Did MS Screw This Hedge Fund?

Time to put on your thinking caps, fellas. Because unless I'm missing something, Morgan Stanley has attempted one of the most audacious screw jobs that I can remember. And I have a long memory for these kinds of things.

The bank is being sued by Hong Kong-based hedge fund Oasis Management for CD $9.5 million because Oasis says Morgan Stanley reneged on Sino-Forest put options the hedge fund purchased prior to the collapse in the stock. Morgan is refusing to pay off because Sino-Forest has been suspended for trading.

Oasis bought the puts on May 12 for $770,000. The stock was at $20.50. Three weeks later the now famous Muddy Waters report was released, cratering the stock to $5. When Sino-Forest shares were suspended from trading, Morgan Stanley offered Oasis $3.8 to cancel the put options. Oasis said no way, and isn't willing to settle for less than $7.5 million.

My question is this: if you're Oasis and you didn't sell the puts prior to the trading suspension, wouldn't you be holding a total loss if the options expired before the stock started trading again? In that case, the Morgan Stanley offer looks generous.

On the other hand, this could just be a blatant attempt by a bank to screw its customer and limit its own liability. If the stock never trades again, isn't that the same thing as holding a put until the stock hits zero?

Granted this is a strange case, because Sino-Forest is expected to be suspended from trading for months, and may never resume trading. I'm looking for analysis here guys, especially from the option traders. I've got a lot of experience trading options, but I've never seen a case like this.

Is Morgan Stanley screwing Oasis, or should Oasis have taken the settlement offer and been grateful? What do the regs say in a case like this?

 

Crucial point you didn't mention that I expect Frieds can expand on in greater depth. Was there a reasonable expectation by Morgan or any other intelligent investor that Sino-Forest was doing shoddy business. If MS had reason to believe SF was shoveling shit into the gold bin and piss painting it, their offer not only should have been taken but was made with benevolent intent with regards to all parties involved. I am never one to feel sorry for a BB but they definitely made a generous enough offer to where Oasis should have thought about it. The main issue here is, are you really expecting any court anywhere to rule against MS in a situation where they made a reasonable offer? I doubt this is more than hubris and I suspect Oasis to be in for the business end of the shaft.

 

It's not always about how the contract is written. All you need in an options contract is to exact only 6 points. They are:

1) whether the option holder has the right to buy (a call option) or the right to sell (a put option) 2) the quantity and class of the underlying asset(s) (e.g., 100 shares of XYZ Co. B stock) 3) the strike price, also known as the exercise price, which is the price at which the underlying transaction will occur upon exercise 4) the expiration date, or expiry, which is the last date the option can be exercised 5) the settlement terms, for instance whether the writer must deliver the actual asset on exercise, or may simply tender the equivalent cash amount 6) the terms by which the option is quoted in the market to convert the quoted price into the actual premium – the total amount paid by the holder to the writer of the option.

That's all you need. As to whether or not there is a contract between MS and Oasis, we do not necessarily know. And if this term wasn't defined, we can argue that this becomes a matter of what the jurisdictional law states.

Well, we first need to resolve the issue of Jurisdiction. Whatever jurisdiction is applied dictates the nature of the rules. We have three possible options, Hong Kong, Canada and the 2nd Circuit Court in the Southern District of New York. If we are looking at Hong Kong, they are going to use Hong Kong Basic Law, which may or may not have the ability to comment with respect to an options contract made between a US Firm over a Canadian issued security.

I would assume we have to consider this to be a matter of Common Law, as this would be heard in either Canada or the 2nd Circuit SDNY, but then it's a question of whether we can further apply the UCC Article 8 or not. I'm not sure if Canada has a UCC in similar form to ours or not. Assuming we have to follow the common law, this then becomes a matter of whether fraudulent activity on behalf of an underlying third party upon whose performance the option contract is based is considered invalid when fraud is introduced. Likewise, assuming the contract is valid, the question becomes how can you value an underlying asset that has no apparent value under the common law with respect a contractual obligation.

 
Frieds:
It's not always about how the contract is written. All you need in an options contract is to exact only 6 points. They are:

1) whether the option holder has the right to buy (a call option) or the right to sell (a put option) 2) the quantity and class of the underlying asset(s) (e.g., 100 shares of XYZ Co. B stock) 3) the strike price, also known as the exercise price, which is the price at which the underlying transaction will occur upon exercise 4) the expiration date, or expiry, which is the last date the option can be exercised 5) the settlement terms, for instance whether the writer must deliver the actual asset on exercise, or may simply tender the equivalent cash amount 6) the terms by which the option is quoted in the market to convert the quoted price into the actual premium – the total amount paid by the holder to the writer of the option.

