(CN) - An Australian hedge fund seeks $50 million in damages from Morgan Stanley, claiming the bank knowingly sold a CDO underwritten with junk residential mortgage backed securities, while at the same time secretly betting $1 billion that the assets would fail.
     Basis Yield Alpha Fund Master sued Morgan Stanley, Morgan Stanley & Co., Morgan Stanley & Co. International, and John Does 1-50 in the County of New York.
     In 2006, Morgan Stanley created and sold a collateralized debt obligation security entitled STACK 2006-1 CDO, comprised of 35 percent cash assets and 65 percent synthetic assets, including credit default swaps and residential mortgage backed securities, according to the complaint.
     "The Fund agreed to purchase $17 million of the STACK Subordinate Notes or 'Equity Tranche.' ... The Fund's cash investment was an essential element of STACK and a necessity in getting the deal completed," the Fund claims.
     However, "unbeknownst to the Fund, Morgan Stanley had provided false and/or misleading information concerning the quality of the assets to be placed into STACK, including the defective nature of underwriting guidelines on underlying RMBS in STACK, had paid exorbitant fees to the Rating Agencies to evaluate STACK using outdated ratings methodologies, and had placed a massive bet on the very type of lower-rated RMBS tranches that made up the majority of STACK's underlying assets," the complaint states. "Morgan Stanley also had peculiar knowledge that a significant percentage of the RMBS underlying STACK was toxic. Morgan Stanley knew that RMBS included in STACK, based on mortgages that Morgan Stanley had securitized, were defective and much riskier than represented. Morgan Stanley knew that the originators of the mortgages included in the Morgan Stanley securitized RMBS had not followed underwriting guidelines and that the representations and information provided to the Rating Agencies about the underwriting guidelines, loan-to-value ratios, owner occupancy rates, and other key information were false."
     "Simply put, Morgan Stanley acted dishonestly and fraudulently in structuring STACK and in representing STACK as supported by assets that were worth of the predominately 'investment grade' rating assigned to them when Morgan Stanley knew STACK was full of toxic 'junk' assets and had bet more than a billion dollars that the same class of assets would fail," plaintiff claims.
     The fund seeks $50 million in compensatory and punitive damages for fraud, concealment, and negligent misrepresentation.
     It is represented by Debra Guzov and Anne Salisbury of Guzov LLC in New York, James Baskin, Casey Dobson and Asher Griffin of Scott Douglass & McConnico in Austin, and John Pierce and Randy Branitsky of Themis in Washington DC.