Morgan Stanley (MS) has been sued by a Virgin Islands pension fund that has accused the bank of defrauding investors in a collateralized-debt obligation, called the Libertas CDO, by marketing $1.2 billion of risky mortgage-related notes that it expected to fail, media reports said Tuesday. Reports said that according to a lawsuit filed in federal court in New York by the public employees' retirement system of the Virgin Islands, Morgan Stanley collaborated with credit rating agencies Moody's Investors Service and Standard & Poor's to obtain "Triple-A" ratings for notes marketed in 2007 as part of Libertas. "Triple-A" is the highest rating for fixed-income instruments.
The complaint reportedly said, "By collaborating with major credit-rating agencies to place Triple-A ratings on the rated notes, Morgan Stanley intentionally or recklessly misled investors in the Libertas CDO. But for Morgan Stanley's violations of law, the rated notes never would have been issued."
Collateralized-debt obligations or CDOs typically repackage bonds and other assets into new securities. According to the complaint, the Libertas CDO did not buy the mortgage-backed securities and instead, entered into credit-default swaps that referenced mortgage-backed securities.
Credit-default swaps are financial instruments that function as insurance for bondholders. As the credit-protection buyer, Morgan Stanley was shorting the securities, or betting they would fall in value.
The notes, due 2045, collapsed in value, according to the complaint, which includes claims for fraud and unjust enrichment. The complaint reportedly said the CDO was backed by low-quality assets, including securities issued by subprime lenders New Century Financial Corp., which quickly went bankrupt, and Option One Mortgage Corp, then owned by H&R Block Inc (HRB).
The portfolio was reportedly 92% residential mortgage-backed securities, and included exposure to more than $130 million in loans from Option One Mortgage and $100 million from New Century Mortgage.
According to reports, the complaint said Morgan Stanley knew securities in the Libertas CDO were suffering a dramatic rise in delinquencies, but provided a misleading "risk factor" in a prospectus that rising delinquencies "may" hurt values in the $1 trillion residential mortgage-backed securities market.
The lawsuit seeks class-action status, and also seeks compensatory and punitive damages, among other remedies.
MS closed Tuesday's regular trading session at $29.43, up $0.14 or 0.48% on a volume of 7.72 million shares.
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June 05, 2026 16:18 ET A busy week for economic news flow saw a slew of reports being released that reflected the trends in the U.S. labor market. In Europe, economic growth and inflation data gained attention as the European Central Bank and Bank of England head for policy session later in the month. In Asia, the monetary policy session of the Indian central bank was in focus as the country, a major oil importer, reels under the pressures of a weaker rupee and rising inflation.