That's all you need. As to whether or not there is a contract between MS and Oasis, we do not necessarily know. And if this term wasn't defined, we can argue that this becomes a matter of what the jurisdictional law states.

Well, we first need to resolve the issue of Jurisdiction. Whatever jurisdiction is applied dictates the nature of the rules. We have three possible options, Hong Kong, Canada and the 2nd Circuit Court in the Southern District of New York. If we are looking at Hong Kong, they are going to use Hong Kong Basic Law, which may or may not have the ability to comment with respect to an options contract made between a US Firm over a Canadian issued security.

I would assume we have to consider this to be a matter of Common Law, as this would be heard in either Canada or the 2nd Circuit SDNY, but then it's a question of whether we can further apply the UCC Article 8 or not. I'm not sure if Canada has a UCC in similar form to ours or not. Assuming we have to follow the common law, this then becomes a matter of whether fraudulent activity on behalf of an underlying third party upon whose performance the option contract is based is considered invalid when fraud is introduced. Likewise, assuming the contract is valid, the question becomes how can you value an underlying asset that has no apparent value under the common law with respect a contractual obligation.

When you buy an option, or any security for that matter, there is an implicit contract that binds the buyer and seller. This applies to whether it's an exchange or an OTC.

Here's an example for if you buy FTSE index options on the Euronext. You can google and find them. They exist for any security, I guarantee you. http://www.euronext.com/fic/000/027/346/273468.pdf

Lawyers for each side will find the relevant passages and advise their clients accordingly. My view, is that MS is screwing them over because it sounds like an OTC contract they held on their books (otherwise, why would MS care or be sued?). I'm sure there's a contract.

If the contract does not state it, then there will be some sort of default common law applied. I would be quite hesitant to say that fraud on behalf of SinoForest somehow invalidates the contract. That's like saying that if I had puts on Enron they would be worthless because the company cooked the books. I don't think that has any say at all. It will simply have to do with what the exercise valuation provision is within the contract for a derivative which is not trading. My guess, if I were writing the contract, would be some sort of arbitration provision whereby in the event of trading disruption through to expiry, the parties delegate the valuation of the derivative to an independent (or two) third party(ies) that would then arrive at an appropriate estimate for valuation. If there is nothing explicitly stated in the contract about valuation in the event of non-trading (I think this is unlikely), well then I don't know what case law says, but the law usually tries to be fair in the event that nothing contractual exists and there is no prior case law or statute that applies; in which case MS would lose.

 
Best Response

I'm pretty sure that MS doesn't have to pay.

If the HF has the shares to sell that is fine and MS must buy them, but if it is a matter of buying back a put option then MS has no obligation. A market maker can say no and no give a price on an instrument. A market maker isn't an automatic liquidity put---they just can't say no too often or else they lose respect and customers. It sounds like MS even gave them a "price" but they turned it down and wanted the full payout.

"Greed, in all of its forms; greed for life, for money, for love, for knowledge has marked the upward surge of mankind. And greed, you mark my words, will not only save Teldar Paper, but that other malfunctioning corporation called the USA."
 

Gekko, I think we can assume that this is a settlement issue on the execution of exercise. Settlement implies an exercised option, not a buyback of an option. If this were a sale of the option itself, then MS can say no, but clearly this is not the case.

 

Futures, nope. No they don't. Again, you are looking at this from the perspective of a trader and not a lawyer. In the eyes of a trader, an options contract needs to be settled if executed. In the eyes of a lawyer, an options contract may be deemed unenforceable if a situation arises for which parties are exposed to fraudulent behavior. This does extend to the underlying entity.

You have the underlying entity engaging in fraud. A contract made where both parties were ignorant of the underlying actor's engagement in fraud may be deemed unenforceable, but it's a matter of which law we are applying to the view of the contract. There is enough Common Law that can be applied to this to resolve the matter, however, it depends on where the case is being venued. Are we going to look at Common Law under the Crown or are we looking at Common Law under American Jurisprudence? It's pretty straight forward that there is no clear answer without having a copy of the options contract between Oasis and MS on hand for review, as it sounds like a bespoke deal between the two. If that is the case, then even more questions arise from this. It's not a cut and dry issue here.

 

blastoise, not all contracts are contracts. Trust me on that one. There are 2 restatements of Contract law and hundreds of volumes of cases from the early King's Bench to today concerning the enforceability of contracts. Fraud with respect to contracts has its own basis for enforcement. This goes doubly true for issues that fall under Article 8 of the UCC governing Financial Instruments and transactions, as if the issue is not there, the common law is applied to the matter at hand.

 

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