is responsible for pioneering the investing style that helped endowments beat market indexes by relying on such hard-to-sell assets as real estate and private equity. A report released by the university endowment last year stated: “Yale is not particularly attracted to fixed income assets, as they have the lowest historical and expected returns of the six asset classes that make up the Endowment. In addition, the government bond market is arguably the most efficiently priced asset class, offering few opportunities to add significant value through active management.”

To contact the <em>aiCIO</em> editor of this story: Paula Vasan at <a href='mailto:pvasan@assetinternational.com'>pvasan@assetinternational.com</a>; 646-308-2742