morgan stanley "pinnacle" law suit filed by hong leong
TRANSCRIPT
JS44C/SDNY
REV. 7/2012
oJJSLCIV 6The JS-44 civil coversheet andthe information contained hereinneitherreplacenorsupplement the filing and serviopleadings or other papers asrequired bylaw, except asprovided by local rules ofcourt This farm, approved bythe"Judicial Conference of the United States inSeptember 1974, is required for use of the Clerk of Court for the purposeofinitiatingthe civil docket sheet.
PLAINTIFFS
HONG LEONG FINANCE LIMITED (SINGAPORE)
ATTORNEYS (FIRM NAME, ADDRESS, AND TELEPHONE NUMBERDavid S. StellingsJason L. Lichtman
LIEFF CABRASER HEIMANN & BERNSTEIN, LLP250 Hudson SL 8th Fl. New Yorfc, NY 10013-1413 Telephone: (212)355-9500CAUSE OF ACTION (CITE THE U.S. CIVIL STATUTE UNDER WHICH YOU ARE FILING AND WRITE ABRIEF STATEMENT OF CAUSE)
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DEFENDANTS
PINNACLE PERFORMANCE LIMITED, et al.
ATTORNEYS (IF KNOWN)
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CONTRACT PERSONAL INJURY PERSONAL INJURY FORFEITURE/PENALTY BANKRUPTCY OTHER STATUTES
1 1110 INSURANCE [ )310 AIRPLANE [ ) 362 PERSONAL INJURY - [)610 AGRICULTURE [ ) 422 APPEAL [ ]400 STATE
[J120IM30I I 140
MARINE | ]315 AIRPLANE PRODUCT MED MALPRACTICE 1)620 OTHER FOOD & 28 USC 158
MILLER ACT LIABILITY [ ) 365 PERSONAL INJURY DRUG ( ]423 WITHDRAWAL 1)410 AN1IIRUST
NEGOTIABLE 1 ]320 ASSAULT, LIBEL& PRODUCT LIABILITY 1)625 DRUG RELATED 28 USC 157 I )430 BANKS & BANKING
INSTRUMENT SLANDER |]368 ASBESTOS PERSONAL SEIZURE OF [)4S0 COMMERCE
1)150 RECOVERY OF [ ) 330 FEDERAL INJURY PRODUCT PROPERTY 1)460 DEPORTATION
OVERPAYMENT & EMPLOYERS' LIABILITY 21 USC 881 PROPERTY RIGHTS 1)470 RACKETEER INFLU
ENFORCEMENT LIABILITY ( )630 LIQUOR LAWS ENCED & CORRUPT
OF JUDGMENT 1 ) 340 MARINE PERSONAL PROPERTY U640 RR & TRUCK [ ]820 COPYRIGHTS ORGANIZATION ACT
1)151[]152
MEDICARE ACT 1 ) 345 MARINE PRODUCT ()650 AIRLINE REGS [ J830 PATENT (RICO)
RECOVERY OF LIABILITY M370 OTHER FRAUD []660 OCCUPATIONAL ( ]840 TRADEMARK [ ] 480 CONSUMER CREDIT
DEFAULTED [ ]350 MOTOR VEHICLE 1 J371 TRUTH IN LENDING SAFETY/HEALTH []490 CABLE/SATELLITE TV
STUDENT LOANS 1 ] 355 MOTOR VEHICLE [ ]380 OTHER PERSONAL []690 OTHER [)810 SELECTIVE SERVICE
(6XCL VETERANS) PRODUCT LIABILITY PROPERTY DAMAGE SOCIAL SECURITY [ ]850 SECURITIES/
I 1153 RECOVERY OF 1 ) 360 OTHER PERSONAL | J385 PROPERTY DAMAGEOVERPAYMENT INJURY PRODUCT LIABILITY LABOR 1 )861 HIA(1395ff) EXCHANGE
[ ]862 BLACK LUNG (923) []875 CUSTOMER
[]710 FAIR LABOR ( ]863 DIWC/DIWW (405(g)) CHALLENGE
()160 STANDARDS ACT [ | 864 SSID TITLE XVI 12 USC 3410
SUITS 1)720 LABOR/MGMT [ | 865 RSI (405(g)) 1)890 OTHER STATUTORY
1)190 OTHER PRISONER PETITIONS RELATIONS ACTIONS
I )730 LABOR/MGMT 1)891 AGRICULTURAL ACTS
1)195 CONTRACT [ )510 MOTIONSTO REPORTING & FEDERAL TAX SUITS [ ]892 ECONOMIC
PRODUCT ACTIONS UNDER STATUTES VACATE SENTENCE DISCLOSURE ACT STABILIZATION ACT
LIABILITY 20 USC 2255 1)740 RAILWAY LABOR ACT I ) 870 TAXES (U.S. Plaintiffor 1 )893 ENVIRONMENTAL
[ ] 196 FRANCHISE CIVIL RIGHTS ( )530 HABEASCORPUS (1790 OTHER LABOR Defendant) MATTERS
1 ) 535 DEATH PENALTY LITIGATION 1 ) 871 IRS-THIRD PARTY (]894 ENERGY
I ]441 VOTING 1)540 MANDAMUS&OTHER |)791 EMPL RET INC 26 USC 7609 ALLOCATION ACT
REAL PROPERTY
| )442 EMPLOYMENT| ]443 HOUSING/
SECURITY ACT |]895 FREEDOM OFINFORMATION ACT
ACCOMMODATIONS IMMIGRATION [)900 APPEAL OF FEE
1 1210 LAND [ ] 444 WELFARE PRISONER CML RIGHTS DETERMINATION
CONDEMNATION ( ]445 AMERICANS WITH [)462 NATURALIZATION UNDER EQUAL
[ ]220 FORECLOSURE DISABILITIES - I ) 550 CIVIL RIGHTS APPLICATION
[ J230 RENT LEASE & EMPLOYMENT | ) 555 PRISON CONDITION 1)463 HABEAS CORPUS- [)950 CONSTITUTIONALITY
EJECTMENT |)446 AMERICANS WITH ALIEN DETAINEE OF STATE STATUTES
I ]240 TORTS TO LAND DISABILITIES -OTHER [)465 OTHER IMMIGRATION
1)245 TORT PRODUCT
LIABILITY
1 )440 OTHER CIVILRIGHTS(Non-Prisoner)
ACTIONS
1)290 ALL OTHERREAL PROPERTY
Check if demanded in complaint: * ACHECK IF THIS IS A CLASS ACTION ^>0 YOU CLAIM THIS CASE IS RELATED TO ACIVIL CASE NOW PENDING IN S.D.N.Y.? f%UNDER FRCP. 23 IF SO, STATE:
DEMANDS32-000-000 OTHER JUDGE Leonard B Sand DOCKET NUMBER 1°-8086
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H 1 Original • 2Proceeding state court
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CITIZEN OF THIS STATE [ ] 1 [ ] 1
CITIZENOF ANOTHER STATE [ ]2 [ ] 2
CITIZEN OR SUBJECT OF AFOREIGN COUNTRY
INCORPORATED or PRINCIPALPLACE [|4M4OF BUSINESS IN THIS STATE
PTF DEF
[]3 []3
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INCORPORATEDand PRINCIPAL PLACE M 5 |]5OF BUSINESS IN ANOTHER STATE
PLAINTIFF(S) ADDRESS(ES) AND COUNTY(IES)
Hong Leong Finance Limited16 Raffles Quay#01-05 Hong Leong BuildingSingapore 048581
FOREIGN NATION
DEFENDANT(S) ADDRESS(ES) AND COUNTY(IES)Pinnacle Performance Limited -PO Box 1093GT, Queensgate House.South Church Street, George Town, Grand Cayman, Cayman IslandsMorgan Stanley Asia PTE -One Marina Boulevard #28-00, Singapore 018989Morgan Stanley &Co. International PLC -25 Cabot Square Canary Wharf.London, E14 Q4AMorgan Stanley Capital Services Inc. Corporate Trust Center, 1209 Orange Street, Wilmington DE 19801Morgan Stanley &Co. Inc. 1585 Broadway, New York, NY 10036
[16 []6
DffRgSSSS^D2™BSS?!LT. AT THIS TIME,. HAVE BEEN UNABLE, WITH REASONABLE DILIGENCE, TO ASCERTAIN THERESIDENCE ADDRESSES OFTHE FOLLOWING DEFENDANTS:
Check one THIS ACTION SHOULD BE ASSIGNED TO: D WHITE PLAINS [X] MANHATTAN(DO NOT check either box if this aPRISONER PETITION/PRISONER CIVIL RIGHTS COMPLAINT.)
DATE 08/06/2012 SIGNATURE OFATTORNEY OF RECORD
&«•RECEIPT #
Magistrate Judge istobe designated by theClerk oftheCourt.
Magistrate Judge
Ruby J. Krajick, Clerk of Courtby. Deputy Clerk, DATED.
UNITED STATESDISTRICT COURT(NEWYORK SOUTHERN)
ADMITTED TO PRACTICE INTHIS DISTRICT
I 1 NOH YES (DATE ADMITTED Mo. 02 Yr. 1996 )Attorney Bar Code # DS5343
is so Designated.
RELATED CASE: No. 10-cv-8086:
This casearisesout of the same facts andcircumstances that gaverise to the filing in this
Court ofplaintiffs' complaint in Ge Dandong, et al, v. Pinnacle Performance Limited, et
al, No. lO-cv-8086 (S.D.N.Y.) (presided overby United States District Court Judge
Leonard B. Sand). Plaintiffs inboth cases seek to recover damages incurred by them as a
result of the failure of certain credit linked notes (the "Pinnacle Notes") that Defendants
designed and issued. Plaintiff inthis case has relied in part on the investigation ofthe Ge
Dandong Plaintiffs informulating this Complaint, and the evidence ofDefendants'
wrongdoing will substantially overlap in the two cases. Indeed, one ofPlaintiffs claims
is for equitable subrogation ofcertain claims asserted by the Ge Dandong Plaintiffs.
Therefore, to avoid unnecessary duplication ofjudicial effort, this caseshould be
assigned to Judge Sand.
1050980.1
12 CIV 6010IN THE UNITED STATES DISTRICT COURT
FOR THE SOUTHERN DISTRICT OF NEW YORK
HONG LEONG FINANCE LIMITED(SINGAPORE),
Plaintiff,
-vs.-
PINNACLE PERFORMANCE LIMITED;MORGAN STANLEY ASIA (SINGAPORE)PTE; MORGAN STANLEY & CO.INTERNATIONAL PLC; MORGANSTANLEYCAPITAL SERVICES INC.;MORGAN STANLEY & CO. INC.,
Defendants.
974839.11
Case No.
Related Action: Case No. 10-CIV-8086
COMPLAINT
JURY TRIAL DEMANDED
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TABLE OF CONTENTS
INTRODUCTION 1
WHY HLF HAS FILED THIS LAWSUIT 2
THE INVESTMENT PRODUCTS AT ISSUE IN THIS LITIGATION 3
I. PARTIES 7
A. Plaintiff 7
B. Defendants 8
C. All Defendants are Dominated and Controlled by Morgan Stanley 11
D. Summary Overview of Defendants' Relationships to Each Otherand to this Litigation 19
II. JURISDICTION, VENUE, AND FORUM 20
III. OVERVIEW OF CLNs AND SYNTHETIC CDOs 20
A. The Basic Structure and Purpose of CLNs 20
B. The Basic Structure and Purpose of CDOs 21
IV. MORGAN STANLEY PERSUADED HLF TO OFFER THE PINNACLE
NOTES TO CUSTOMERS 27
V. DEFENDANTS' FRAUDULENT SCHEME 34
A. The Pinnacle Notes Were the Deceptive"Bait" Employed ByMorgan Stanley to Secure Control Over Customers' Principal 34
B. Morgan Stanley Structured the Synthetic CDOs to TransferCustomers' Investment in the Pinnacle Notes to Morgan Stanley 35
VI. THE PINNACLE NOTES OFFERING DOCUMENTS WERE
MATERIALLY FALSE AND MISLEADING 55
A. Representations that the Underlying Assets for the Pinnacle Notes"May Include" Synthetic CDOs Were Materially False andMisleading 55
B. The Offering Documents Did Not Disclose that the UnderlyingAssets Were Single-Tranche CDOs That Morgan Stanley HadCreated and in which Morgan Stanley Possessed anAdverse/Opposite Interest 58
C. The Offering Documents Failed to Disclose that, Given MorganStanley's Also Undisclosed Adverse Interests and CounterpartyPositions in the Synthetic CDOs it Created, Morgan StanleyCustom-Designed for Use as Underlying Assets Bespoke Built-to-Fail Synthetic CDOs 60
D. The Offering Documents' Representationthat the UnderlyingAssets Were "Acceptable" to MS Capital Was Materially Falseand/or Misleading 62
974839.11
TABLE OF CONTENTS
VII. LOSSES SUFFERED BY HLF 64
VIII. COUNTS 66
COUNT I (FRAUD: ALL DEFENDANTS) 66
COUNT II (FRAUDULENT INDUCEMENT TO CONTRACT: MORGAN STANLEY,PPL, MS INTERNATIONAL, AND MS SINGAPORE) 68
COUNT III (NEGLIGENT MISREPRESENTATION: ALL DEFENDANTS) 70COUNT IV (BREACH OF CONTRACT: MORGAN STANLEY, PPL, AND MS
SINGAPORE) 71
COUNT V (BREACH OF CONTRACT - BREACH OF THE IMPLIED COVENANTOF GOOD FAITH AND FAIR DEALING: MORGAN STANLEY, PPL ANDMS SINGAPORE) 73
COUNT VI (EQUITABLE SUBROGATION: ALL DEFENDANTS) 74RELIEF REQUESTED 75
JURY TRIAL DEMANDED 75
-11-
974839.11
INTRODUCTION
1. Plaintiff Hong Leong Finance Limited ("HLF" or "Plaintiff) alleges that Morgan
Stanley & Co., Inc. and the other Defendants (collectively "Morgan Stanley" or "Defendants")
created and deceptively sold certain investmentproducts - the "Pinnacle Notes" - that were
designed to fail. Thosefailures benefited Morgan Stanley, but cost HLF (whichdistributed the
Pinnacle Notes) tens of millions of dollars.
2. On information and belief, Defendants' scheme was conceived in New York,
directed from New York, and executed (in part) in New York. More evidence relevant to this
case will be found in New York than in any other single location.
3. Allegations concerning HLF's acts are based on personal knowledge. All other
allegations are basedon the investigation by Plaintiffs counsel. That investigation included, but
was not limited to, a review and analysis of: (a) the Offering documents for the Pinnacle Notes;
(b) the Offeringdocuments for the Synthetic Collateralized Debt Obligations("CDOs") that
served as Underlying Assets for each Series of Pinnacle Notes; (c) a report issued by the
Monetary Authority of Singapore with respect to the marketing and sale of "structured notes,"
including some of the PinnacleNotes; (d) the Pinnacle Notes "notifications" concerningmatters
relating inter alia to the performance, value, and price of the PinnacleNotes and their Synthetic
CDO Underlying Assets; (e) newspaper, magazine, and other periodical articles relating to the
Pinnacle Notes; (f) the Complaint filed in Ge Dandong, etal, v. Pinnacle Performance Limited,
et al, No. lO-cv-8086 (SDNY); and (g) other matters of public record.
4. Many of the facts supportingthe allegations contained herein are known only to
the Defendants or are exclusively within their custody and/orcontrol. A reasonable opportunity
for discovery will yield additional, substantial evidentiary support for Plaintiffs allegations.
974839.11
5. Plaintiff hereby incorporates byreference all allegations contained in the
Complaint filed in Ge Dandong, etal, v. Pinnacle Performance Limited, etal, No. 10-cv-8086
(SDNY). See Ex. A (the "Class Complaint").
WHY HLF HAS FILED THIS LAWSUIT
6. As explainedmore fully below,HLF is a local retail financial institutionsimilar to
a savings and loan association. HLF is a small, conservative business devoted to serving the
financial needs ofits customers ("Customers"): middle-class and working-class Singaporeans
(sometimes known as "Heartlanders"), and small- and medium-sized enterprises. It is regulated
bythe Monetary Authority of Singapore ("MAS"), Singapore's de facto central bank.
7. Morgan Stanley fraudulently convinced HLF to enter into a distribution
agreement to sell Pinnacle Notes to Customers.
8. HLF ultimately sold approximately $72.4 millionofPinnacleNotes to
Customers.1
9. When the Pinnacle Notes failed, MAS required HLF to compensate Customers by
establishing a "complaints handling process," even though HLF itself was anunwitting victim of
Morgan Stanley's scheme. Morgan Stanley's fraud has cost HLF more than approximately $32
million (so far).
10. HLF brings this action to recover the money that it lost asa result ofMorgan
Stanley's fraud, including the value ofgoodwill lost because Customers and potential customers
now associate HLF with the failure of the Morgan Stanley Pinnacle Notes.
