Morgan Stanley was accused in a lawsuit Tuesday of defrauding investors in a collateralized debt obligation, called the Libertas CDO, by collaborating with ratings companies to get AAA ratings for the notes.

Morgan Stanley arranged the offering as it was short-selling almost the entire $1.2 billion worth of assets in the CDO, according to a complaint filed in U.S. District Court in New York.

"Morgan Stanley was betting the entire investment it was promoting would fail," the public employees' retirement system of the Virgin Islands said in the complaint. "The firm achieved its objective."

The notes, due 2045, collapsed in value, according to the complaint, which includes claims for fraud and unjust enrichment. AAA is the highest rating for fixed-income instruments.

The portfolio was 92% residential mortgage-backed securities and included exposure to more than $130 million of loans from Option One Mortgage Corp. and $100 million from New Century Mortgage Corp., both lenders to homebuyers with poor credit scores, according to the complaint.

Alyson Barnes, a spokeswoman for Morgan Stanley, declined to comment.

The retirement system seeks class-action status.

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