In a suit filed Monday in the US District Court for the Southern District of New York, Morgan Stanley said traders at Bermuda-based Peak Ridge repeatedly exceeded their margin limits in nine months of trading until the fund was crushed by a sudden spike in gas futures prices in June.
Morgan Stanley said in court papers that Peak Ridge opened its account in September 2009 with the bank acting as the fund's futures commission merchant (FCM) for trading of futures, options on futures and calendar spread options.
Morgan Stanley said Peak Ridge initially traded with a 2-to-1 margin limit -- having to post twice as much collateral as it had risk in its portfolio -- but the bank tightened up its limits throughout the year.
On June 3, Morgan Stanley said Peak Ridge's margin was raised to 4.5-to-1and the next day the hedge fund's gas futures book lost $9.8 million, dropping in value from $25 million to $15 million.
Gas futures prices surged 20% higher in the first two weeks of June as power demand peaked as a result of hot weather. Traders who bet on prices falling on surging gas supplies were caught short by the move.
Even after losing nearly $10 million in a day, Morgan Stanley let Peak Ridge continue trading, increasing its margin ratio to 6-to-1, according to court papers.
Peak Ridge told the bank on June 9 that it wouldn't be able to post enough cash to meet the 6-to-1 threshold and on June 10 the bank took over the book.
Morgan Stanley said it traded out of Peak Ridge's portfolio over the next two weeks, eventually taking $40.6 million on losses.
Hunter was formerly the top gas futures trader at Amaranth Advisors, a Greenwich, Connecticut-based hedge fund that imploded in September 2006 with more than $6 billion in losses after the market turned the wrong way on Hunter's bets on the futures price spreads between winter 2007 gas and summer 2007 gas.
Hunter advised Peak Ridge in 2007, a year after Amaranth went belly up, and didn't stay long, leaving that fund in 2008, more than a year before Morgan Stanley says the Bermuda fund blew up, allegedly costing the investment bank millions of dollars.
