The appellate division of the Supreme Court of New York
refused to dismiss a fraud suit filed by China Development Industrial Bank
against Morgan Stanley (MS)
over the sale of collateral debt obligations backed by low-quality mortgages.
In the complaint, the international bank accuses Morgan Stanley of concealing underlying risks associated with CDOs sold to the firm.
The court ruled "China has sufficiently alleged that Morgan possessed peculiar knowledge of the facts underlying the fraud."
The finding means the international bank can go ahead with its complaint against the investment bank, which includes claims of fraud, fraud in the inducement and fraudulent conceal of an investment product.
Manal Mehta with Branch Hill Capital
calls the case significant, saying it could encourage claims from other international investors and pension funds that acquired similar investment products. He argues prior to the ruling, investors may have felt it was too difficult for a sophisticated investor -- such as an investment bank -- to maintain fraud claims over a soured investment deal.
That could change with the appellate court sustaining the suit, Mehta advised.
"It's a huge development," he asserted. "Now buyers of these CDOs are going to come back and say more importantly what was represented to the ratings agencies."
Mehta says its probable CDO buyers will come back against the products' sellers claiming the firms "created these securities to offload their garbage onto us."
Write to Kerri Panchuk.