Justice, SEC investigate Morgan Stanley's mortgage-related deals

By Jerry Markon and Zachary A. Goldfarb
Washington Post Staff Writer
Thursday, May 13, 2010; A11

The Justice Department and the Securities and Exchange Commission are investigating Morgan Stanley as part of a probe into whether Wall Street firms misled investors in selling mortgage-related securities, according to federal law enforcement officials and others familiar with the matter.

Since summer, the SEC has been looking at how a number of banks packaged and marketed those securities, according to sources familiar with the matter. The criminal probe into Morgan Stanley, which came to light early Wednesday, is focused on whether the bank accurately represented to investors its role in mortgage-related deals it helped design but sometimes bet against, the sources said.

The investigation into Morgan, which is at a preliminary stage, is reminiscent of a federal criminal probe into mortgage transactions at Goldman Sachs. The SEC sued Goldman on civil fraud last month, alleging that the firm created and marketed an investment, known as a synthetic collateralized debt obligation, that was secretly designed to fail.

According to a source familiar with Morgan Stanley's business, the bank bet against one CDO that it also marketed to investors, a $160 million investment known as Baldwin. The sources all spoke on the condition of anonymity because the inquiries are at an early stage.

The Wall Street Journal first reported the investigation on its Web site Wednesday morning, saying that prosecutors were scrutinizing two mortgage-related deals named after U.S. presidents James Buchanan and Andrew Jackson.

Sources could not immediately confirm that those transactions are part of the probe, and it is not clear what misrepresentations Morgan Stanley might have made to clients. The firm made bets that the Buchanan and Jackson investments would lose value but did not create the investments or play any role in marketing them, according to a source familiar with Morgan Stanley's business.

"We have not been contacted by the Justice Department about the transactions being raised by the Wall Street Journal, and we have no knowledge of a Justice Department investigation into these transactions," Mark Lake, a Morgan Stanley spokesman, said Wednesday.

A source familiar with Morgan Stanley's business said the firm has received some requests for information from the SEC but not any broader subpoenas seeking documents or depositions.

Citigroup and UBS created the Buchanan and Jackson CDOs. The review of the deals might be focusing on whether Citigroup and UBS properly told its clients that Morgan Stanley would be betting against the investment.

Citigroup and UBS declined to comment.

The SEC lawsuit against Goldman claims the firm and an executive, Fabrice Tourre, committed fraud when they sold clients a CDO linked to the value of home loans that was secretly designed to fail.

A hedge fund, Paulson & Co., had helped Goldman create the CDO and planned to bet against it. But the SEC claims that relationship was not disclosed to Goldman's clients, ACA Financial Guaranty and the German bank IKB.

Goldman has denied the charges. It has recently signaled an interest in settling the matter and has been talking to the SEC about a possible resolution, according to sources familiar with the matter.

The Justice Department probe is essentially on a parallel track with the SEC investigation, the sources said. Although prosecutors and investigators are focusing on some of the same mortgage-related transactions as the SEC, the sources said, Justice has cast a wider net.

Goldman's stock has fallen nearly 20 percent since it was first disclosed that the firm faced an SEC investigation.

Morgan Stanley suffered a far more modest hit to its share prices Wednesday, losing 58 cents, or 2 percent, closing at $27.80.

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