The global investment bank Morgan Stanley face informal federal scrutiny over its collateralized debt obligations (CDOs), bond-related derivative investments marketed to investor pools. While Morgan Stanley officials state they have not received a Wells notice from the SEC - which informs individuals and firms that the SEC staff plans to bring charges - the issue reportedly under an informal probe is whether Morgan Stanley misled investors by betting against CDO deals that it created.
Disclosure Standards to Derivative Investors
According to a 05/11/10 Wall Street Journal news report, the informal probe was originally initiated by the SEC investigators in 2009. The New York Times DealBook blog 05/12/10 reports that "traders have said that Morgan Stanley was involved in the selecting and selling of [CDOs] to investors," which Morgan Stanley also bet against in separate transactions without disclosing these parallel deals to CDO investors.
This informal probe comes on the heel of a similar probe and subsequent filing of civil charges against Goldman Sachs. The Goldman civil complaint involves mortgage-derivative transactions (the Abacus deal) and raises the issue of what is the legal standard of disclosure in securities transactions in the United States.
Morgan Stanley's "Dead Presidents" Deals
According to the WSJ report, the main Morgan Stanley deals under the federal probe were dubbed "Dead Presidents" by traders because the transactions were named after President Andrew Jackson and President James Buchanan. These pair of derivatives were valued at $200 million and tied to mortgage-backed securities that lost significant value during the U.S. mortgage crisis.
The so-called Dead Presidents deals were not marketed to clients by Morgan Stanley. Instead, Citigroup Inc. and UBS AG marketed and underwrote the derivatives to investors. This is slightly different than the Goldman Sachs facts, as Goldman reportedly directly marketed the Abacus deal that brought about the filing of a civil fraud lawsuit by federal securities prosecutors this year.
U.S. Investment Banks Undergo Increased CDO Scrutiny
"Every investment bank has been receiving subpoenas about CDOs and the marketing of CDOS," said Mark Lane, a William Blair analyst, to the WSJ. At the time of this report, Morgan Stanley Chief Executive James Gorman had not been contacted by the U.S. Department of Justice and made a public statement in Tokyo that Morgan Stanley has no "reason to believe that there is any substance behind any supposed investigation."
Federal criminal investigators must prove criminal securities charges beyond a reasonable doubt. The level of knowledge of an investment bank is important if such a burden of proof is to be proven in a court of law. It should be noted, however, that SEC informal probes do not always lead to filing of either civil or criminal securities charges.
References:
"U.S. Probes Morgan Stanley: Prosecutors Look at Mortgage Securities; Firms Say It Hasn't Been Contacted," by Amir Efrati, Susan Pulliam, Serena NG, and Aaron Lucchetti, The Wall Street Journal (May 11, 2010).
"Morgan Stanley Said to Face C.D.O. Scrutiny," DealBook blog edited by Andrew Ross Sorkin, The New York Times (May 12, 2010).
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