Morgan Stanley vs. the nuns

August 13, 2010 | By Jim Kim

Recall that earlier this week, the Sisters of Charity of Jesus and Mary in Hertfordshire, England, and the Holy Faith Sisters in Dublin, Ireland were among a group of roughly 90 investors that sued Morgan Stanley (NYSE: MS) over some soured bond derivatives that tanked.

The investors allege that Morgan Stanley caused these losses. Morgan Stanley, however, responds that it sold the product directly to Bloxham, an Irish brokerage firm who then sold them to the nuns and other clients. Morgan Stanley is thus arguing that this is a suitability case involving the brokerage. That makes sense on the surface. But the facts as related by CNBC are quite interesting.

In 2009, the bonds that underlied the swaps were downgraded to junk by Moody's--which should have prompted Morgan Stanley to sell the bonds immediately. Instead, the firm waited five months to sell the Dresdner bonds--during which period the bonds actually rose slightly in value, according to Morgan. But the investor suit "argues that the delay deprived Bloxham of an opportunity to buy Dresdner bonds at the earlier date, a move that might have allowed it to restore some of the losses the nuns and other investors had already sustained."

But didn't the swaps recover over that time? If Morgan had a contractual obligation to sell at certain, the case might be stronger. At some point, if you opt for a legal strategy to recoup losses, you might as well cast a wide net.

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