(FORTUNE Magazine) – Is Morgan Stanley excessively combative with regulators and the courts? That's what its critics charge, and if a $2.7 billion lawsuit brought by billionaire investor Ronald Perelman is any indication, they have a point. Perelman claims that Morgan Stanley conspired with Sunbeam to fraudulently inflate the value of Sunbeam shares that Perelman received in 1998 in exchange for shares he owned in camping-gear-maker Coleman. (Sunbeam, which manufactures small appliances, is now owned by American Household.)

Because of its litigation tactics, Morgan Stanley is being forced to fight the case with one hand tied behind its back. In late March the judge ruled that the firm and its lawyers had "deliberately and contumaciously violated numerous discovery orders," made "false representations" to the court, and chosen to "hide information about its violations." The judge was incensed and so concerned that Perelman's ability to make a case had been harmed that she imposed a highly unusual punishment: She ruled that the jurors must assume that Morgan Stanley had in fact conspired with Sunbeam to defraud Perelman. That means the bankers are not permitted to deny the fraud or litigation misconduct (both of which they vociferously dispute outside court) or even mention their view that they were victimized by Sunbeam, losing $300 million in loans that were never repaid.

With the fraud issue determined, jurors heard testimony on the other key question: whether Perelman had actually relied on the information from Morgan Stanley. (The notion that one of the savviest, richest investors in the world was dependent on bankers for the other side caused chuckles on Wall Street, but Florida law apparently does not have a provision for irony.) On this issue, Morgan appears to have a strong case. Perelman's advisors, in early trial testimony, showed little sign of having relied on Morgan Stanley--and gave plenty of indications that they had had questions about Sunbeam before Perelman agreed to the deal. One Perelman expert was forced into uncomfortable contortions to explain why it made sense for Perelman to ignore a front-page Barron's article, eight months before the deal, that warned of accounting games at Sunbeam. (That evidence cuts both ways. Why was Morgan representing such a company?) But even on this issue, Morgan was hamstrung. Every time Morgan scored a point, it seemed, the judge undercut it, with an instruction to the jury that "Morgan Stanley cannot claim that [Perelman] could or should have investigated whether statements made to it were true."

Despite the rulings in Perelman's favor, his case was slow out of the gate. His lawyers spent much of the early days of the trial in an extended tutorial on corporate accounting. One was reduced to placing a phony dollar bill in a giant white cookie jar and then removing it, to illustrate Sunbeam's accounting machinations. Jurors looked on blankly.

The real drama occurred outside the jury's presence, where Morgan Stanley's lawyer moved for a mistrial practically every time someone coughed. Indeed, by presstime in mid-April, Morgan Stanley had completely written off its chances with the judge. The firm filed a long-shot motion to get the judge to recuse herself for bias against Morgan Stanley. When she declined to step down, the firm tried and failed to get an appeals court to intervene. Morgan Stanley, which has set aside a $360 million reserve for the case, is clearly betting on its post-trial appeal. Having pushed the judge to the extreme, they'll now hope to turn her extreme reaction against her. -- Nicholas Varchaver