Morgan Stanley & Co. last Monday filed a lawsuit seeking damages of $40.6 million from hedge fund Peak Ridge Master SPC Ltd. for allegedly defaulting on bad bets made on natural gas trades.

The lawsuit, accusing Peak Ridge of defaulting on its contracts with Morgan Stanley, was brought in the U.S. District Court for the Southern District of New York. New York-based Morgan Stanley is a futures commission merchant (FCM) that executes and clears commodity futures trades for customers, such as Peak Ridge. It acted as an FCM on Peak Ridge’s behalf, purchasing, selling and/or clearing natural gas futures and options on futures.

Peak Ridge, which is incorporated in the Cayman Islands and based in Bermuda, trades a variety of futures and derivatives in the natural gas markets, including futures and options on futures. “Each of the instruments purchased and sold by Peak Ridge in its Morgan Stanley account is a highly leveraged, risky and speculative bet on the underlying natural gas markets,” Morgan Stanley said in the lawsuit.

On June 4, 2010 the Peak Ridge account lost $9.8 million in a single day, reducing the account’s net liquidation value (NLV) to about $15 million from approximately $25 million, and leaving the hedge fund significantly below its required 4.5:1 minimum margin ratio, Morgan Stanley told the court. As a result of the loss Morgan Stanley increased the minimum margin ratio to 6:1.

But by the close of business on June 9 Peak Ridge allegedly had not satisfied the 6:1 margin ratio, and Morgan Stanley said it declared the hedge fund in default and terminated Peak Ridge’s access to its account.

“On July 29…Morgan Stanley sent Peak Ridge a written demand for payment of approximately $40.6 million, the estimated amount then due and owing from Peak Ridge for losses incurred by Morgan Stanley arising out of or related to the positions established by Peak Ridge in its Morgan Stanley account. In breach of the customer agreement, Peak Ridge failed to pay these amounts rightfully due to Morgan Stanley under the customer agreement,” the investment bank said in the lawsuit.

As a result of Peak Ridge’s default, Morgan Stanley said it “has suffered substantial money losses.”

The lawsuit has some parallels with the collapse of the multi-million hedge fund Amaranth Advisors in 2006. Brian Hunter, the gas trader behind the $6 billion loss that buried Amaranth four years ago provided trading strategy advice to Peak Ridge as the fund was starting out, Reuters reported.

After the Amaranth debacle, Hunter tried to set up a new hedge fund, Solengo Capital Partners. But his efforts were blocked by regulators who found his trading practices to be questionable. He eventually sold Solengo’s assets to Peak Ridge Capital Group and was hired by the firm as an adviser.

Earlier this year a Federal Energy Regulatory Commission (FERC) administrative law judge issued an initial decision finding that Hunter had manipulated the gas futures market between February and April 2006, which subsequently took a toll on physical gas contracts over which FERC has jurisdiction (see NGI, Feb. 1). Hunter faces up to $30 million in penalties if the manipulation claims are upheld by the Commission.

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