* Germany's HSH Nordbank not excused from losses
* "Near-total" loss on $500 mln investment alleged
* NY state appeals court reverses lower court filing
By Jonathan Stempel
March 27 Germany's HSH Nordbank AG may not pursue a fraud case against UBS AG over a soured $500 million mortgage investment, a New York appeals court ruled on Tuesday, reversing a lower court.
A five-justice panel of the New York State Appellate Division in Manhattan unanimously found that HSH had not been misled into assuming the risk of default on part of a $3 billion credit default swap transaction.
The underlying portfolio was composed mainly of mortgage-backed securities and instruments from real estate investment trusts. Many went into default in 2008 as property values collapsed.
HSH claimed that UBS intended to move securities in and out of the portfolio to minimize its own risk and benefit from pricing inefficiencies, creating a conflict of interest.
But the appeals court said HSH could not recover for its alleged "near-total loss" from having bought $500 million of notes tied to the 2002 transaction, known as North Street Referenced Linked Notes, 2002-4 Ltd (NS4).
"However much UBS's alleged conduct leaves to be desired as a matter of business ethics, the undisputed documentary evidence and HSH's own allegations eliminate, as a matter of law, any reasonable inference that HSH justifiably relied on the representations of which it now complains," Justice David Friedman wrote for the panel.
The case is one of many accusing major lenders of misleading investors or insurers about the risks of mortgage and other real estate investments.
Tuesday's decision reversed an October 2009 ruling by New York State Supreme Court Justice Richard Lowe allowing HSH to pursue its fraud claims. Lowe dismissed other claims raised by HSH.
Philippe Selendy, a lawyer for HSH, did not immediately respond to a call for comment. UBS spokeswoman Karina Byrne also did not immediately respond to a request for comment.
HSH accused UBS of professing a misleading "faith" in models used by credit rating agencies to assess the portfolio's risks, even as it rejected those models for its own use.
It contended that UBS engaged in a form of "ratings arbitrage" by selecting securities for the portfolio that were mispriced relative to their ratings, and then using its own superior knowledge to profit from those discrepancies.
Friedman said, however, that HSH was a sophisticated investor that had assented to UBS's "inherent conflicts of interest" in managing the portfolio, and had been warned of the risks.
"HSH could have uncovered any misrepresentation of the risk of the transaction through the exercise of reasonable due diligence within the means of a financial institution of its size and sophistication," the justice wrote.
The case is HSH Nordbank AG v. UBS AG et al, New York State Supreme Court, Appellate Division, 1st Department, No. 4677.