All values are approximate and are listed inUnited States Dollars, using the approximateprevailing exchange rate for the relevant time period.
-2-974839.11
THE INVESTMENT PRODUCTS AT ISSUE IN THIS LITIGATION
11. The investment products at issue in this litigation are referred to throughout this
complaint as the "Pinnacle Notes." See generally Ex. B("Base Prospectus").
12. Each Pinnacle Note appeared to be a straightforward type of investment called a
Credit-Linked Note ("CLN").
13. The purchaser of a CLN bears what is known as credit risk, or the risk that a
particular group ofentities will not meet obligations on their debt. To compensate him for
accepting this risk, the CLN purchaser receives periodic payments.
14. CLNs arecreated viaa three-step process.
a. Stepl: The Credit Default Swap.
i. This process begins when aninvestment bank (also known as the"sponsoring bank") creates a new entity, known as a SpecialPurpose Vehicle ("SPV") (also known as the "issuing trust"). TheSPV exists only to facilitate the issuance ofthe CLNs; it generallyhas no employees, subsidiaries, orday-to-day management.
ii. After creating the SPV, the investmentbank enters into a contractwith the SPV (although this is something of a legal fiction, becausethe SPV is controlled by the investment bankitself).
iii. Under the contract, the SPV agrees toprotect the bank from therisk that a certaingroup of entities, referredto as "disclosedreference entities," will not meet the obligations ontheir debt (i.e.,"credit risk"). Inreturn, the bank provides regular payments to theSPV, known as"credit protection payments." Essentially, theseare fixed payments in exchange for taking on credit risk.
iv. The riskier the disclosed reference entities, the higher the creditprotectionpayments. For example, given the current financialturmoil in Greece, the creditprotection payments involved if thedisclosed reference entities were Greek bonds would generally bemuchhigherthan the creditprotection payments that wouldberequired if the disclosed reference entities were Canadian bonds,all other things being equal.
v. Theend result of this step is that the SPV generates a stream of"money in" (the credit protection payments from the bank), while
974839.11-3-
incurring a contingent obligation to pay "money out" to the bank inthe event the disclosed reference entities default.
vi. Putanother way, the SPV agrees to pay the value of the debt if thedisclosed reference entities default ontheir debt. This process isknown as a credit default swap, because the counterparties swapresponsibility for a credit default.
b. Step 2: The SPV Issues CLNs.
i. The SPV (again: anentity 100% controlled bythe investmentbank) begins this step of the process in the position of havingagreed to pay to the investment bank the value of the disclosedreference entities' debt if they default, but the SPV has no assetswith which to make such a payment.
ii. To remedy this shortfall, the SPV issues CLNs to investors. Theinvestors' money (their "principal") is to be used to cover theSPV's obligations to the investment bank if the disclosed referenceentities default. In exchange, the SPVpays investors a fixedincome stream.
iii. The CLNs are issued for a defined period of time. As a generalrule, assuming that the disclosed reference entities do not defaultduring that period of time, the investors' principal ultimately isreturned to the investors. Thus, in a typical CLN, investorsultimately recover 100% of theirprincipal, plusyield in the formof payments fromthe SPV during the CLN term.
c. Step 3: The SPV Invests in Underlying Assets.
i. During the term of the CLNs, the investors' principal is investedby the SPV in what are known as "underlying assets."
ii. The underlying assets are themselves investment products, and thereturn from these underlying assets is passedon to the investorsalong withtheSPV's credit protection payments. This combinedpayment is the total yield that investors receive on the CLNs.
iii. In the event ofa disclosed reference entity default, the SPV mustliquidate the underlying assets to satisfy itsobligation to theinvestment bank under theterms of thecredit default swap.
iv. Accordingly, in the normal case, it is in the interest ofboth theCLN investors and the investment bank that the underlying assetsbe both safe and liquid. If the underlying assets arerisky orilliquid, the investment bank is not assured of full payment shouldthe disclosed reference entities default.
1 _4_1 974839.11
15. CLNs generally areattractive to investors because their yields frequently are
higher than the yields of other "fixed-income" securities (i.e., securities that pay a certain fixed
payment periodically). This is because an investor receives both credit protection payments
(income received for assuming the risk ofdefault) and income from the underlying assets (e.g.,
the yield on U.S. Treasury securities).
16. CLNs are not withoutrisk, of course. As explained above, if the disclosed
reference entities default, the CLN's underlying assets (purchased with the investors' principal)
are liquidated to cover the default.
17. Importantly, however, the usual risk inherent in CLNs is that a disclosed reference
entity will default. The underlying assets are safe.
18. The Pinnacle Notes at issue in this case werepresentedas especially safe CLNs,
because thedisclosed reference entities were highly-rated sovereign nations andmajor
corporations: entities withan infinitesimal riskof default. Morgan Stanley went to extreme
lengths to analyze and promote and prominently advertise these entities. Indeed, this is why
HLF and Customers were drawn to the Pinnacle Notes.
19. But, unbeknownst to HLF, the Pinnacle Noteswere not normal CLNs. Morgan
Stanley secretly, deceptively, andwrongfully invested the investors' principal in very risky
underlying assets.
20. As indicated above, under normal circumstances, an investment bank would never
causeits SPVto select riskyunderlying assets, because if those underlying assets were to fail,
the investment bank would losethe credit protection provided by the SPV. ButMorgan Stanley
was not concerned about potential disclosed reference entity default in connection with the
974839.11
Pinnacle Notes, because Morgan Stanley itself had chosen especially safe, disclosed reference
entities.
21. Theunderlying assets were a different story. Unlike the underlying assets in most
CLNs, thePinnacle Notes' underlying assets were structured to profit Morgan Stanley - at the
expense ofinvestors - when theyfailed.
a. The underlying assets in the Pinnacle Notescomprised a type of
investment known as a Collateralized DebtObligations ("CDO").
b. Asexplained in much more detail below, CDOs areessentially a group of
credit default swaps bundled together. Inother words, a CDO, like a CLN, is a type of financial
instrument thatpays a fixed stream of money to investors in exchange for accepting the riskthat
certain entities (reference entities involved in the creditdefault swaps) will defaulton their debt
obligations.
c. The CDOs that formed the basis of the Pinnacle Notes' underlying assets
were specifically designed by Morgan Stanley to transfer the investors' principal to Morgan
Stanley if the reference entities (whichwereundisclosed) underlying the CDOs failed to meet
their credit obligations.
d. These CDOsalso weredesigned to fail. Broadly speaking, this was
because they were composed both of extremely risky undisclosed referenceentities andbecause
the failure of only a small number of undisclosed reference entities would lead to the CDOs'
failure.
22. The identities of the reference entities contained within each CDO were not
disclosed to HLF before thePinnacle Notes were issued. Nordid Morgan Stanley reveal that it
stood to profit, at the expense of Customers, if the Pinnacle Notes failed.
974839.11
23. HLF never would have sold the Pinnacle Notes to Customers if it had been aware
of the Notes' true nature, and no rational investor would have purchased them.
24. In sunt, HLF and investors in the Pinnacle Notes reasonably believed the
Pinnacle Notes were very safe investments because the disclosed reference entities were
extremelysafe. In reality, however, Morgan Stanley (through its various alter egos) placed the
investor's principal in Morgan Stanley-createdCDOs that were designed to transfer the
investors' money to Morgan Stanley. The CDOs operated as designed, and Morgan Stanley
profited at the investors' and HLF's expense.
I. PARTIES
A. Plaintiff
25. Plaintiff Hong Leong Finance Limited ("HLF") is a corporation duly incorporated
and existing under the laws of Singapore. It is headquarteredat 16 Raffles Quay, #01-05 Hong
Leong Building, Singapore 048581.
26. Last year's "Singapore Finance Company of the Year," HLF is a relatively small
institution that takes deposits, makes mortgage and automobile loans to consumers, and offers
financing for small- and medium-sized businesses.
27. Singapore law distinguishes between "banks" (full service financial institutions
(e.g., Chase, Citibank, etc.) that offer a wide array of investment products and services) and
"finance companies" (smaller entities that are permitted to offer only a discrete range of financial
services and products). The closest equivalent in the United States is a savings and loan
association.
28. While there were 34 finance companies in Singapore as recently as the mid-90s,
today there are only three, including HLF. As a finance company, HLF does business in only a
974839.11
single city-state, and it has no expertise in foreign markets. The majority of HLF's branches are
suburban retail outlets.
29. HLF is also much smaller than a bank. The three local banks in Singapore each
have marketcapitalizations 25-30 times largerthan HLF's.
30. While HLF takes pride in its ability to servethe needs of middle-class and
working-class Singaporeans, it has essentially no experience in the structuring of investment
products. It was therefore the perfect target for Morgan Stanley, as explained below.
B. Defendants
1. Pinnacle Performance Limited ("PPL")
31. Defendant Pinnacle Performance Limited ("PPL") is a limited liability
corporation duly organized andexisting under the laws of theCayman Islands (registration
number MC-158263), withregistered offices located at PO Box 1093GT, Queensgate House,
South Church Street, George Town, Grand Cayman, Cayman Islands.
32. WhilePPLwas described as the "Issuer"of the Pinnacle Notes, PPL was created,
operated, and controlled by Defendant Morgan Stanley & Co., Inc. ("Morgan Stanley").
33. PPL is what is knownas a "special purposevehicle" ("SPV"). It has never had
employees, subsidiaries, or day-to-day management.
2. Morgan Stanley Asia (Singapore) Pte ("MS Singapore")
34. Defendant Morgan Stanley Asia (Singapore) Pte, f/k/a/Morgan Stanley Dean
Witter Asia (Singapore) Pte. ("MS Singapore"), is an indirect wholly-owned subsidiary of
Morgan Stanley, incorporated under the laws of the Republic of Singapore, withregistered
offices located at One Marina Boulevard #28-00, Singapore 018989, and with a principal place
of business located at 23 Church Street, #16-01 Capital Square, Singapore 049481.
974839.11
35. MS Singapore was what is known as the "Arranger" of the Pinnacle Notes. MS
Singapore'srole in this litigation, however, was generally a tertiary one. See Ex. C
("Distribution Agreement") at f 9 ("Arranger's Undertakings"). Forexample:
a. MS Singapore had no ability to "makeany determinations in respect of the
[Pinnacle Notes]." Ex. B ("Base Prospectus") at 44.
b. The majority of MS Singapore's limited duties are "on behalfof PPL.
E.g., Ex. C ("Distribution Agreement") at Iflf 3.2.2; 3.3; 7.5(v).
c. On information and belief, MS Singapore's relevant activities relating to
the PinnacleNotes were operated and controlled by MorganStanley.
3. Morgan Stanley & Co. International pic ("MS International")
36. DefendantMorgan Stanley& Co. International pic, f/k/a MorganStanley& Co.
International Limited ("MS International"), a wholly owned subsidiary of Morgan Stanley, is a
corporation duly organized and existing underthe lawsof England and Wales, with registered
offices located at 25 Cabot Square, Canary Wharf, London, E14 Q4A.
37. MS International is identified in the PinnacleNotes' Offering Documentsas, inter
alia, the "Determination Agent," "Dealer," "MarketAgent" and "Forward Counterparty."
38. MS Internationalwas provided with "sole and absolute discretion," in selecting
the investments to serve as the Underlying Assets for the Pinnacle Notes, and was further
charged with the role of monitoring suchassets and taking further action(suchas declaring early
redemption) should such assets threatento suffer impairment or loss. See Ex. B ("Base
Prospectus") at 12.
39. At all relevant times, MS Internationalwas operated and controlled by Morgan
Stanley.
-9-974839.11
40. Morgan Stanley utilized its control over MS International to further the
Defendants' fraudulent scheme; in particular, Morgan Stanley caused MS International to place
money from Customers into "rigged" underlying assets thathad been created byMorgan Stanley.
41. At all relevant times, Defendant MS International functioned as a mere
department or alter-ego of Morgan Stanley. Morgan Stanley exercised complete domination and
control over MS International.
4. Morgan Stanley Capital Services Inc. ("MS Capital")
42. Defendant Morgan Stanley Capital Services Inc. ("MS Capital"), is a wholly-
ownedsubsidiary of Morgan Stanley, incorporated in the State of Delaware, with registered
offices at Corporate Trust Center, 1209 Orange Street, Wilmington DE 19801, and its principal
executive offices located at 1585 Broadway, New York, NY 10036 (identical to thoseof Morgan
Stanley).
43. MS Capital's "primary business [] is entering into over-the-counter derivative
contracts with institutional clients." Ex. B ("Base Prospectus") at 45.
44. MS Capital is identified in the Pinnacle Notes' Offering Documents as the "Swap
Counterparty" with respect to the "Swap Agreement" underlying the PinnacleNotes. This
means, among other things, that it was MS Capital that provided the actual credit protection
payments to PPL.
45. When Morgan Stanley's "rigged" underlying assets failed, money from
Customers was transferred to MS Capital.
46. As explained more fully below, MS Capital was operated and controlled by
Morgan Stanley with respect to the Pinnacle Notes.
-10-974839.11
5. Morgan Stanley & Co. Inc. ("Morgan Stanley")
47. Morgan Stanley is a Delaware corporation, with itsprincipal executive offices
located at 1585 Broadway, New York, NY 10036. Morgan Stanley isa global financial services
firm that, "through its subsidiaries and affiliates," "provides its products and services to a large
and diversified group ofclients and customers, including corporations, governments, financial
institutions and individuals." Ex. B ("Base Prospectus") at 45.
48. Morgan Stanley is identified in the Pinnacle Notes' Offering Documents as the
"Swap Guarantor" and "Forward Guarantor" with respect to the Pinnacle Notes. As "Swap
Guarantor," Morgan Stanley undertook to"unconditionally guarantee" MS Capital's periodic
credit protection payments to PPL. See Ex. B. ("Base Prospectus") at 18.
49. Morgan Stanley created each of theCDOs comprised in theunderlying assets for
the Pinnacle Notes.
C. All Defendants are Dominated and Controlled by Morgan Stanley.
50. Morgan Stanley "is a global financial services firm that, through its subsidiaries
and affiliates, provides itsproducts and services toa large and diversified group of clients "
Morgan Stanley 2009 Form 10-K at 1(emphasis added); see also June 15, 2010 Registration
Document of Morgan Stanley and Morgan Stanley & Co. International pic, filed with the
Financial Services Authority ("FSA") at 23-24 (the "June 15, 2010 Registration Document").
51. Inparticular, "Morgan Stanley provides financial advisory andcapital-raising
services toa diverse group ofcorporate and other institutional clients globally, primarily through
wholly owned subsidiaries that include Morgan Stanley & Co. Incorporated ("MS&Co."),
Morgan Stanley &Co. Internationalpic, Morgan Stanley Japan Securities Co., Ltd. and Morgan
Stanley Asia Limited " Morgan Stanley 2009 Form 10-K at 2 (emphasis added).
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52. Morgan Stanley "conducts itsbusiness from itsheadquarters inand around New
York City, its regional offices and branches throughout the U. S. and its principal offices in
London, Tokyo, Hong Kong and other world financial centers." Morgan Stanley 2009 Form 10-
Kat2.
1- PPL is Dominated and Controlled by Morgan Stanley.
53. As explained above, PPL has never had any employees, subsidiaries, orday-to
day management.
54. PPL atall times has been wholly controlled and dominated by Morgan Stanley -
it has never had a separate existence of its own.
2. MS Singapore is Dominated and Controlled by Morgan Stanley.
55. On information and belief, MS Singapore is a wholly owned subsidiary of
Morgan Stanley, whose keystrategic decisions are made by Morgan Stanley.
56. Oninformation and belief, MS Singapore's activities relating to the Pinnacle
Noteswereoperated and controlled by Morgan Stanley.
3. MS International is Dominated and Controlled by Morgan Stanley.
57. MS International is a wholly owned subsidiary of Morgan Stanley. Indeed, it is
one of the primary companies through which Morgan Stanley conducts itsoperations. See
Morgan Stanley 2009 Form 10-K, at 2, 122; June 15, 2010 Registration Document, at 13-14
("Morgan Stanley is the holding company ofa global financial services group. MSIpic isone of
the principal operating companies inthe Morgan Stanley Group ..." (emphasis added)).
58. MS International is merely the organizational name given to Morgan Stanley's
"principal officeQ in London." 2009 Form 10-K, at 1; June 15, 2010 Registration Document at
23- 24.
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59. The"Organisational Structure" subsection of Registration Documents filed by
Morgan Stanley andMS International with various securities regulators identifies Morgan
Stanley as MS International's "controlling entity" and "ultimate parent undertaking": "MSIpic's
ultimate parent undertaking andcontrolling entity is Morgan Stanley...." June 15,2010
Registration Document, at 44; May 29, 2007 Registration Document, at 19(emphasis added).
60. MS International's own financial statements stateexactly the same relationship:
uThe Company's ultimate parent undertaking andcontrolling entity is Morgan Stanley ...."
May 29, 2007 Registration Document, at 27.
