Earlier this month, California Attorney General Kamala Harris filed suit against Morgan Stanley in San Francisco Superior Court, alleging violations of the California False Claims Act and other state laws.  Brought on behalf of the California Public Employees Retirement System—the nation’s largest pension fund—and the California State Teachers Retirement System, the suit alleges that Morgan Stanley failed to disclose that the loans underlying many of the residential mortgage-backed securities (“RMBS”) it sold to the pension funds were delinquent.

From 2004 to 2007, Morgan Stanley packaged the RMBS it sold to investors with loans it purchased from subprime mortgage originators including its subsidiary, Saxon, and California-based New Century.  As the subprime mortgage market soared, those and other originators pressured Morgan Stanley to purchase as many loans as possible, pushing the bank to loosen restrictions on purchasing high-risk mortgages.  The complaint alleges that Morgan Stanley’s RMBS offering materials failed to disclose the true risk of the loans underlying the RMBS.  Morgan Stanley knowingly purchased loans made by borrowers with poor credit, and loans for which the accompanying appraisal was purposefully inflated to allow the borrower to obtain as large a loan as possible.

The California pension funds ultimately lost hundreds of millions of dollars on their RMBS investments, including investments in structured investment vehicles (“SIVs”) backed by RMBS and other assets that were created by Cheyne Capital Management, together with Morgan Stanley.  The complaint alleges that Morgan Stanley failed to disclose concerns about the risks of the Cheyne SIVs, and even pressured rating agencies to give them unmerited high ratings.

The suit seeks treble damages and civil penalties under the California False Claims Act, the Corporate Securities Law, the Unfair Competition Law, and the False Advertising Law.  The case is People of the State of California v. Morgan Stanley, No. 16-551238 in the Superior Court of California, County of San Francisco.

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