A lawsuit brought against Morgan Stanley alleging it misled investors in
residential mortgage-backed securities (RMBS), was settled in February
with the firm agreeing to pay a $3.2 billion penalty. From that amount,
$2.6 billion is allocated to resolving the claims of the U.S. Justice
This settlement is the largest fine out of a group of previous resolutions
agreed to by Morgan Stanley with the RMBS Working Group. The RMBS Working
Group is a federal and state task force established in 2012 by President
Obama to investigate misconduct of financial institutions stemming from
the financial crisis of 2008.
Part of the agreement includes Morgan Stanley confirming in writing that
it had failed to disclose crucial data to investors about the rating of
mortgages constituting its RMBS, and about its due diligence process.
A multitude of investors that included some federally insured financial
institutions endured billions in losses from investing in RMBS that were
issued in 2006 and 2007 by Morgan Stanley.
The case against the bank claimed that Morgan Stanley misled investors
about the quality of mortgage loans they were packaging in their RMBS,
with many loans having severe defects.
Residential Mortgage-Backed Securities are a type of investment instrument
that is made up of a pool of mortgage loans issued by banks and other
residential lenders or brokers. The price and returns of an RMBS are evaluated
based on factors that include creditworthiness of the borrowers and the
values of the properties that make up the RMBS portfolio. Morgan Stanley
was one of the major institutional players issuing RMBS during the height
of the mortgage boom and prior to the financial crash of 2008.
A Morgan Stanley spokesman commented, “We are pleased to have finalized
these settlements involving legacy residential mortgage-backed securities
But in a 2006 email, a Morgan Stanley team manager in charge of conducting
due diligence on the value and quality of the securities sent an email
to another employee instructing him, “please do not mention the
‘slightly higher risk tolerance’ in these communications.”
Morgan Stanley told investors that it did not securitize loans that were
underwater (the loan exceeded the value of the property). The firm did
disclose to investors about how in April 2006, it had expanded its “risk
tolerance” in evaluating the quality of the loans so as to securitize
“everything possible.” They then increased the number of mortgage
loans it purchased, regardless if they knew that the pools contained loans
with poor underwriting standards.
In regards to misleading potential investors, Morgan Stanley acknowledged
that they “…securitized certain loans that neither comported
with the originators’ underwriting guidelines or had adequate compensating
factors.” They also admitted that their employees had received information
that certain loans did not comply with underwriting guidelines and were
missing “adequate compensating factors.”
The agreement maintains the government’s authority to bring future
additional charges against Morgan Stanley and does not release any associates
from the possibility of criminal or civil liability. As part of the settlement,
Morgan Stanley also agreed to cooperate completely with ongoing investigations
in regards to their conduct in this matter.
Brian J. Stretch, U.S. Attorney for the Northern District of California,
issued a statement that read, “In today’s agreement, Morgan
Stanley acknowledges it sold billions of dollars in subprime RMBS certificates
in 2006 and 2007 while making false promises about the mortgage loans
backing those certificates.”
He further stated, “[M]organ Stanley touted the quality of the lenders
with which it did business and the due diligence process it used to screen
out bad loans. All the while, Morgan Stanley knew that in reality, many
of the loans backing its securities were toxic. Our office is committed
to dedicating the resources necessary to hold those who engage in such
reckless actions responsible for their conduct.”
The civil monetary penalty of $2.6 billion settles the claims leveled under
the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA).
The law allows the federal government to impose monetary penalties against
banks and other financial organizations known to have committed particular
acts of fraud.
As part of the resolutions, Morgan Stanley reached settlements with New
York and Illinois – both members of the RMBS Working Group –
in the amounts of $550 million and $22.5 million, respectively, for the
sale of RMBS in those states.
This agreement is not the first time Morgan Stanley has had to pay up to
settle claims of wrongdoing. They previously paid out $225 million to
end claims of losses by the National Credit Union Administration from
their participation in the purchasing of RMBS; they paid $86.95 million
to resolve charges leveled by the Federal Deposit Insurance Corporation
as receiver of failed financial institutions; and $1.25 billion to settle
claims by Federal Housing Finance Agency for Morgan Stanley’s potential
violations of federal securities laws in relation to purchases of RMBS
by Fannie Mae and Freddie Mac. In total, Morgan Stanley has been forced
to pay almost $5 billion dollars to members of the RMBS Working Group
due to their involvement with the sale of RMBS.
If you would like more information on this topic, or would like to set
up a free consultation, please call the main office line at (949) 298-8050 or
email Kevin Kim, Esq.