61. Registration Documents filed by Morgan Stanley and MS International with
various securities regulators further disclose"substantial inter-relationships" between MS
International and Morgan Stanley:
There are substantial inter-relationships between MSI pic andother Morgan Stanley group companies
Morgan Stanley is the holding company ofa global financialservices group. MSIpic is one oftheprincipal operatingcompanies in theMorgan Stanley Group (as defined below). MSIpic itself provides a wide range of financial and securities services.There are substantial inter-relationships between MSIpic andMorgan Stanley as well as othercompanies in the Morgan StanleyGroup, includingtheprovision offunding, capital, services andlogistical supportto or byMSIpic, as well as common or sharedbusiness or operationalplatforms or systems, including employees.As a consequence of such inter-relationships, and of theparticipation of both MSI pic and other Morgan Stanley Groupcompanies in the global financial services sector, factors whichcould affect the business and condition of Morgan Stanley or othercompanies in the Morgan Stanley Group may also affect thebusiness and condition of MSI pic. Any such effect could be direct,for example, where economic or market factors directly affect themarkets in which MSI pic and other companies in the MorganStanley Group operate, or indirect, for example where any factoraffects the ability ofother companies in the Morgan Stanley Grouptoprovide services orfunding or capital to MSIpic or, directlyorindirectly, toplace business with MSIpic. Similarly, anydevelopment affecting the reputation or standing of Morgan
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Stanley orother companies in the Morgan Stanley Group may havean indirect effect onMSI pic. Such inter-relationships shouldtherefore be taken into account inany assessment of MSI pic.
June 15, 2010 Registration Document, at 13-14 (emphasis added, bold in the original); see alsoJune 15, 2010 Registration Document, at44; May 29, 2007 Registration Document, at4, 17-19.
62. Among the self-described inter-relationships between Morgan Stanley and MS
International were: (1) Morgan Stanley's "provision offunding, capital, services and logistical
support to []MSI pic"; and (2) "common orshared business oroperational platforms orsystems,
including employees" and (3) common employees. Id.
63. In fact, these substantial "inter-relationships" between Morgan Stanley and MS
International existed because MS International was simply an appendage ofMorgan Stanley
through which Morgan Stanley conducted many of itsEuropean operations.
64. MS International and Morgan Stanley share a common office space, address, and
telephone number in the United Kingdom.
65. Morgan Stanley's website makes no distinction between Morgan Stanley and MS
International: MS International simply appears as "Morgan Stanley inthe United Kingdom." Id.
This lack of differentiation is underscored by MS International's statement that "an
understanding" of MS International's success would not be gained through disclosure of
company-specific performance indicators, but only through consideration ofthe Morgan Stanley
Group's overall performance:
TheGroup manages its key performance indicators on a globalbasis. For this reason, the Company's Directors believe thatproviding performance indicators for the Company itselfwould not enhance an understanding of the development,performance or position of the business of the Company.
May 29, 2007 Registration Document, at 27 (emphasis added).
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66. Morgan Stanley hasprovided financial support to MS International through both
capital injection and debt financing. See June 15, 2010 Registration Document at 14 ("Morgan
Stanley has in the past provided financial support to MSI pic through capital injection anddebt
financing"); May 29, 2007 Registration Document, at 15 (same).
67. MS International's Financial Statements detail multipleoccasions where MS
International secured at leasthundreds of millions of dollars of funding from otherentities
controlled by Morgan Stanley. See May 29, 2007 Registration Document, at 47 and 75.
68. The Pinnacle Notesare an example of the manner in which Morgan Stanley
guaranteed MS International's debts and/or obligations. In the Pinnacle Notes, MS International
was required, as the designated "Forward Counterparty," to perform certain operations and
obligations (and to transfer certain funds) in the case of certain events. Morgan Stanley
guaranteed MS International's contingent obligations and funds transfers by designating itselfas
the "Forward Guarantor"and providing a "Forward Guaranty." It appears from the Pinnacle
Notes that Morgan Stanley undertook thisobligation gratuitously. This "free," non-arm's-length,
assumption of such contingent obligations further shows that Morgan Stanley and MS
International were not independent entities.
69. In a subsection of the MS International Financial Statements titled "Directors
Report" and subtitled "Principal and Business Review," MS International and its directors
represented that MS International and its directors did not control MS International's
management of credit risk, market risk, credit risk, liquidityand cash flow risk. Risk
management was centrally controlled, operated, and applied throughout Morgan Stanley:
Risk management
Risk is an inherent part of the Company's business activity and ismanaged within the context of the broader Group's businessactivities. The Groupseeks to identify, assess, monitor and manage
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each of the various types of risk involved in its activities, inaccordance with defined policies and procedures.
i
1 Market risk
Market risk refers to the risk that a change in the level ofone ormore marketprices, rates, indices, implied volatilities (the pricevolatilityof the underlying instrument imputed from optionprices), correlations or other market factors such as liquidity, willresult in losses for a position or portfolio.
The Group manages the market risk associated with its tradingactivities in consideration of each individual legal entity, but on aglobal basis, at both a trading division and an individual productlevel.
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Credit risk
Credit risk refers to the risk of loss arising from borrower orcounterpartydefault when a borrower, counterpartyor obligor isunable to meet its financial obligations.
The Group manages credit risk exposure in consideration of eachindividual legalentity, but on a global basis, by ensuringtransparency of material credit risks, ensuring compliance withestablished limits, approving material extensions of credit, andescalating risk concentrations to appropriate senior management.
Liquidity and cashflow risk
The Group's senior management establishes the overall liquidityand capital policies of the Group. The Group's liquidity andfunding risk management policies are designed to mitigate thepotential risk that the Group and the Company may be unable toaccess adequate financing to service its financial obligations whenthey come due without material, adverse franchise or businessimpact. The key objectives of the liquidityand funding riskmanagement framework are to support the successful execution ofthe Group's and the Company's business strategies while ensuringongoing and sufficient liquidity through the business cycle andduring periods of financial distress.
May 29, 2007 Registration Document, at 27-28 (underlining added).
70. Despite the fact that MS International issued "Financial Statements," it did not
publicly disclose its financial results separately from Morgan Stanley. Instead, MS
International's results were reported as one portion of Morgan Stanley's consolidated financial
results for operations.
71. At times relevant to the action, there was significant overlap in officers, directors
and personnel between MS International and Morgan Stanley. See id. 18-19. All of the MS
International directorswere "employed withinthe Morgan Stanleygroupofcompanies." See id.
at 19.
72. MS International directors were high-level Morgan Stanley executives and
members of senior Morgan Stanley management and operating committees.
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a. One of Morgan Stanley's three primarily business segments is its
Institutional Securities business. Two of the seven members of the operating committee
overseeing that business were MS International board members. One of those two served as
Morgan Stanley's co-head of institutional securities sales and trading.
b. Four MS International directors sat on Morgan Stanley's management
committee.
c. As for the other MS International directors:
i. One served as chief operating officer for Morgan Stanley's privatewealth management operations in Europe and the Middle East;
ii. One was tasked by Morgan Stanley (per a press release) "withresponsibility for further developing Morgan Stanley'srelationships with key clients across Europe and the emergingmarkets"; and
iii. The final was CEO of Morgan Stanley's German operations.
73. In sum, at all times relevant to this action, MS International was an alter-ego/mere
department of Morgan Stanley.
4. MS Capital is Dominated and Controlled by Morgan Stanley.
74. Defendant MS Capital is a wholly-owned subsidiary of Morgan Stanley; indeed,
its purported headquarters and offices are listed at the same address and phone number as
Morgan Stanley's headquarters.
75. MS Capital does not publicly report its own financial results of operations.
Rather, such results are consolidated into Morgan Stanley's results.
76. MS Capital does not have a true separate corporate existence from Morgan
Stanley; it instead merely serves as Morgan Stanley's face/alter-ego for its derivative and swap
transactions within the United States. See Moody's Customers Service, Swaps Push-Outto Have
Major Impact on U.S. Dealers, June 21, 2010, at 4, 5, 6.
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77. To make MS Capital a credible counterparty to derivative transactions and swap
contracts entailing substantial obligations, Morgan Stanley routinely guaranteed MS Capital's
performance in such transactions. See Id. at 5. For example, in a prospectus regarding the
issuance of mortgage-backed securities, Morgan Stanley explains:
Morgan Stanley Capital Services Inc. is a Delaware corporationthat is a wholly-owned, unregulated, special purpose subsidiary ofMorgan Stanley. Morgan Stanley Capital Services Inc. conductsbusiness in the over-the-counter derivatives market, engaging in avariety of derivatives products, including interest rate swaps,currency swaps, credit default swaps and interest rate options withinstitutional clients. The obligations of Morgan Stanley CapitalServices Inc. are 100% guaranteed by Morgan Stanley.
See Morgan Stanley Capital, Inc. "free writing prospectus" filed with the SEC on July 13, 2006,at 31 (emphasis added).
78. In keeping with its general practice, Morgan Stanley guaranteed MS Capital's
contractual obligations for both the Pinnacle Notes and the CDOs that Morgan Stanley created to
serve as the underlying assets for the Pinnacle Notes.
79. Although Morgan Stanley's provision of such guarantees entailed the assumption
of substantial potential liabilities, these guarantees were provided by Morgan Stanley to MS
Capital free of charge: they were not arm's length transactions. This "free," non-arm's-length,
assumption of obligations further shows that Morgan Stanley and MS Capital were not
independent entities.
D. Summary Overview of Defendants' Relationships to Each Other and to this
Litigation
80. Morgan Stanley created the underlying assets in such a way that money placed
into the underlying assets would flow to its alter ego, MS Capital. MS International, controlled
by Morgan Stanley, placed the money from Customers who invested in Pinnacle Notes into those
underlying assets. PPL, which had no employees, subsidiaries, or day-to-day management,
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existed solely to enter into the various contracts necessary for Morgan Stanley to carry out its
fraudulent scheme. MS Singapore, under the control ofMorgan Stanley, played only a
tangential role in the events described herein.
II. JURISDICTION, VENUE. AND FORUM
81. The court hassubject matter jurisdiction over thismatter pursuant to 28U.S.C. §
1332(a)(2).
82. Venue is proper pursuant to 28 U.S.C. § 1391 because a substantial partof the
events or omissions giving rise to the claim occurred in the Southern District of New York.
83. The Southern District of New York is the most convenient forum for this
litigation because, among other things, it is substantially similar to litigation currently pending in
the Southern District. See Ex. A ("Class Complaint"). In particular, it involves identical
defendants, identicalcore facts, and overlapping discovery.
III. OVERVIEW OF CLNs AND SYNTHETIC CDOs
A. The Basic Structure and Purpose of CLNs
84. A CLN is a type of financial instrument in which the value of that instrument is
linked to performance of debt that has been issued byentities such as corporations or sovereign
nations (this is the "credit" in the term "credit linked note"). The entities whose "credit" is
"linked" to a CLN are referred to as the "disclosed reference entities."
85. CLNs are "linked" to the credit of entities such as corporations or sovereign
nations through the use of what is known as a creditdefault swap. This is a transaction that
transfers the risk that the disclosed reference entities will default on their debt from the holders
of that debt (the "counterparty") to the purchasers of the CLN.
86. In return for this risk, the purchasers of a CLN receive a higher yield than they
might otherwise obtain through more traditional fixed income financial instruments. They
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receive both yield from the investmentof their principal into the underlying assets, plus credit
protection payments from the counterparty (i.e., the counterparty is paying the holder of a CLN
for bearing the risk that the disclosed reference entities default on their debt).
87. As described above, investment banks such as Morgan Stanley create CLNs in a
series of three steps:
a. First, the sponsoring bank establishes an entity through which it will issue
its CLN, known as an issuing trust. These issuing trusts are customarily SPVs: brain-dead
entities controlled by the sponsoring bank whose sole purpose is the issuance of CLNs. The SPV
and sponsoring bank then enter into a credit default swap under which the bank transfers to the
SPV the risk of certain corporate and/or sovereign bonds failing. The sponsoring bank provides
credit protection payments to the SPV in exchange for this risk.
b. Second, the SPV now has to fund its obligations. The SPV does this by
issuing and selling CLNs to investors.
c. Third, the issuing trust/SPV, upon receipt of the CLN investors' principal,
customarily invests that principal in a safe and liquid income-generating asset (the "underlying
asset"). This principal secures the SPV's obligations in two distinct senses:
i. If the linked credit ("disclosed reference entities") default andsuffer losses, the SPV uses the principal raised from CLN investorsto make requisite counterparty payments.
ii. On the other hand, if no disclosed reference entity defaults andsuffers losses, the SPV returns investors' principal upon CLNmaturity.
B. The Basic Structure and Purpose of CDOs
88. As indicated above, the underlying assets in which Morgan Stanley invested the
capital raised by the Pinnacle Notes were not safe, liquid assets. Rather, they contained a
particular type of CDO.
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89. A CDO is based on a portfolio of assets. This portfolio may consist of actual
assets that the CDO purchases and holds (a "cash CDO"),or a collection of credit default swaps
that merely "reference" such assets (a "synthetic CDO").
90. The CDOs used by Morgan Stanley, discussed below, are known as custom
("bespoke") single-tranche synthetic CDOs.
1. Cash CDOs
91. A cash CDO is similar to a mutual fund, albeit one that invests in bonds rather
than in stocks. A principal benefit of a cash CDO structure is diversification of risk.
a. For example, a $100 million cash CDO could be based on ten bonds of
$10 million each issued by ten different investmentgrade corporations (e.g., IBM, Coca-Cola,
General Electric, etc.).
b. To purchase these assets, the CDO would issue notes to investors and use
the cash proceeds from their purchase to actually buy the underlying bonds (i.e., the notes are
now "backed" by the bonds themselves).
c. The end result is that the purchasers of the CDO notes gain "exposure" to
the CDO's asset portfolio. In other words, the income generated by the bonds is passed to CDO
noteholders and any failure ("impairment") in any of those assets creates an impairment to the
CDO notes, thus resulting in losses to the noteholders.
2. Synthetic CDOs
a. Synthetic CDOs "Reference" an Asset Portfolio
"Synthetically" Through Credit Default Swaps.
92. In a synthetic CDO, exposure to a portfolio of debt is achieved "synthetically" via
credit default swaps, rather than by cash purchase of the actual assets. A bank issuinga synthetic
CDO does not actually buy the reference assets; rather, it effectively permits investors to invest
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in a fictional portfolio ofassets that the bank has not purchased. For example, whereas a $100
million cash CDO canraise $100 million from investors to purchase tenactual bonds of $10
million each, a $100 million synthetic CDO seeking to replicate that portfolio would enter into
credit default swaps that reference the same ten $10 million bonds. The amount any particular
bond is referenced is known as the notional amount.
a. Synthetic CDOs share many basic features with CLNs, including: (A) An
issuing trust (to issue the CDO), set up by a sponsoring bank, such as Morgan Stanley; (B) credit
default swap contracts between the issuing trust andthe sponsoring bank; (C) the issuance of
CDO notes to investors to fund the CDO's swap obligations to the sponsoring bank; and (D) the
reinvestment of the funds raised bythat issuance into safe, liquid underlying assets, to serve as
collateral (the "Investment Collateral") if the reference entities fail.
b. Thus, like CLNs, synthetic CDOs transfer the credit risk associated with
certain reference entities from the sponsoring bank to investors. The principle difference, as
detailed below, is that CDOs are structured in a way that allows different types of investors to
bear different amounts of risk.
93. Synthetic CDOs are very flexible financial instruments. This is because the
issuing trust for a synthetic CDO can enter into credit default swaps referencing any notional
amount (e.g., $10 million, $200 million) ofany credits (e.g., an IBM bond, anApple bond, the
bonds issued byall Eastern European states, the bonds issued byevery company whose name
includes anumlaut, etc.), whether ornot any such bonds actually are available for purchase.
b. Because Synthetic CDOs Are Based on Credit Default Swaps,They Feature Counterparties Who Take Opposing Positions.
94. Because synthetic CDOs arebased on credit default swaps, they feature
counterparties whose interests are opposed to each other.
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a. One counterparty (the sponsoring bank paying for credit protection) is
"short" on the CDO's risks —i.e., it stands to benefit if the reference entities underlying the
CDO fail (it stops paying credit protection yet loses no principal).
b. Theother counterparty (the CDO issuing trust) is "long"on the risk— it
stands to benefit if the reference entities underlying the CDO do not fail (i.e., it is accepting
credit protection payments inexchange for bearing the risk that the reference entities will fail).
95. The CDO issuing trust "funds" itspotential counterparty obligations byselling
notes to investors. This transfers the "long" riskfrom the CDO issuing trust to investors who
purchase the notes. The principal paidby investors to purchase the CDO notes is invested, but is
at riskof impairment should the reference entities included in the CDO's portfolio default
(because default triggers the CDO issuing trust's obligation to pay itscredit default swap
counterparty with the investors' principal).
a. This highlights a crucial feature of synthetic CDOs: CDOinvestors, by
definition, take the"long" position (stand to benefit if the reference entities do not fail).
b. There is also a counterparty to the creditdefaultswapunderlying the CDO
thathas taken a "short" position (stands to benefit if the reference entities do fail).
3. CDO Tranches Determine Risk.
96. For CDO investors, the most important determinant of risk is generally the
manner in which the CDO is "sliced" — what is knownas tranching.
97. An issuing trust will issue multiple sets ("tranches") of unequal notes representing
senior/subordinate interests in the portfolio of a given CDO. The mostjunior of the tranches
stands first in linefor any portfolio losses. Senior tranches are in turnprotected from portfolio
losses by the sumtotal of themore junior tranches below them. To compensate more junior
tranche investors for the increased risk they bear, the CDO structure also redirects the income
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generated by the CDO portfolio and Investment Collateral so that junior tranches are provisioned
withhigher yields and seniortranches with lower yields.
98. Losses accumulate from the most junior to the most senior tranche. Forexample,
in a $100 million CDO, the most juniortranche could be $5 million. If losses rise to $1 million,
the$5 million tranche suffers a $1 million principal impairment (i.e., it has lost20% of its
value), even as more senior tranches remain untouched. If losses rise to $5 million, the $5
million tranchesuffers 100%principal impairment, even as more senior tranches remain
untouched. If losses rise above $5 million, however, the next mostjunior tranche begins to
suffer principal impairment.
99. EachCDO tranche represents a concrete, discrete "slice" of the aggregate risk
residing in the CDO portfolio. In the above example, the $5 million tranche of the $100 million
CDO represents the 0%-5% slice of aggregate risk. If the next most junior tranche is $2 million,
that tranche would thus represent the 5%-7% riskslice: it would startexperiencing principal
impairment if lossesrose above$5 million (or 5% of the CDO's total portfolio) and would
experience full principal impairment whenaggregate lossesreached $7 million(or 7%).
100. The risk embodied in each CDO tranche is defined by three structural factors:
a. The tranche's "AttachmentPoint." This is the level of aggregate portfolio
losses at which the tranche in question begins to sufferprincipal impairment (e.g., 5% for the
second-most-junior tranche in the exampleabove). This indicates the proximityof the tranche to
CDO portfolio risk.
b. The tranche's "DetachmentPoint." This is the level of aggregate portfolio
losses at which the tranche in question suffers total principal impairment (e.g., 7% for the same
tranche).
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c. The tranche's "Thickness." This is the difference between the tranche's
Detachment Point and the Attachment Point (e.g., 7%-5% =2%). This indicates the speed and
severity of principal impairment. All other things being equal, a thintranche will suffer severe
or total principal impairment more quickly than a thick one.
4. Bespoke Single-Tranche Synthetic CDOs
a. A Single Tranche of Securities Representing One Specific Sliceof Aggregate Portfolio Risk
101. As implied above, an issuing trust will usually create a CDO with an array of
tranches, eachwitha different level of risk, to appeal to a variety of investors.
102. A bespoke single-tranche synthetic CDO ("single-tranche CDO"), however,
issues just onetranche, representing one discrete slice of portfolio risk.
103. Single-tranche CDOs can be based on a portfolio of any reference entities, can
focus on however senior orjunior a "slice" ofrisk the parties agree upon, and can be ofany
thickness.
b. Single-Tranche CDOs; A Bet Between Two Parties over aPrecisely-Specified, Discrete Slice of Losses PotentiallyGenerated by a Portfolio of Reference Entities
104. Normally, sophisticated counterparties to a single-tranche CDO bargain overthe
precise reference entitiesto be included in the portfolio, as wellas the tranche's location and
thickness.
105. Thereare threepossible outcomes for any given single-tranche CDO:
a. Aggregate portfolio losses remain below the tranche Attachment Point. In
this situation, the issuing trust owes nothing under the credit default swap to its counterparty.
Upon maturity, the issuing trust liquidates the Investment Collateral and returns 100% of
investors' principal.
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b. Aggregate portfolio losses rise above the tranche Attachment Point, but
belowthe tranche Detachment Point. Here, the issuing trust mustmakepayments to its
counterparty under the credit default swap. These paymentsare made by liquidating some of the
Investment Collateral, which impairs investors' principal to some degree.
c. Aggregate portfolio losses rise to or exceed the tranche Detachment Point.
In this scenario, the issuing trust liquidates all of the Investment Collateral to makepayments to
its credit default swap counterparty. Accordingly, it has nothing left to return to its investors,
who suffer 100%) principal loss.
106. Morgan Stanley caused the underlyingassets for the Pinnacle Notes to be single-
tranche synthetic CDOs. See Ex. E.
IV. MORGAN STANLEY PERSUADED HLF TO OFFER THE PINNACLE NOTES
TO CUSTOMERS.
1. The Pinnacle Notes' Offering Documents
107. Each Series of Credit-Linked Pinnacle Notes was created, issued, and sold
pursuant to certain "Offering Documents":
a. The Base Prospectus. Each Series of Pinnacle Notes was created, issued,
and sold pursuant to a shared Base Prospectusdated August 7, 2006. It was amended by
Supplementary Base Prospectusesdated April 24, 2007 and August 13, 2007; however, these
amendments were not substantive, and merely noted changes in the names of various parties
involved in the Pinnacle Notes transactions, including MS Singapore and MS International.
These documents are referred to, collectively, as the "Base Prospectus." See Ex. B.
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b. The Pricing Statements. Each Series ofPinnacle Notes was created,
issued, and sold pursuant to a Pricing Statement specific to that Series.2 These documents are
referred to, collectively, as the "Pricing Statements." See Ex. D. The Pricing Statements were
standardized documents that did not materially differ from each other. In particular, they were
substantively identical in their representations concerning what the Pinnacle Notes were, how the
Pinnacle Notes worked, and the risks to which the Pinnacle Notes were exposed. The only
differences related to the specific dates ofissuance and maturity ofeach Series, the specific
interest rates promised by each Series, and the specific basket of disclosed reference entities to
which each Series was credit-linked.
c. The Brochures. Pages ii and iii of eachPricing Statement purported to
providea "Summaryof Terms" with respect to each Seriesof PinnacleNotes. These are referred
to, collectively, as the"Brochures." The Brochures, like thePricing Statements, were
standardized documents that did not materially differfrom eachother.
108. EachSeries of Pinnacle Notes wasprominently linked to the creditworthiness of a
basket of five to seven specific disclosed reference entities that, inall cases, were highly-rated
sovereign nations and/or major corporations that were well-known in Singapore. The Offering
Documents prominently displayed these disclosed reference entities and made clear that should
any default orexperience any other defined "Credit Event," Pinnacle Notes investors' principal
would suffer substantial or total impairment. None of the disclosed reference entities ever
defaulted or experienced any other defined "Credit Event."
Inparticular: (1) Pinnacle Notes Series 2 Pricing Statement dated October 6, 2006; (2)Pinnacle Notes Series 3 Pricing Statement dated January 9, 2007; (3) Pinnacle Notes Series 6/7Pricing Statement dated May 16, 2007; and (4) Pinnacle Notes Series 9/10 Pricing Statementdated October 25, 2007, asamended by a Pinnacle Notes Series 9/10 Supplementary PricingStatement dated November 7, 2007.
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109. HLF incorporates byreference the particularized description of each of the
Pinnacle Notes from Ge Dandong, etal, v. Pinnacle Performance Limited, etal, No. 10-cv-
8086(SDNY). See Ex. A ("Class Compl.") at ffif 129-134.
110. Between August 2006 andDecember 2007, Morgan Stanley created and issued
eight "Series" ofCredit-Linked Pinnacle Notes (1-3, 5-7, 9-10) through itsalter ego, PPL. Six of
these were sold through HLF (2-3, 6-7, 9-10).
111. These notes were worth an aggregate of approximately $156.2million. HLF sold
approximately $72.4 million of them to Customers.
2. The Pinnacle Notes Appeared to Be Typical, Conservative, CLNs.
112. The Pinnacle Notes' Offering Documents describe each Series ofPinnacle Notes
as CLNs.
113. Indeed, the Pinnacle Notes appeared on their face to be typical CLNs- i.e., fixed-
income investments whose risk is related almost exclusively to the chance that the disclosed
reference entities might fail. To reiterate the basic structure of the notes:
a. Morgan Stanley set up an issuing trust, PPL. PPL was a "brain-dead"
SPV controlled entirely by Morgan Stanley.
b. Morgan Stanley thencaused PPLto enter into a creditdefaultswap
transaction with MS Capital (alsowholly controlled by Morgan Stanley). This transaction
referenced a discrete basket of five to seven highly-rated sovereign nations and/or major
corporations. These were the disclosed reference entities that would form the basis of the credit
risk in the Pinnacle Notes.
i. PPL (controlled by MorganStanley) receivedregular creditprotection payments from counterparty MS Capital (controlledbyMorgan Stanley), in exchange for which it assumed the credit riskpresented by the basket of disclosed reference entities.
974839.11
-29-
ii. PPLthen created and issued the Pinnacle Notes, morethan 45% ofwhich it soldthrough HLF. Themoney collected by PPLforissuing the Pinnacle Notes wasCustomers' principal.
iii. The apparent risk of the Pinnacle Notes was exactly of the sorttypical to CLNs: the risk that the linked credits - the disclosedreference entities - would default.
iv. As explained above, Customers' principal would usually be storedin a safe, highly liquid investment so that it would be availableeither to payPPL's obligations to MS Capital (i.e., MorganStanley's obligations to Morgan Stanley) if the disclosed referenceentities defaulted, or to return Customers' principal to them uponmaturity if they did not default.
114. The Pinnacle Notes, ontheir face, were not risky. They also were not high-yield
investments - they offered only slightly enhanced yields over other fixed-income products. This
seemed accurately to reflect the return thatonemight expect from the combination of safe,
liquid, underlying assets and the slight risk that the disclosed reference entities (highly-rated
sovereign nations andsecure major corporations) might default. As expected, thedisclosed
reference entities never defaulted.
3. Morgan Stanley Approached HLF.
115. In 2006, Mr. Mao Nan Hua, a Morgan Stanley employee (through MS Singapore)
approached HLF President Ian Macdonald. Mr. Mao explained that Morgan Stanley was talking
to regulators about selling "structured notes" (i.e., the CLNs) in Singapore.
116. Mr. Macdonald explained that he did not think that HLF would be interested
because Customers preferred fixed deposits: they were older and more risk-averse than the
population as a whole.
117. Mr. Mao responded byexplaining thatMorgan Stanley hada product thatwas
ideal for Customers, the Pinnacle Notes. He explained that these provided a better return for
Customers, butwere still quite conservative. Indeed, heexplained that theproducts were "AA"
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rated andbased on disclosed reference entities thatwere sovereign nations or extremely secure
multinational corporations.
118. HLF had no experience withCLNs, but HLF was aware (or, rather, thought it was
aware) that the risk in such products was related to the risk that the disclosed reference entities
mightdefault. In HLF's (correct) judgment, the reference entities were "gold brick,"which,
according to Morgan Stanley (and common sense), made the Pinnacle Notes suitable for
Customers.
119. The Pinnacle Notes returned a yield ofaround 1% to 2% higher than other
products like investment grade corporate bonds that Customers could purchase. This also
indicated to HLF that there likely was not a large additional incremental risk.
120. Generally, CLNs and other "structuredproducts"require a large minimum
investment, frequently more than $100,000. The Pinnacle Notes, however, required a minimum
amount of only$3,750. This also led HLF to conclude that it would be a good product for
Customers.
121. HLF decided to market the Pinnacle Notes to Customers, believing them to be
low-risk products basedon Morgan Stanley's representations in the Base Prospectus, which had
beenreinforced by Morgan Stanley's verbal representations through Mr. Mao, Mr.Ng Chee
Keen, and Mr. Mark Han.
4. The Distribution Agreement Between HLF and Morgan Stanley
122. On October 6, 2006, HLF and Morgan Stanley (through PPL, MS International,
and MS Singapore) entered into a contract whereby HLF agreed to distribute the Pinnacle Notes
(the "Distribution Agreement.") See Ex. C.
123. HLF agreed to use "all reasonable efforts" to convince Customers to purchase the
Pinnacle Notes. Id. at Iffl 3.1; 3.3.
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124. HLF also agreed to collect Customers' investments for Morgan Stanley and to
transfer thatmoney to Morgan Stanley. See id. at f 3.4.
125. The Distribution Agreement expressly contemplated that HLF would rely on the
Base Prospectus andthe terms of the Distribution Agreement:
Other thanrelying on the Prospectus andthe representations and warrantiescontained inthis Agreement, it has not relied on the Issuer, the Arranger and theMarket Agent or anyof their Affiliates in assessing the merits, risks andsuitability ofentering into this Agreement and ithas conducted its own suitabilitychecks andprocedures for entering into this Agreement[.]
Id. at 5.3 (ii).
126. The Distribution Agreement stated that HLF was Customers' fiduciary. Morgan
Stanley was aware of the obligation that the Distribution Agreement imposed onHLF vis-a-vis
Customers. See id. at \ 6.2.
127. The Distribution Agreement obligated HLF to instruct Customers torely onthe
Base Prospectus. See, e.g., id. at \ 7.5 ("[N]o application ... shall be accepted from a
prospective investor who has not had the opportunity to receive and read the Base Prospectus
and the relevant Pricing Statement ").
128. The Distribution Agreement contains an indemnification agreement that obligates
Morgan Stanley (through PPL and MS Singapore) to compensate HLF for losses (including legal
expenses incurred) related to the Pinnacle Notes. This provision is further evidence that Morgan
Stanley was aware that HLF could incur losses in connection with its distribution of the Pinnacle
Notes to Customers:
Each of the Issuer and theArranger hereby separately covenants andundertakesto the Distributor to keep the Distributor and its directors, officers, employeesand agents (for the purposes of this Clause 14.1, each a "DistributorIndemnified Party") fully and effectively indemnified from and against all losses,liabilities, costs, charges and expenses arising directly orindirectly out ofanyclaim which are brought against any such Distributor Indemnified Party
-32-974839.11
(whether or not such claim is successful or compromised or settled butsubject as provided below), and any right of action which are exercised, arisingin relation to any breach of the representations, warranties or undertakingscontained in or made or deemed to be made by itself under this Agreement. Inaddition, each of the Issuer and the Arranger separately agree to reimburse eachsuch Distributor Indemnified Party for any legal or other expenses (in eachcase as reasonably and properly incurred and evidenced in writing) incurred by itin connection with investigating or defending any claim referred to in this Clause14.1 in respect of itself. If any action shall be brought against any DistributorIndemnified Party in respect of which payment under this Clause 14.1 may besought from the Issuer or the Arranger, the Distributor shall promptly notify theIssuer and the Arranger in writing and shall employ such legal advisers as maybe agreed between the Distributor, the Issuer and the Arranger or, failingagreement, as the Arranger may select. Neither the Issuer nor the Arranger shallbe liable in respect of any settlement of any such action effected without itswritten consent.
Id. at f 14.1.
129. The Distribution Agreement is to be construed in accordance with Singapore law
and has a non-exclusive jurisdiction clause indicating that Singapore is only one of the places
where disputes relating to the Distribution Agreement can be litigated. See id. at If 24.
5. Morgan Stanley Continued to Emphasize the "Safe and
Conservative" Nature of the Pinnacle Notes to HLF.
130. After Morgan Stanley signed the Distribution Agreement, a representative from
Morgan Stanley (through its alter ego, MS Singapore), Mr. Ng, trained HLF's staff to sell the
Pinnacle Notes to Customers. Throughout this training, Mr. Ng at all times held himself out as
Morgan Stanley's agent.
131. Mr. Ng conducted training for HLF's then-existing wealth management group
beginning in the fall of 2006, and continued through the summer of 2007. In substantially all
training sessions:
a. Mr. Ng emphasized that the disclosed reference entities underlying the
Pinnacle Notes were very safe. He explained, moreover, that the secondary risk, the underlying
assets, had a AA rating and that they were comprised of approximately 100 companies spread
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across different industries. When he was asked to provide more detail regarding the structure of
the underlying assets, Mr. Ngexplained that he could not do so until after "closing," but stressed
that HLF and Customers did notneed to worry because they were rated AA overall.
b. Mr. Ng stated explicitly that the failure of the disclosed reference entities
was the "primary risk" to the Pinnacle Notes, and conveyed that the default rate on the Pinnacle
Notes would be no higher than 0.1%.
c. Mr. Ng conveyed that HLF should feel particularly comfortable selling the
Pinnacle Notes because they were Morgan Stanley's product and Morgan Stanley was an honest
and reputable company.
132. At no time did Mr. Ng (or any other individual from Morgan Stanley) reveal that
Morgan Stanley stood to profit if the Pinnacle Notes failed. HLF never would have sold the
Pinnacle Notes had it been aware of this fact.
133. Mr. Ng also conducted training at various HLF branches for "front-line" HLF
employees. When heconducted this training, he mentioned riskonly briefly, andconveyed that
the PinnacleNotes were like a long-term fixed deposit.
134. A number of HLF's own staff members purchased Pinnacle Notes based on the
strength of Morgan Stanley's representations (through Mr. Ng) that these notes were safe. Those
staffmembers - likethe other investors in thePinnacle Notes - lost theirmoney when the
Pinnacle Notes failed.
V. DEFENDANTS' FRAUDULENT SCHEME
A. The Pinnacle Notes Were the Deceptive "Bait" Employed By Morgan Stanleyto Secure Control Over Customers' Principal.
135. As indicated above, if the Pinnacle Notes hadbeenthe conservative CLNs they
purported to be, Customers' principal would have been invested in a safe andliquid underlying
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asset. If the underlying assets had been safe, Customers and HLF would not have lost their
money because the disclosed reference entities did not default.
136. But unbeknownst to HLF or Customers, Morgan Stanley(throughMS
International) invested Customers' principal intounderlying assets that comprised single-tranche
CDOs. Theywerenot liquid and theywere not conservative; rather, they werespecifically
designed to fail.
137. Thiswas in Morgan Stanley's interest for two reasons: (A) Morgan Stanley stood
on all sides of this transaction, such that the failure of the underlying assets transferred
Customers' moneydirectly to Morgan Stanley; and (B) there was virtuallyno risk to Morgan
Stanley, because the risk of any default on the part of disclosed reference entities was remote:
they were, as HLF understood, "gold brick."
138. The goal and result of Morgan Stanley's Pinnacle Notes scheme was the transfer
of the vast majority of Customers' approximately $72.4 million investment in the Pinnacle Notes
to Morgan Stanley's coffers.
139. The foreseeable and actual consequence of Morgan Stanley's scheme was that
HLF eventually was compelled to compensateCustomers for losses they incurred as a result of
Morgan Stanley's fraud.
B. Morgan Stanley Structured the Synthetic CDOs to Transfer Customers'
Investment in the Pinnacle Notes to Morgan Stanley.
140. The Pinnacle Notes indicated that Morgan Stanley (through alter ego MS
International) was the "Determination Agent." In other words, MorganStanley (through MS
International) had sole authority to select the underlying assets into which Customers' principal
would be placed.
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141. As explained above, Morgan Stanley (through MS International) selected single-
tranche synthetic CDOs created by Morgan Stanley. This made Customers "long" on the risk in
those CDOs, and Morgan Stanley (through MS Capital) "short."
142. Morgan Stanley duped HLF into selling a product to Customers through which
Customers placed their principal into the control of Morgan Stanley (through MS International),
which used that control to ensure that essentially everydollar lost by Customers would be
transferreddirectly to Morgan Stanley (through MS Capital).
143. Thus, Morgan Stanley wanted Customers to lose their capital. Morgan Stanley
achieved this end through blatant and undisclosed self-dealing: it invested the underlying assets
into single-tranche CDOs that were so fundamentally unsound that their failure, and the transfer
of money from Customers, and HLF itself, to Morgan Stanley was very likely.
144. All of the single-tranche CDOs created by Morgan Stanley to serve as the
underlying assets for the Pinnacle Notes sold by HLF have failed completely, transferring the
vast majority of the money invested in the Pinnacle Notes to Morgan Stanley.
1. Morgan Stanley Structured the Synthetic CDOs to Fail.
145. Morgan Stanley structured the Synthetic CDOs to be built to fail in at least three
ways.
a. First, Morgan Stanley filled its single-tranche CDO portfolios with
undisclosed reference entities that Morgan Stanley knew presented elevated risks of default.
b. Second, Morgan Stanley structured the Synthetic CDOs' single tranches to
have a very low Attachment Point, thus exposing those tranches to principal impairment upon a
relatively low level ofdefaults and losses in the undisclosed reference entity portfolios.
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c. Third, Morgan Stanley structured the Synthetic CDOs' bespoke single
tranches to be extremely "thin," so thata very small rise in aggregate portfolio defaults and
losses would cause 100%principal impairment.
146. Morgan Stanley did notdisclose either the listof CDO reference entities, or the
Attachment and Detachment Points, prior to HLF's sale of the Pinnacle Notes to Customers.
a. Morgan Stanley Seeded the Portfolios With ConcentratedRisk.
147. The bespoke Synthetic CDO portfolios created by Morgan Stanley for use in
connection with the Pinnacle Notesweresubstantially riskier than standardized credit risk
portfolios ordinarily created and traded bybanks, including Morgan Stanley.
148. This was by design. Morgan Stanley, negotiating onlywith itself ratherthan with
an independent counterparty, structured these transactions so that it had an interest in the
Synthetic CDOs' failure ratherthan in their success (by taking the "short" sideof the
transactions). Morgan Stanley seeded eachof its Synthetic CDO's portfolios withundisclosed
reference entities that presented a high likelihood of default.
149. The undisclosed reference entitiesMorganStanleychose for use within the CDOs
for the Pinnacle Notes' underlying assets weresuspect for two reasons.
a. First, Morgan Stanley included as undisclosed reference entities in each of
its single-tranche CDO portfolios certain Icelandic banks whose elevated risk of default had been
identified in early2006, wellbefore Morgan Stanley created the CDOs.
b. Second, Morgan Stanley included in eachof its single-tranche portfolios a
highconcentration of undisclosed reference entities susceptible to a housing market downturn;
thatconcentration wasfar higher than appeared in the standardized credit riskportfolios that
Morgan Stanley typically created and traded.
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i. This was true eventhough, byno later than mid-2006, MorganStanley had adopted a "bearish"stance towards the housingmarket, and was predicting - andpositioning itself to profit from -a housing bust.
ii. Morgan Stanley internally had elaborated a theorythat already-evident housing price declinesduring 2006 could devastate notonly the real estate front lines - such as home builders andmortgage lenders - but also numerous other companies andindustries exposed to real estate (e.g., home improvement retailers,furniture and appliance makers, construction materials purveyors),including financial companiesheavily exposed to real estate(including banks, non-bank lenders, real estate investment trusts,and insurance companies).
i. Morgan Stanley's Consistent, Concentrated Inclusion ofIcelandic Banks at Elevated Risk of Default
150. Of the six single-trancheCDOs that Morgan Stanley created for use in all of their
Credit-Linked Pinnacle Notes, three contained as undisclosed reference entities all three of
Iceland's largest banks- Glitnir, Kaupthing, and Landsbanski (the "IcelandicBanks")- while
the remaining three contained as undisclosed reference entities two of the three Icelandic Banks.
See Ex. A ("Class Complaint") at Appx. B.
151. This madeMorgan Stanley's single-tranche CDOs highly unusual. Investment
banks and credit ratingagency research shows that, at the time: (a) all three Icelandic Banks
were included as reference entities in only 4% of U.S. CDOs; (b) two of the three Icelandic
Banks were included in a further 5% of U.S. CDOs; and (c) an overwhelming majority of U.S.
CDOs - 87%) - did not reference any Icelandic Banks at all. See Puneet Sharma, CDOs Unwind
Headwinds, Barclays Capital European Credit Research, October 16,2008, at p. 3. Therefore, it
is statistically unlikely that the Icelandic Banks were included in the Synthetic CDOs by chance.
Morgan Stanley's inclusion of these risky banks was intentional.
152. Since at leastearly2006, Morgan Stanley wasaware that Icelandic Banks posed
an elevated riskof default. Indeed, in February and March 2006, analysts at various credit rating
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agencies and investment banks (including Fitch Ratings, JPMorgan and Merrill Lynch) issued a
series of critical reports identifyingsubstantial credit concerns at the Icelandic Banks. See Ex. A
("Class Complaint") atf 175 n. 5 (collecting sources). The reports identified five factors causing
these institutions to pose heightened risk.
a. First, the Icelandic Banks' loan portfolios were ofsuspect credit quality.
b. Second, the Icelandic Banks' loans were secured, toa uniquely high
degree, by shares ofstock (and, especially, shares of Icelandic companies, whose share prices
had quadrupled between 2004 and 2007). This transformedthe credit risks of the loans into
market risks of Icelandic equities; i.e., the Icelandic Banks were defacto hedge funds.
c. Third, the Icelandic Banks engaged in a high degree of lending to related
parties, including to investment companies controlled bythe controlling investors of the
Icelandic Banks themselves (who collateralized such loans with their shareholdings of the
Icelandic Banks, so that suchloans were collateralized by their ownshares).
d. Fourth, and in part as a resultof the foregoing, the Icelandic Banks faced a
uniquely-difficult funding situation when compared to theirpeerbanks: without much of a
deposit base in tiny Iceland, they were dependent onwholesale and short-term funding sources.
This left them exposed to severe liquidity risk.
e. Fifth, giventheir tremendous asset growthduring the 2000s, should the
Icelandic Banks threaten to fail, theywerebeyond the ability of Iceland to save: the Icelandic
Banks' assets were nine times greater than Iceland's entire gross domestic product by year-end
2007. This meant that rather than having the luxury of being "too bigto fail," they were instead
"too big to rescue."
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153. All of the Icelandic Banksdefaulted in 2008. On April 12,2010, the Special
Investigation Commission to the Althingi (the Icelandic Parliament) published a lengthy report
on the failure of the Icelandic Banks. See http://sic.althingi.is/ (partially available in English).
Thereport explained that theabove five factors (identified andunderstood by Morgan Stanley in
2006) led to the downfall of the Icelandic Banks in October 2008.
154. Morgan Stanley caused the Icelandic Banks to be included in each of the
Synthetic CDO portfolios during2006 and 2007precisely because oftheir then-known risks.
Indeed, investment bankanalyst reports from March 2006concluded that the smartest way to
approach the Icelandic Banksfrom an investment perspective was to "Buy Protection on the
Icelandic Banks." See Richard Thomas, Icelandic Banks: Not What You Are Thinking, Merrill
Lynch, March 7, 2006, at p. 1. And that is exactly what MorganStanleydid by includingthem
as undisclosed reference entities in the single-tranche CDOs that Morgan Stanley constructed
and then bet against.
ii. Morgan Stanley's Consistent, Concentrated, Inclusionof Companies at Elevated Risk of Default in the Eventof a Housing Downturn as Reference Entities
155. Morgan Stanley also filled the single-tranche CDOs' portfolios of undisclosed
reference entities withan unusually-high concentration of companies whose unifying themewas
elevated risk of default in the eventof a housing bust. Rather than seeking broad, representative,
coverage of the overall economy (as the standardized creditrisk portfolios offered by Morgan
Stanley to sophisticated investors did), Morgan Stanley hand-picked its portfolios in the single-
tranche CDOs to include a lopsided concentrationof companies exposed to elevated risk of
default in a housing bust.
a. Suchcompanies included: (1) home builders; (2) other companies
dependent on home construction(such as manufacturers of materials used in home construction,
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including lumber, cement, etc., manufacturers of home appliances, andhome improvement
retailers); (3) real estate investment trusts (REITs); (4) financial institutions withsignificant
exposures to real estate, mortgages, and mortgage-backed securities (banks, and non-bank
lenders); and (5) insurance companies with significant exposures to real estate, mortgages, and
mortgage-backed securities (particularly, monoline insurers and mortgage insurers).
b. These companies fall within therubric described by the acronym "FIRE"
- standing for those sectors of the economy involved in Finance, Insurance and Real Estate.
156. The tablebelowcompares the composition of the reference portfolios of Morgan
Stanley's bespoke Synthetic CDOs to a standard reference portfolio known as the CDX.NA.IG.3
a. The CDX.NA.IG had been created by a consortium of investment banks
including Morgan Stanley, and Morgan Stanley made an active market in the CDX.NA.IG
during the time the Pinnacle Notes and the Synthetic CDOs were created, issued, and sold.
b. In the bespokeSynthetic CDOportfolios that MorganStanleycreated for
use in the Pinnacle Notes, the concentration of reference entities exposed to a housing market
downturn was, on average, nearly double the concentration of such reference entities in the
standard CDX.NA.IG reference portfolio.
"CDX" refers to credit default swap; "NA" refers to North America; "IG" refers to investmentgrade. The CDX.NA.IG was based, like Morgan Stanley's bespoke Synthetic CDOs, on aportfolio of reference entities - specifically, 125 investment grade North American corporations(e.g., American Express, AT&T, Caterpillar, etc.) chosen by a consortiumof major investmentbanks including Morgan Stanley. The CDX.NA.IG index was updated twiceper yearby thesame consortium of banks, so that every half year a slightly"new" standardversionwas created.Each newversion of the CDX.NA.IG was identified witha successive number: e.g., CDX.NA.IG8, CDX.NA.IG 9, etc. The CDX.NA.IG wastraded by banks suchas Morgan Stanley in and ofitself, but also was traded in tranched form as if Synthetic CDO tranches had been created fromthe portfolio of reference entities contained in the CDX.NA.IG.
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Table 3:
The Lopsided Risk Exposures that Morgan Stanley BuiltInto its Bespi)ke Synthetic CDOs
Pinnacle Notes Series 2 3 6/7 9/10
Underlying Synthetic CDOs(Morgan Stanley ACES Series)
2006-
32
2007-
5
2007-
26
2007-
41
CDX.
NA.IG
Homebuilders 3.2% 8.0% 6.6% 8.0% 0.0%
Other Home Construction 1.6% 7.0% 4.1% 4.8% 1.0%
REITS 0.8% 2.0% 0.0% 5.6% 6.0%
Financial 8.0% 14.0% 13.2% 16.0% 27.0%
Insurance 9.6% 8.0% 8.3% 8.8% 20.0%
Total FIRE 23.2% 39.0% 32.2% 43.2% 54.0%
157. In sum, where the CDX.NA.IG had been developed by a consortium of
investment banks, including MorganStanley, as a portfolio providingstandard, representative,
balanced exposure to the wider economy as a whole, Morgan Stanley's single-tranche CDOs
provided an idiosyncratic, unrepresentative, and lopsided exposure. While 23.2%) of the
CDX.NA.IG portfolio consisted of "FIRE" companies, for the Series sold by HLF, their
representation in the Synthetic CDOs averaged 42.1%, nearly double the normal.
a. HLF incorporates by reference the Class Complaint's listing and
classification of all the reference entities included in the Synthetic CDO portfolios and in the
CDX.NA.IG, providing the full details underlying the above analysis. See Ex. A ("Class
Complaint") at Appx. B. This exhibit also indicates the specific reference entities that defaulted
in each portfolio, almost all of which were FIRE-classified reference entities.
b. The above analysis and its broad sector categories understates the degree
to which Morgan Stanley filled its single-tranche CDO portfolios with undisclosed reference
entitiesat elevatedrisk of default. Withineach of the above-summarized broad categories are
further subcategories that entailed greater or lesserexposure to a real estatedownturn. Morgan
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Stanley over-weighted in itsbespoke Synthetic CDO portfolios in those particular subcategories
or companies with greater exposure to a housing downturn.
158. For example, insurance has many different subcategories, including insurance
brokerage, health, life, casualty, and surety & title. This lastsubcategory includes insurance
providers particularly exposed to real estate, including providers of mortgage insurance (who
guarantee mortgage payments and become liable for making them in casethe borrower defaults);
andproviders of insurance on financial obligations ("monolines") (who were exposed to
subprime residential mortgages).
159. Morgan Stanley included a sharply disproportionate concentration of monolines
and surety and title insurers (i.e., the insurance companies mostdirectly exposed to a real-estate
downturn) in its single-tranche CDOs - nearly four times the concentration of such entities in
the CDX.NA.IG:
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Table 4:
Morgan Stanley"owards Insurance Companies Most Direct
's Bias
y Exposed to a Housing ])ownturn
Pinnacle Notes Series 2 3 6/7 9/10
Underlying Synthetic CDOs(Morgan Stanley ACES Series)
2006-
32
2007-
5
2007-
26
2007-
41
CDX.
NA.IG
Insurance Subcategories
Monolines /
Surety & Title16.7% 62.5% 80.0% 72.7% 30.0%
Property/Casualty 50.0% 0.0% 0.0% 0.0% 10.0%
Fire/Marine/Casualty 0.0% 12.5% 20.0% 18.2% 15.0%
Health 16.7% 0.0% 0.0% 0.0% 0.0%
Life 8.3% 0.0% 0.0% 0.0% 25.0%
Brokerage 8.3% 12.5% 0.0% 9.1% 0.0%
Other 0.0% 12.5% 0.0% 0.0% 20.0%
Total 100% 100% 100% 100% 100%
160. Because there were relatively few monolines available for Morgan Stanley to
name in its single-tranche CDOs, Morgan Stanley took theextraordinary step of naming some of
them twice within anindividual CDO portfolio (by naming both the corporate parent entity and
an operating insurance subsidiary). For example, the monoline MBIA was named twice in the
single-tranche CDOs underlying Series 3 of the Pinnacle Notes (by including both MBIA Inc.
and MBIA Insurance Corp. as reference entities), and the monolines Ambacand XL were both
named twice in the single-tranche CDOs underlying Series6 and 7 of the PinnacleNotes.
161. Evenbefore Morgan Stanley had created the single-tranche CDOs and seeded
them with reference entities in these high risk sectors, Morgan Stanley had concluded that the
housing boom was turning to a housing bust. By mid-2006, Morgan Stanley's leading
economists, including chiefeconomist Stephen Roach, were publicly predicting that an imminent
housing bust (already evident in declining home prices) would deepen, inflict losses on
974839.11
-44-
companies with substantial real estateexposures, and causethe entireeconomyto experience
recession. Concurrently (and not publiclydisclosed at the time), Morgan Stanley's proprietary
trading operations had taken a "bearish" stance towards housing and real estate, and were
predicting - and positioning themselves to profit from - a housing bust. See Michael Lewis, The
Big Short at 202-03 ("Big Short").
iii. The Single-Tranche CDO Underlying Series 9 andSeries 10 of the Pinnacle Notes Reveals MorganStanley's Intentions
162. Morgan Stanley's intentional seeding of the single-tranche CDO portfolios with
entities it believed most likely to fail is perhaps most evident in the case of Series 9 and Series 10
of the Pinnacle Notes, which HLF sold to Customers during November 2007 and were issued on
December 14, 2007.
163. These Pinnacle Notes had as their underlying assets a Morgan Stanley single-
tranche CDO, Morgan Stanley ACES SPC Series 2007-41,whose notes had been issued one day
before the Pinnacle Notes were issued, on December 13, 2007.
164. By November 2007 (and certainly by December 2007, during which Morgan
Stanley constructed Morgan Stanley ACES SPC Series 2007-41), the severity of the housing bust
had become apparent.
a. In early 2007, subprime mortgage origination had collapsed, most
subprime mortgage originators went bankrupt or were acquired for pennies on the dollar, larger
financial institutions announced tens of billions of dollars in subprime mortgage losses, and
home builders suffered an industry-wide collapse.
b. During October, November, and December of 2007, banks and investment
banks revealed further billions of dollarsof losses from direct subprime mortgage exposures.
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c. Morgan Stanley,at the time, was both: (1) aware from its own first-hand
experience ofthe severe losses; and (2) cognizant ofwhich financial institutions were exposed to
large stores of such instruments and their associated losses.
d. The Class Complaint's discussion of The Big Short asevidence of Morgan
Stanley's knowledge is incorporated by reference. See Ex. A at ffl| 199-209.
165. In other words, byNovember/December of 2007, at the time it was creating
Series 9 and Series 10 of the Pinnacle Notes, Morgan Stanley was aware of the market downturn.
Had it wished to create a safe Synthetic CDO to serve as theunderlying asset for Series 9 and
Series 10 of the Pinnacle Notes, it could simply have excluded, ordecreased the percentage of,
entities falling within such at-risk sectors as finance and insurance.
166. Instead, Morgan Stanley created a single-tranche CDO, Morgan Stanley ACES
SPC Series 2007-41, that went far outof its way to expose itselfto exactly suchknown-to-be-at-
risk undisclosed reference entities. See Ex. A ("Class Complaint") at Appx. C. The 100
undisclosed reference entities Morgan Stanley selected to constitute the reference portfolio for
Morgan Stanley ACES SPC Series 2007-41 included among them, to aneven greater degree than
Morgan Stanley's prior single-tranche CDOs, concentrated exposure to such undisclosed
reference entities. Id. Nearly halfof the 100 undisclosed reference entities that Morgan Stanley
included in the underlying portfolio consisted ofvarious financial institutions (banks, investment
banks, insurers, reinsurers, monoline insurers, etc.) with large exposures to thehousing market.
Id.
167. By seeding the portfolios of its single-tranche CDOs with undisclosed reference
entities selected for their risk rather than their lack of it,Morgan Stanley engineered the single-
tranche CDOsto be more likely to generate portfolio lossesand fail. Indeed, the first of the
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CDOs to fail was the last created: the above-discussed Morgan Stanley ACES SPC Series 2007-
41, which failed on or about November 14, 2008, less than a year after Morgan Stanley had
created it to yield that very result.
b. Morgan Stanley Designed the CDOs to Have Very Low
Attachment Points and "Thin" Single Tranches.
168. Morgan Stanley structured the Synthetic CDOs' bespoke single tranches to have
both very low Attachment Points and to be very thin.
a. As explained above, the low Attachment Points of the bespoke single
tranches that Morgan Stanley structured in the single-tranche CDOs meant that those tranches
would become impaired after relatively low levels of aggregate losses in the portfolios
underlying the CDOs.
b. Morgan Stanley's CDOs were also structured to have an extremely thin
single tranche. Three of the four single-tranche CDOs featured a single tranche structured to
represent a precise and incrediblythin slice of portfolio risk amounting to 0.75% of the total
portfolio (the single tranche in the fourth Synthetic CDO was only marginally thicker at 1.00%).
This extreme thinness meant essentially that there was almost no difference between the first and
the last dollar ofprincipal loss.
Table 5:
Morgan Stanley Created Bespoke Single Tranches in the Synthetic CDOsTo Be Very Low and Very Thin
Pinnacle Notes
Series
UnderlyingSynthetic CDO
CDO Tranche
Attachment
Point
CDO Tranche
Detachment
Point
CDO Tranche
Thickness
Series 2
Morgan StanleyACES SPC
Series 2006-32,Class II
4.30% 5.05% 0.75%
Series 3
Morgan StanleyACES SPC
Series 2007-5
6.20% 6.95% 0.75%
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Series 6 and 7
Morgan StanleyACES SPC
Series 2007-26
4.60% 5.35% 0.75%
Series 9 and 10
Morgan StanleyACES SPC
Series 2007-41
2.67% 3.67% 1.00%
169. The standardized Synthetic CDO tranches based on like reference portfolios of
investment-grade corporations (i.e., "CDX.NA.IG.") that banks including Morgan Stanley traded
featured the following standard Attachment Points and Detachment Points:
Standard S
Table 6:
Synthetic CDO Tranche Structure (CDX.NA.IG tranches)
Tranche Name Tranche RatingStandard
Attachment Point
Standard
Detachment Point
30-100 Tranche
Super Seniorunrated super senior 30% 100%
15-30 Tranche
Junior Super Seniorunrated super senior 15% 30%
10-15 Tranche
SeniorAAA 10% 15%
7-10 Tranche
Senior MezzanineAA 7% 10%
307 Tranche
Junior MezzanineBBB 3% 7%
0-3 Tranche
Equityunrated equity 0% 3%
170. Pursuantto the Offering Documents, the underlying assets for the PinnacleNotes
would have an aggregate credit rating of at least AA— i.e., the Synthetic CDOs that Morgan
Stanley created to serve as underlying assets hadpurported AAratings.
171. In standardized Synthetic CDO tranches, the closestequivalent to such a AA-
rated tranche is the AA-rated 7%-10% "Senior Mezzanine" tranche in Table 6.
172. The AA-rated bespoke Synthetic CDO tranches that Morgan Stanley constructed
foruse in the Pinnacle Notes were far riskier than equivalently-rated AA tranches of
standardized Synthetic CDOs.
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a. In the standardized Synthetic CDOs, the equivalentAA-tranche has a
tranche thickness of 3.00% (the difference between its Attachment Point of 7.00% and its
Detachment Point of 10.00%).
i. Thus, the equivalent tranches of standardized Synthetic CDOswerefour times thicker than the bespoke single tranches MorganStanleyconstructed in three of the single-tranche CDOs (3.00%versus 0.75%), and three times thicker than the bespoke singletranche featured in the fourth CDO (3.00% versus 1.00%).
ii. By structuring its CDOs' tranches to be far thinner than normal,Morgan Stanley constructed them to be far riskier than normal. A.75 to 1.00%) rise in aggregate portfolio losses above theAttachment Pointwould causea 100%o impairment in MorganStanley'sbespoke Synthetic CDO tranches, but a substantiallysmaller impairment of 25.0% to 33.33% in the equivalent trancheof standardized Synthetic CDOs - assuming, of course, that theAttachment Points in the CDOs were the same.
b. Morgan Stanley also set the Attachment Points so low in the CDOs within
the Pinnacle Notes' underlying assets that the Detachment Point of every single-tranche CDO
was lowerthan the Attachment Point for the equivalent tranche in standardized Synthetic CDOs.
In other words, Morgan Stanley's bespoke tranches in its Synthetic CDOs would suffer 100%
principal impairment before equivalent tranches instandardized Synthetic CDOs would lose
even a dollar.
c. Additional Factors Show that Morgan Stanley IntentionallyBuilt the Synthetic CDOs to Fail.
173. Morgan Stanley's intentions are further evidenced: (1) by comparing the
Synthetic CDOs to each other; and (2) by comparing the Synthetic CDOs, which servedas the
underlying assets for the money raised by the Pinnacle Notes, with the Investment Collateral into
which Morgan Stanley reinvested the money raised by the saleof the Synthetic CDOs (which
Morgan Stanley sought to preserve until its scheme came to fruition and those funds passed from
Customers to Morgan Stanley).
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i. Morgan Stanley's CDOs Became Riskier Over Time,Even as the Financial and Housing Crises Worsened.
174. The last of the single-trancheCDOs that Morgan Stanley created for use in the
Pinnacle Notes - the December 2007 Morgan Stanley ACES SPC Series 2007-41 - should have
featured a higher Attachment Point than Morgan Stanley's prior Synthetic CDOs,because the
level of risk in the market had increased significantly since the earlier Synthetic CDOs.
175. Despite the well-publicized downturn in the sectors from which Morgan Stanley
selected the Synthetic CDOs' undisclosedreference entities (discussed above), this CDO had the
fewest structural protections. The December2007 Morgan Stanley ACES SPC Series 2007-41
featured a single tranche with an Attachment Point (2.67%) that was far lower than that of the
three prior Synthetic CDOs (with Attachment Points ranging from 4.30%> to 6.20%).
176. Indeed, the 3.67% Detachment Point for this CDO was itself lower than the
Attachment Points ofallprior single-tranche CDOs associated with the Pinnacle Notes sold by
HLF.
ii. Morgan Stanley Reinvested the Money Raised by theSale of the Single-Tranche CDO Notes in a Far MoreConservative Investment.
177. Until the tranched referenceportfolio underlying the single-tranche CDOs
defaulted, Morgan Stanley needed to preserve the funds it had raised from Customers and other
investors by reinvesting them in an investment collateral (i.e., the investment purchased with the
money raised from the sale of the single-tranche CDO notes that collateralized the CDO
obligations).
178. As explained above, Morgan Stanley wanted the CDOs to fail. But Morgan
Stanley wanted to preserve the investment collateral so that it would be there for Morgan Stanley
when the undisclosedreference entities in the single-trancheCDOs failed.
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179. Thetable below presents, foreachSeries of Pinnacle Notes (a) the Synthetic
CDOs serving as the underlying assets for eachSeries of Pinnacle Notes, and (b) in turn, the
security serving as the underlying assets to the investmentcollateral:
The UnderlyingTable 7:
Assets for the Pinnacle Notes and the Investment Collateral
Pinnacle Notes Series
Underlying Asset forPinnacle Notes - the
Synthetic CDOsInvestment Collateral
Pinnacle
Series 2
Morgan StanleyACES Series
2006-32
MBIA Global Funding LLC Medium TermNotes due May 3, 2012 (ISIN XS0275386497)
Pinnacle
Series 3
Morgan StanleyACES Series
2007-5
Morgan Stanley Funds pic U.S. DollarLiquidity Fund (Money Market fund,Institutional Class)
Pinnacle
Series 6 and 7
Morgan StanleyACES Series
2007-26
Chase Issuance Trust CHASEseries Class A
(2007-10) Notes (asset-backed securitizationofcredit card receivables) (CUSIP — US161571 CA05)
Pinnacle
Series 9 and 10
Morgan StanleyACES Series
2007-41
Capital One Multi-Asset Execution TrustClass A (2006-8) Series Notes (asset-backedsecuritization of credit card receivables)(CUSIP — I404INCX7)
180. In each case, the investmentcollateral for the Synthetic CDOs' notes was safer
and more liquidthan the single-tranche CDOs that comprised the underlying assets for the
Pinnacle Notes.
181. While the single-tranche CDO tranches underlying the PinnacleNotes were
purportedly rated AA, each of the investment collateral for the Synthetic CDO notes was rated
AAA — the highest possible credit rating.
a. The investment collateral for Series3 of the PinnacleNotes was money
market funds. Money market funds investin short-maturity highly-rated obligations. The
number of timesthat money market funds have lost even 1%of capital can be counted on one
hand. Indeed, Morgan Stanley explained that its money market fund was intended "to provide
-51-974839.11
liquidity and an attractive rate ofreturn, to the extent consistent with the preservation ofcapital."
See http://www.morganstanley.com/liquidity/usd.html. The substantial liquidity and capital
preservation available through amoney market fund are in sharp contrast to the illiquid and risky
Synthetic CDOs underlying PinnacleNotes 3.
b. The investment collateral for Series6, 7, 9, and 10 of the PinnacleNotes
were credit card securitizations. These are asset-backed securities backed by pools ofcredit card
receivables. These particular receivables were the senior-most tranche ofsecurities backed by
such asset pools, and were protected from collateral losses by multiple more junior tranches. In
addition to being a safe and senior security, this type of credit card securitizations is also
extremely liquid for two reasons: (1) specific securities were issued invery large amounts,
which created a large market ofpurchasers and sellers; and (2) issuers regularly issued many
series ofnear-identical securities each year, which created substantial market familiarity with
the securities. For example, the credit card securitization connected to Series 9 & 10 of the
Pinnacle Notes was issued in May 2006 in an amount of $300 million, andthatwas the 8thsuch
issuance thatyear (all the others were even larger). And thecredit cardsecuritization connected
to Series 6 &7 ofthe Pinnacle Notes was even larger - it was part ofa $1.05 billion issuance in
June 2007 (the 10th such issuance that year). The substantial liquidity and capital preservation
available through such credit card securitizations stand in sharp contrast to the illiquidity and risk
Morgan Stanley created in the Synthetic CDOs underlying Series 6, 7, 9, and 10of the Pinnacle
Notes.
2- Morgan Stanley Had Full Control Over Portfolio Construction, andHLF and Customers Were Excluded from Any Input.
182. HLF has attached a full list ofthe reference entities ineach ofthe Synthetic
CDOs' reference entity portfolios. See Ex. A("Class Complaint") atAppx. C.
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183. Normally, in legitimateSynthetic CDO transactions involving truly independent
parties, the reference portfolio contents are subject to, and the result of, negotiation between the
parties, each of which has a direct interest in the portfolio's risks.
184. Here, Morgan Stanley alone determined the portfolio of undisclosed reference
entities.
185. Morgan Stanley stood on both sides of every relevant transaction, because the
initialcounterparties to the underlying credit default swap agreement that purportedly agreed to
contract over each risk portfolio were all controlled by (and were alter egos of) Morgan Stanley.
In particular, the Synthetic CDO issuing trust, MS Capital, and MS International were all
controlled by (and were the alter egos of) Morgan Stanley.
186. At the time HLF sold the Pinnacle Notes, Morgan Stanley had not disclosed, and
HLF was unaware, that Morgan Stanley had concocted the above scheme.
3. Morgan Stanley Created the Single-Tranche CDOs for the SpecificPurpose of Receiving the Principal Raised Through Morgan Stanley's
Creation of the Pinnacle Notes.
187. The financial, logistical, and chronologicaldetails surrounding the creation of the
single-tranche CDOs that comprised the underlying assets for the Pinnacle Notes demonstrate
that MorganStanleycreated them for the specificpurposeof receiving the principal raised from
each series of PinnacleNotes. This had been Morgan Stanley's undisclosed plan since the
conception of the Pinnacle Notes.
a. First, the dollar size of the single bespoke tranche of each of the Synthetic
CDOs matched, exactly, the amount of funds raised through the creation, issuance, and sale of
each series of Pinnacle Notes.
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Table 1
The Matching Issuance Amounts of Pinnacle Notes and Synthetic CDO Notes
Pinnacle Notes
Series
Series 2
Series 3
Series 6 and 7
Series 9 and 10
Dollar Amount of
Pinnacle Notes
Issued
$16.9 million
$24.6 million
$69.9 million
$17.9 million
Synthetic CDOUnderlying Asset
Morgan StanleyACES SPC Series
2006-32, Class II
Morgan StanleyACES SPC Series
2007-5
Morgan StanleyACES SPC Series
2007-26
Morgan StanleyACES SPC Series
2007-41
Dollar Amount of
Single BespokeTranche CDO Notes
Issued
$16.9 million
$24.6 million
$69.9 million
$17.9 million
b. Second, Morgan Stanley created each single-tranche CDOafter the sales
and marketing process had allowed Morgan Stanley to determine the precise amount of funds
raised from each Series of Pinnacle Notes, and in conjunction with thecreation andsale of each
series of the Pinnacle Notes. In particular, each Series ofPinnacle Notes was marketed and sold
during an"Offer Period" ofapproximately one month, which allowed Morgan Stanley to
determine total investor subscriptions for each Series of Pinnacle Notes. Approximately two
weeks after the Offer Period ended, Morgan Stanley caused a sum ofPinnacle Notes matching
total investor subscriptions to be created and officially issued onan"Issue Date" that Morgan
Stanley designated. One day prior to the Issue Datefor each Series ofPinnacle Notes, Morgan
Stanley issued the matching Synthetic CDOs (with single tranche sizes exactly matching the
amountof funds raised from each Seriesof PinnacleNotes):
Table 2
Chronological and Logistical Coordinationof the Pinnacle Notes and the Synthetic CDOs
Pinnacle Notes | Pinnacle Notes | Pinnacle Notes [Underlying | Synthetic CDO
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Series Offer Period Issue Date Synthetic CDO Issue Date
Series 210/9/2006-
11/3/200611/21/2006
Morgan StanleyACES SPC
Series 2006-32,Class II
11/20/2006
Series 31/10/2007 -
2/8/20072/16/2007
Morgan StanleyACES SPC
Series 2007-5
2/15/2007
Series 6 and 75/18/2007-
6/22/20077/6/2007
Morgan StanleyACES SPC
Series 2007-26
7/5/2007
Series 9 and 1010/29/2007-
11/30/200712/14/2007
Morgan StanleyACES SPC
Series 2007-41
12/13/2007
188. Third, the Synthetic CDO tranches were sold toonly one purchaser (Morgan
Stanley itself, through PPL), not only because they had been explicitly created for purchase by
PPL, but also because there was no general market for these products. In other words, Morgan
Stanley created and issued only asmany single-tranche CDO notes asMorgan Stanley could sell
to captive investors, such as Customers.
VI. THE PINNACLE NOTES OFFERING DOCUMENTS WERE MATERIALLYFALSE AND MISLEADING.
A. Representations that the Underlying Assets for the Pinnacle Notes uMavInclude" Synthetic CDOs Were Materially False and Misleading.
189. Synthetic CDOs were integral to Morgan Stanley's scheme to transfer Customers'
funds to Morgan Stanley. Morgan Stanley intended atall times that the underlying assets would
only be Synthetic CDOs specifically designed by Morgan Stanley. No other asset would provide
the necessary features to enactMorgan Stanley'sscheme, because otherassetswouldhave
lacked the necessary swap provisions.
190. The Offering Documents materially misrepresented these facts by portraying
synthetic CDOs as one choice, among other classes ofassets and securities, for the underlying
assets. Specifically, the Offering Documents described investment insynthetic CDOs as merely
974839.11
-55-
possible, when investment in the Synthetic CDOs was certain. Indeed, the Offering Documents
described other possible securities and assets as possible underlying assets: in truth they were
never possible alternatives.
191. The Base Prospectus stated:
INFORMATION ON THE UNDERLYING ASSETSjfc 5fC $ j|C 9|c
Onthe Issue Date of a Series of Notes, the Issuer (in consultationwith theDetermination Agent) will invest theentire proceedsreceived from the Issue of the Notes of that Series in the purchaseof assets asdescribed below. Such assets shall bethe"OriginalUnderlying Assets" and will, as at the Issue Date ofNotes of thatSeries, meet the criteria setout inthe applicable Pricing Statementfor Notes of that Series.
Original Underlying Assets ofa Series may include one or more ofCash Deposit, Medium Term Notes, Liquidity Funds, CommercialPaper, Certificates ofDeposit, Asset-Backed Securities, SyntheticCDOSecurities, CDOSquared Securities, and/orCreditCommodityLinkedSecurities, as described below. ...
(BaseProspectus at 24) (boldin original, italics added).
192. Each ofthe Pricing Statements included, immediately after the cover page and its
notices and immediately prior to the Table ofContents, introductory/summary pages. One of
those pages was represented to be a "Summary of Terms" for each Series of Pinnacle Notes.
They stated:
-56-974839.11
Pinnacle Notes [] Summary ofTerms
Collateral/Security: The Notes will be secured by, amongst other assets,(i) Underlying Assets which may include AA-ratedor higher rated US Dollardenominated portfoliocredit-linked securities (i.e., Synthetic CDOsecurities), and (ii) the SwapArrangements.
(Pricing Statements at iii) (emphasis added)
193. These representations were materially false and/or misleading in at least four
ways.
a. First, the Offering Documents misrepresented a certainty (that the
underlying assets would only and always be Synthetic CDOs) asa mere possibility (the
underlying assets "may include" Synthetic CDOs). In truth, Morgan Stanley had always
intended for the underlying assets to be Synthetic CDOs. As explained above, its scheme in
connection withthe Pinnacle Notes required useof the Synthetic CDOs.
b. Second, the Offering Documents misleadingly suggested thateven if
Synthetic CDOs constituted par? ofthe underlying assets, they would not be all ofthe underlying
assets (the underlying assets "may include" Synthetic CDOs). Intruth, Morgan Stanley had
always intended for the underlying assets in their entirety to be Synthetic CDOs - and had in fact
custom-built bespoke single-tranche Synthetic CDOs with those single tranches sized in an
amount thatexactly equaled the total amount of principal raised through eachSeries of Pinnacle
Notes.
c. Third, the Offering Documents provided a listof other purportedly
possible forms ofunderlying assets, including "Cash Deposits," "Certificates ofDeposit," and
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"Liquidity Funds" (akin to money market funds). See Base Prospectus at 24, Pinnacle Notes
Series 2 Pricing Statement at 13-14, Pinnacle Notes Series 3 Pricing Statement at 13-14,,
Pinnacle Notes Series 6/7 Pricing Statement at 31-32, and Pinnacle Notes Series 9/10 Pricing
Statement at 30-31. This represented as possible a matter that was impossible (namely, that the
Underlying Assets would be anything other thanSynthetic CDOs).
d. Fourth, each of the other supposedly possible forms of underlying assets
(cash deposits, certificates of deposit, and liquidity funds) were safe and liquid. This was
intended to suggest, and did suggest, that the Synthetic CDOs with which they had been grouped
were also safe and liquid. Intruth, the Synthetic CDOs were neither, and were thus wholly
unlike the other supposedly possible forms of underlying assets with which they had been
grouped.
B. The Offering Documents Did Not Disclose that the Underlying Assets WereSingle-Tranche CDOs That Morgan Stanley Had Created and in whichMorgan Stanley Possessed an Adverse/Opposite Interest.
194. As explained above, Morgan Stanley (through its affiliates, MS Capital and MS
International) was the "short" counterparty to the credit default swap underlying thesingle-
tranche CDOs - i.e., Morgan Stanley bet against the success of the very product that Morgan
Stanley created.
195. The OfferingDocuments omittedand intentionally concealedthe material facts
that:
a. Morgan Stanley wouldcreate (throughMS Capital) the single-tranche
CDOs that formed the basis of the underlying assets;
b. Morgan Stanley would (through the Determination Agent, MS
International) ensure thatCustomers' funds were placed into those single-tranche CDOs;
-58-974839.11
c. Morgan Stanley (through MS Capital), had assigned itselfas the "short"
counterparty in the single-trancheCDOs it created; and
d. Morgan Stanley stoodto profit from Customers' loss. Had HLF been
informed that Morgan Stanley was intending to "invest" Customers' principal in a single-tranche
Synthetic CDOs with risky undisclosed reference entities, low Attachment Points, thin tranches,
and against which CDO Morgan Stanley held ashort position, HLF would not have agreed to
sell the Pinnacle Notes.
196. The Pricing Statements provided almost no disclosures concerning, and no
explanation of, Synthetic CDOs. The Pricing Statements only represented certain purported
conditions that Synthetic CDOs would have to meet to serve as underlying assets - including
denomination in U.S. dollars, minimum credit ratings ofat least AA, maturity dates prior to
those of the Pinnacle Notes, and their purported acceptability to MS Capital. See Pinnacle Notes
Series 2 Pricing Statement at 13-14, Pinnacle Notes Series 3 Pricing Statement at 13-14, Pinnacle
Notes Series 6/7 Pricing Statement at31-32, and Pinnacle Notes Series 9/10 Pricing Statement at
30-31.
197. Such statements were materially misleading inat least two ways:
a. First, bystating that the underlying assets had to be"acceptable" to
Morgan Stanley, the statements implied that Morgan Stanley would be selecting already existing
Synthetic CDOs for the underlying assets, when inreality, Morgan Stanley was creating new
Synthetic CDOsfor the underlying assets.
b. Second, they indicated thattheunderlying assets would be selected based
on their merits (e.g., the underlying assets had tomeet certain minimum credit ratings), when, in
-59-974839.11
truth, the single-tranche CDO underlying assets were selected for their lack ofmerit, i.e., their
propensity to fail.
198. The Base Prospectus provided further disclosures concerning Synthetic CDOs and
a brief purported explanation oftheir risks (see Base Prospectus at 11-12, 25, and A-16), as well
as vague disclosure of "potential and actual conflicts of interest" between Customers and
Morgan Stanley (id. at 16-17). These disclosures were all materially misleading, for the same
reasons. They failed to disclose that Morgan Stanley had created single-tranche CDOs with
highly risky undisclosed reference entities to be used as underlying assets, and that Morgan
Stanley possessed opposed interests andcounterparty positions to those of Customers.
C. The Offering Documents Failed to Disclose that. Given Morgan Stanley'sAlso Undisclosed Adverse Interests and Counterparty Positions in theSynthetic CDOs it Created, Morgan Stanley Custom-Designed for Use asUnderlying Assets Bespoke Built-to-Fail Synthetic CDOs.
199. As explained above, the Offering Documents failed to disclose that the underlying
assets had not been selected to preserve Customers' principal, but rather to transfer that principal
to Morgan Stanley.
200. TheOffering Documents also failed to disclose other specific facts (such as the
details, tranche structure, and reference entity portfolios ofthe Synthetic CDOs) that would have
allowed HLF orCustomers to fully assess the risks ofthe Pinnacle Notes (and that would have
revealed Morgan Stanley's scheme).
a. A reasonable distributor or investor would have considered these omitted
facts toberelevant, particularly the Synthetic CDOs': (1) undisclosed reference entity
portfolios; (2) Attachment Points; and (3) DetachmentPoints.
b. Such material omissions also rendered affirmative statements made in the
Offering Documents materially misleading.
-60-974839.11
c. Although the Pricing Statements were bereft of any explanation of
Synthetic CDOs or their risks, they did, as explained above, represent that the Synthetic CDOs
chosen as the underlying assets would be made based on the merits of those assets. Yet, the
disclosure of the above omitted facts would have made plain that this was not the case.
201. The Pinnacle Base Prospectus contained certain brief representations concerning
synthetic CDOs and their risks. See Base Prospectus, at 11-12. Specifically, the Base Prospectus
stated in passing that akin to the Pinnacle Notes and their Nominal Reference Entities (i.e., the
disclosed reference entities), Synthetic CDOs themselves had reference entities to which they
were credit-linked, and the value of the Synthetic CDOs would depend on the performance of
those credit entities:
Prospective investors should note that if the Underlying Assets forany Series of Notes consist of or include Synthetic CDO.Securities, CDO Squared Securities, or Credit Commodity LinkedSecurities, the market value of the Underlying Assets of suchSeries will, amongst other things, depend on the occurrence ofcredit events or potential credit events in respect of the referenceentities to which such securities are linked.
Whether the principal amount of any Synthetic CDO Security isreduced or otherwise written down will depend on whether one ormore credit events in respect of the underlying reference entities ofsuch Synthetic CDO Security occur (and whether any otherapplicable conditions are satisfied) as well as whether any losscalculations in connection with such credit event(s) exceed anyrelevant threshold amount. (Base Prospectus at 11)
202. These statements were misleading because they did not state (or otherwise
provide any facts informing investors) that the specific Synthetic CDOs that Morgan Stanley had
created for use in connection with the Pinnacle Notes had been custom-built to intensify the
normal risk of principal/value loss or that this was to Morgan Stanley's advantage. There were
thus at least three material omissions that render the above disclosure misleading:
-61-974839.11
a. First, that Morgan Stanley had filled the Synthetic CDO undisclosed
reference portfolios with reference entities that Morgan Stanley deemed to present elevated risks
of default, thereby intensifying the very risk that the Base Prospectus neutrally and abstractly
described - that "occurrence of credit events" could cause diminution of principal or market
value.
b. Second, that Morgan Stanley had created the Synthetic CDOs with
abnormally low Attachment Points and thin bespoke single tranches, thereby intensifying the
risk.
c. Third, that the risks were to HLF and Customers' detriment, but inured to
Morgan Stanley's benefit.
D. The Offering Documents' Representation that the Underlying Assets Were
"Acceptable" to MS Capital Was Materially False and/or Misleading.
203. The Offering Documents represented that, notwithstanding MS International's
purported sole discretion as "Determination Agent" to select underlying assets for the Pinnacle
Notes, MS Capital had to deem the underlying assets "acceptable." See Pinnacle Notes Series 2
Pricing Statement at 13, Pinnacle Notes Series 3 Pricing Statement at 13, Pinnacle Notes Series
6/7 Pricing Statement at 31, and Pinnacle Notes Series 9/10 Pricing Statement at 30.
204. The Offering Documents further explained that MS Capital had to deem the
underlying assets "acceptable" because of its purported interest in such assets (i.e., the
underlying assets must be ones "acceptable to the Swap Counterparty [MS Capital] as a funding
source for the obligations of the Issuer [PPL] under the Swap Agreement"). Id.
205. The "obligations of the Issuer under the Swap Agreement" included the
contingent payment to MS Capital, pursuant to the credit default swap between PPL and MS
Capital, should a reference entity default. Were a reference entity to default, PPL would
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liquidate the underlying assets and use the proceeds of the underlying assets' sale to fund its
counterparty payment to MS Capital.
206. Thus, the plain meaning of this representationwas that MS Capital would deem
the underlying assets to be acceptable insofar as they safeguarded the Pinnacle Note investors'
principal, which was the "fundingsource" for PPL's obligation to pay MS Capitalunder the
"Swap Agreement" should a reference entity default.
207. This representation was materially false and/or misleading.
208. Far from deeming the underlying assets as an "acceptable" safe place to preserve
principal, MS Capital was in fact betting against the underlying assets (the Synthetic CDOs) and
stood tobenefit by over approximately $156.2 million from their failure.4 Indeed, aspart of
Defendants' concerted scheme, MS Capital had participated in constructing the Synthetic CDOs
so that they would fail, and in failing effect the transfer of Customers' principal to MS Capital
and Morgan Stanley.
209. With respect to each of these Synthetic CDO tranches, MS Capital was "short":
should defaults in the Synthetic CDOs' undisclosed reference entities rise to breach the low, thin
tranches, MS Capital would gain tens of millions of dollars, and up to approximately $156.2
million. This monetary gain to MS Capital would include Customers' lost principal, which MS
International as "Determination Agent" had caused to be invested in the single-tranche CDOs.
210. Thus, MS Capital's interests were directly opposed to those of Customers.
Customers wanted the single-tranche CDOs to succeed and to preserve principal (for return
Customers upon the Pinnacle Notes' maturity). MS Capital wanted them to fail and for the
money to default to Morgan Stanley.
4The $156.2 million includes money from all ofthe investors in the Pinnacle Notes, not onlyCustomers.
-63-974839.11
211. MS Capital did not viewthe Synthetic CDOs as an "acceptable" placeto preserve
principal. Rather, as part of Defendants' concertedaction, MS Capital helpedcreate the
Synthetic CDOs so that they would fail.
212. If the Pinnacle Noteshad been bonafide credit-linked notes, MS Capital's
interests would have been aligned with those of Customers: both would have wanted the
underlying assets to preserve principal value, to secure PPL's respective obligations to each (for
counterparty payments in caseof disclosed reference entitydefault or for principal return upon
Pinnacle Notesmaturity). Because MS Capital was not interested in the credit protection for
which it had facially contracted, and instead had an undisclosed interest in the failure of the
underlying assets, MS Capital's interests were opposed to HLF's and Customers' interests.
VII. LOSSES SUFFERED BY HLF
213. Through the fraud described above, Morgan Stanley wrongfully appropriated
approximately $156.2 million from investors. Of this, more 45%) belonged to Customers.
214. In Singapore, financial institutions are regulated by the Monetary Authority of
Singapore ("MAS").
215. MAS summoned HLF President Mr. Ian Macdonald to a number of meetings to
assess, among other things, HLF's liability after the Pinnacle Notes started to fail.
216. HLF invited MorganStanley, in writing, to attend these meetings, in keepingwith
both good business practices and the requirements of the Distribution Agreement. Morgan
Stanley flatly refused to participate, even though Morgan Stanley was aware that MAS could be
imposing liability on HLF.
217. MAS required HLF to "immediately" notify Customers regarding the failure of
the Pinnacle Notes.
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218. MAS instructed Customers to file claims relating to the failure of the Pinnacle
Notes directly with HLF.
219. MAS required HLF "tohave a rigorous process to look into every complaint and
to ensurethat legitimate grievances [were] dealtwithexpeditiously."
220. MAS appointed an"independent person" to "ensure that [HLF's] complaints
handling and resolution process" was "serious and impartial" and to"highlight to MAS any
shortcoming in [HLF's] processes ...."
221. HLF's payments to Customers were made only as part of MAS' mandated
"rigorous process" and under the "independent person['s]" oversight: the payments were not
voluntary.
222. HLF has paidapproximately $32 million (so far) to Customers through the
"rigorous process" mandated by MAS. ThatMAS would require HLF to compensate its
Customers for their losses caused by Morgan Stanley's Pinnacle Notes was the logical,
foreseeable, and proximate result of MorganStanley's actions in connection with the Pinnacle
Notes because, among other reasons:
a. Morgan Stanley itself described HLF as Customers' fiduciary;
b. TheDistribution Agreement specifically contemplated that HLF might be
liable for Customer losses in connection with the Pinnacle Notes;
c. MorganStanleywas aware that Customers were primarily working-class
andmiddle-class people, to whom HLF owed a particularly high duty;
d. It is a general rule under the common law that a distributor is liable for
selling a "defective" product, evenif the distributor hadno reason to be aware of the defect; and
e. Morgan Stanley was aware of MAS' broad regulatory power.
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VIII. COUNTS
COUNT I
(Fraud: All Defendants)
223. HLF incorporates by reference the allegations contained in the preceding
paragraphs of this Complaint.
224. This Count is assertedagainstMorgan Stanley& Co., Inc. It is also asserted
against any of Morgan Stanley's co-defendants (if any) that ultimately are found not to be
Morgan Stanley's alter ego.
225. Morgan Stanley & Co., Inc. made, directly and through its control of the co-
defendants, materially false andmisleading representations andomissions concerning the
Pinnacle Notesand the single-tranche CDOs serving as Pinnacle Notes' underlying assets.
226. Defendants intentionally and materially misrepresented to HLF that the Pinnacle
Notes constituted a safe, conservative investment, andthatthe purpose of the underlying assets
(into which the principal raised by the Pinnacle Notes would be reinvested) wasprincipal
preservation. The Pinnacle Notes would have been unmarketable and would not have been
issued but for these misleading statements and omissions.
227. Defendants also failed to disclose the following material information in the
Offering Documents, which rendered theirrepresentations false andmisleading: (i) that Morgan
Stanley, pursuant to a non-arm's-length transaction, was going to investthe funds raised by
investors' purchase of Pinnacle Notes intosingle-tranche CDOs of Morgan Stanley's own
making, in whichMorganStanley held interests directly opposite to those of investors; (ii) the
structure and mechanics of the single-tranche CDOs, including the fact that the single-tranche
CDOs hadbeen structured such thateach dollar lostby Customers would be a dollar gained by
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Morgan Stanley; (iii) that the Synthetic CDOs were designed to fail, and thereby redound to
Morgan Stanley's benefit; and (iv) that this was Defendants' plan all along.
228. Morgan Stanley made these false and misleading representations and omissions in
the Offering Documents knowingly, recklessly, without regard for their truth or falsity, and with
the intent to induce HLF to rely upon them by marketing the Pinnacle Notes to Customers.
229. Morgan Stanley's conduct was malicious, willful, and wanton because it intended
that its conduct would injure HLF. In the alternative, Morgan Stanley was no less than
recklessly indifferent to the possibility that its conduct would injure HLF.
230. HLF reasonably relied on Morgan Stanley's materially misleading statements and
omissions. Indeed, they went to the core of the reasons HLF agreed to market the Pinnacle
Notes - the amount and nature of risk associated with the Pinnacle Notes, and the determination
that the rates of return associated with the Pinnacle Notes adequately compensated investors for
such risks.
231. HLF had no knowledge of and no way to know that the underlying assets would
be single-tranche CDOs that had been built by Morgan Stanley to fail and, once failing, to effect
the transfer of the vast majority of approximately $72.4 million from Customers to Morgan
Stanley. HLF believed in and relied upon Morgan Stanley's good faith, among other reasons
because of its roles as creator of the Pinnacle Notes and as selector of the underlying assets into
which the principal raised by the Pinnacle Notes would be invested.
232. As a direct and proximate result of HLF's reliance upon the false representations
and omissions of Morgan Stanley, HLF was compelled to pay more than $32 million (so far) to
its Customers to partially compensate them for losses they suffered as a result of Morgan
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Stanley's fraud. HLF also has lost substantial goodwill with Customers and potential customers,
in an amount to be proven at trial.
COUNT II
(Fraudulent Inducement to Contract: Morgan Stanley, PPL,MS International, and MS Singapore)
233. HLF incorporates by reference theallegations contained in the preceding
paragraphs of this Complaint.
234. This Count is asserted against Morgan Stanley & Co., Inc. It is also asserted
against PPL, MS International, and/or MS Singapore if anyof those entities is found not to be
Morgan Stanley & Co., Inc.'s alter ego.
235. Morgan Stanley& Co., Inc. made, directlyand through its controlof the co-
defendants, materially false and misleading representations and omissions concerning the
Pinnacle Notes andthe single-tranche CDOs serving as Pinnacle Notes' underlying assets.
236. Morgan Stanley & Co., Inc. andthe co-defendants named above intentionally and
materially misrepresented to HLF that the PinnacleNotes constituted a safe, conservative
investment, andthat the purpose of the underlying assets (into which the principal raised bythe
Pinnacle Notes would be invested) was principal preservation. The Pinnacle Notes would have
beenunmarketable and would not have been issued but for these misleading statements and
omissions.
237. Morgan Stanley & Co., Inc. and the co-defendants named above also failed to
disclose the following material information in the Offering Documents, which renderedtheir
representations false and misleading: (i) thatMorgan Stanley, pursuant to a non-arm's-length
transaction, was going to invest the funds raised by investors' purchase of PinnacleNotes into
single-tranche CDOs of Morgan Stanley's own making, in which Morgan Stanley held interests
directly opposite to those of investors; (ii) thestructure andmechanics of the single-tranche
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CDOs, includingthe fact that the single-tranche CDOshad been structured such that each dollar
lost by Customers would be a dollar gained by Morgan Stanley; (iii) that the Synthetic CDOs
were designed to fail, and thereby redound to Morgan Stanley's benefit; and (iv) that this was
Defendants' plan all along.
238. Morgan Stanley & Co., Inc. and the co-defendants named above made these false
and misleading representations and omissions in the Offering Documents knowingly, recklessly,
without regard for their truthor falsity, and withthe intent to induce HLF to enter into the
Distribution Agreement as a result of them.
239. Morgan Stanley's conduct was malicious, willful, and wanton because it intended
that itsconduct would injure HLF. Inthe alternative, Morgan Stanley was no less than
recklessly indifferent to the possibility that itsconduct would injure HLF.
240. HLF reasonably relied on thematerially misleading statements andomissions.
Indeed, they went to the core of the reasons HLF agreed to market the Pinnacle Notes - the
amount and nature of risk associated with the PinnacleNotes, and the determinationthat the rates
of return associated with the Pinnacle Notes adequately compensated investors for such risks.
241. HLF had no knowledge of and noway to know that the underlying assets would
be single-tranche CDOs that had been built by Morgan Stanley to fail and, once failing, to effect
the transfer ofthe vast majority ofapproximately $72.4 million from Customers toMorgan
Stanley. HLF believed inand relied upon Morgan Stanley's good faith, among other reasons
because of its roles as creator ofthe Pinnacle Notes and as selector ofthe underlying assets into
which the principal raised by the PinnacleNotes would be invested.
242. As a direct and proximate result ofHLF's reliance upon the false representations
and omissions of Morgan Stanley, HLF entered into the Distribution Agreement. Because HLF
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entered into the Distribution Agreement, it has been compelled topay approximately $32 million
(so far) to Customers to partially compensate them for losses they suffered as a result ofMorgan
Stanley's fraud. HLF also has lost substantial goodwill with Customers and potential customers,
in an amount to be proven at trial.
COUNT III
(Negligent Misrepresentation: AH Defendants)
243. HLF incorporates byreference the allegations contained in the preceding
paragraphs of this Complaint.
244. This Count is assertedagainst MorganStanley& Co., Inc. It is also asserted
against Morgan Stanley & Co., Inc.'s co-defendants to the extent thatanyof them is found not to
be Morgan Stanley's alter ego.
245. Based on its unique and special expertise with respect to the Pinnacle Notes and
underlying assets, Defendants hada special relationship of trust or confidence withHLF, which
createda duty on the part of Defendants to impart full and correct informationto HLF.
246. Defendants materially misrepresented to HLF, in connection with Customers'
investment in the Pinnacle Notes, that the Pinnacle Notes were a safe, conservative investment,
and that the purpose of the underlying assets - into which the principal raised bythe Pinnacle
Notes would be invested- was principalpreservation. The PinnacleNotes would have been
unmarketable andwould nothave been issued but for these misleading statements andomissions.
247. Defendants failed to disclose the following material information in theOffering
Documents which, among other things, rendered their representations false and misleading: (i)
that Morgan Stanley, pursuant to a non-arm's-length transaction, was going to invest thefunds
raised by investors' purchase ofPinnacle Notes into Synthetic CDOs ofMorgan Stanley's own
making, in which Morgan Stanley held interests directly opposite to those of investors; (ii) the
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structure andmechanics of the Synthetic CDOs, including thefact thatthe Synthetic CDOs had
been structured such that each dollar lost by investors would be a dollar gained by Morgan
Stanley; (iii) that theSynthetic CDOs were designed to fail, and thereby redound to Morgan
Stanley's benefit; and (iv) thatthis was Defendants' scheme all along.
248. Morgan Stanley wasnegligent in making these false andmisleading
representations and omissions.
249. Morgan Stanley breached its duty of care to HLF in making these false and
misleading representations and omissions.
250. As a direct, foreseeable and proximate result of Morgan Stanley'snegligent false
representations and omissions, HLF has been compelled to payapproximately $32 million (so
far) to Customers to partially compensate them for losses they suffered as a result of Morgan
Stanley's negligent misrepresentations. HLF also has lost substantial goodwill from Customers
and potential customers, in an amount to be proven at trial.
COUNT IV
(Breach of Contract: Morgan Stanley, PPL, and MS Singapore)
251. HLFincorporates by reference the allegations contained in the preceding
paragraphs of this Complaint.
252. This Count is assertedagainstMorgan Stanley & Co., Inc. It is also asserted
against PPL and/or MS Singapore, in theevent thateither is found not to be Morgan Stanley &
Co., Inc.'s alter ego.
253. TheDistribution Agreement obligates Morgan Stanley & Co., Inc. (through PPL
and MS Singapore) to compensate HLF for losses incurred in connection with the Pinnacle
Notes.
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254. Specifically, the Agreement obligates Morgan Stanley &Co., Inc. to"fully and
effectively indemnify [HLF] from and against all losses, liabilities, costs, charges and expenses
arising directly or indirectly outof any claims which are brought against [HLF]." Ex. C
("Distribution Agreement") at ^ 14.1.
255. As explained above, MAS required HLF to settle the claims of Customers for
losses relating to the Pinnacle Notes. These were "claim[s]" under themeaning of the
Distribution Agreement.
256. TheDistribution Agreement required HLF to notify Morgan Stanley in writing in
the event that it mightrequire indemnification. See Ex. C. at ^ 14.1.
257. On March 5, 2009, thePresident of HLF, IanMacdonald, sent a letter to Morgan
Stanleyasking if it would be willingto participate in the claimsprocess beforethe MAS that
related to Customers' losses from Morgan Stanley's Pinnacle Notes.
258. On March 9, 2009, Mr. Macdonald again wrote Morgan Stanley asking it to
participate. In this letter, he emphasized thatMAS would "require" action on HLF'spart in the
near future.
259. Morgan Stanley flatly refused to participate.
260. Morgan Stanley's refusal breached (or was an anticipatory breach of) its
obligation to indemnify HLF.
261. The Distribution Agreement requires Morgan Stanley to reimburse HLF for all
money paidto claimants (Customers), as well as all "costs, charges andexpenses arising directly
or indirectly out of any claim" and "any legal or other expenses."
262. MorganStanleywillfully frustrated HLF's rights under an unambiguous contract.
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263. As a direct, foreseeable andnatural result of Morgan Stanley & Co., Inc.'s, PPL's,
and MS Singapore's breach of contract, HLF has been compelled to pay approximately $32
million (so far) to Customers to partially compensate them for losses they suffered as a result of
Morgan Stanley's fraud. HLF also has incurred substantial expenses, including legal fees.
Morgan Stanley is required to compensate HLF for all such claims payments and expenses.
COUNT V
(Breach of Contract - Breach of the Implied Covenant ofGood Faith and Fair Dealing: Morgan Stanley, PPL, and MS Singapore)
264. HLF incorporates by reference the allegations contained in the preceding
paragraphs of this Complaint.
265. This Count is asserted against Morgan Stanley & Co., Inc. It is also asserted
against PPL and/or MS Singapore, in theevent thateither is not found to be Morgan Stanley &
Co., Inc.'s alter ego.
266. The Distribution Agreement obligates Morgan Stanley & Co., Inc. (through PPL
and MS Singapore) to compensate HLF for losses related to the Pinnacle Notes.
267. The Distribution Agreement also provides that Morgan Stanley shall not "be
liable in respect of any settlement of any such action effected without its written consent." See
Ex. Catf 14.1.
268. The entirety of *j[ 14.1 (the "Indemnification Clause") would be a nullity if
Morgan Stanley could withhold such consent unreasonably and in bad faith.
269. It was unreasonable and in bad faith for Morgan Stanleyto refuse to participate in
the MAS claimsprocess afterbeingrepeatedly invited to participate by HLF, particularly
without providing any reasonable rationale for its decision. Morgan Stanley therebybreached its
implied duty of good faith and fair dealing with respect to the IndemnificationClause.
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270. TheDistribution Agreement requires Morgan Stanley to reimburse HLF for all
money paid to claimants (Customers), as well as all "costs, charges and expenses arising directly
or indirectly outof anyclaim" and "anylegal or other expenses."
271. Asa direct, foreseeable and natural result of Morgan Stanley & Co., Inc.'s, PPL's,
and MS Singapore's breach of the implied covenant ofgood faith and fair dealing, HLF has been
compelled to pay approximately $32 million (so far) to Customers to partially compensate them
for losses they suffered as a result of Morgan Stanley's fraud. HLF also has incurred substantial
expenses, including legal fees. Morgan Stanley is required to compensate HLF for all such
claims payments and expenses.
COUNT VI
(Equitable Subrogation: All Defendants)
272. HLF incorporates byreference the allegations contained in thepreceding
paragraphs of this Complaint.
273. This Count is assertedagainst MorganStanley& Co., Inc. It is also asserted
against any of Morgan Stanley's co-defendants in the event that any is not found to be Morgan
Stanley's alter ego.
274. This Count is asserted in the alternative, if Morgan Stanley is found not to have a
contractual obligation to indemnify HLF.
275. As explained above, MAS required HLF to compensate Customers for losses they
suffered asa result ofMorgan Stanley's wrongful actions. HLF's provision of compensation
wasnotvoluntary; rather, it was necessary to protect HLF's legal andeconomic interests.
276. It is unjust andmanifestly unfair for HLF to be required to payfordamages
Customers incurred as a result of Morgan Stanley's wrongdoing. Justice requires thatMorgan
Stanley be responsible for paying for the results of its wrongdoing.
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277. HLF is entitled to assert against Defendants all claims that Customerswould have
had, had HLF not provided compensation tothose Customers. HLF incorporates by reference all
claims included within the class complaint asdirect claims asserted byHLF against all
Defendants underthe doctrine of equitable subrogation.
RELIEF REQUESTED
WHEREFORE, HLF requests that the Court enterjudgment against Defendants,awarding the following relief:
(A) Compensatorydamages, including loss of goodwill;
(B) Punitive damages for Defendants' gross, oppressive, aggravated conduct, or anyconduct that involved a breach of trust or confidence;
(C) Prejudgment andpost-judgment interest on suchmonetary relief;
(D) The costs of bringing this suit, including reasonable attorneys' fees andcosts asprovided by § 14.1 of the Master Distributor Appointment Agreement; and
(E) All other reliefto which HLF may beentitled that the Court deems proper.
JURY TRIAL DEMANDED
HLF hereby demands a trial by jury.
Dated: August 06, 2012
974839.11
Respectfully submitted,
David S. StellingsJason L. Lichtman
LIEFF CABRASER HEIMAlj250 Hudson Street, 8th FloorNew York, NY 10013-1413Telephone: (212)355-9500Facsimile: (212) 355-9592
Attorneysfor Plaintiffs
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& BERNSTEIN, LLP