Morgan Stanley’s Gorman Says No Substance to CDO Allegations

By Takahiko Hyuga and Finbarr Flynn Businessweek

Morgan Stanley Chief Executive Officer James Gorman said there is “no substance” to any allegations that the U.S. bank misled investors about mortgage derivatives it sold them.

Gorman, speaking at a press conference in Tokyo today, made the comment when asked about a Wall Street Journal report that U.S. federal prosecutors are investigating Morgan Stanley transactions in so-called collateralized debt obligations. He added that the firm hasn’t been contacted by the U.S. Justice Department.

“We have no reason to believe there is any substance behind any investigation that appeared in the Wall Street Journal article,” Gorman said.

Morgan Stanley arranged and sold CDOs backed by home loans, even as its trading desk would sometimes bet that their value would fall, the Journal said, citing traders. The investigation is reviewing whether Morgan Stanley clearly represented its roles, according to the report.

The probe, which is at a preliminary stage, marks deepening scrutiny of Wall Street firms by U.S. regulators following the global financial crisis, the Journal said. Rival Goldman Sachs Group Inc. is contesting a fraud lawsuit from the U.S. Securities and Exchange Commission, which alleges the firm misled investors about a mortgage-linked security in 2007.

Spokespeople for the Manhattan U.S. Attorney’s office and the SEC declined to comment, the Journal said.

Dead Presidents’

The probe stemmed from an ongoing civil-fraud investigation of more than a dozen Wall Street firms’ mortgage bond businesses by the SEC that began in 2009, the newspaper said. The Manhattan U.S. Attorney’s office is now conducting a criminal probe into some of those firms’ activities, it said.

The government frequently begins criminal investigations without filing charges, the Journal said. In bringing criminal charges, the government would need to prove beyond a reasonable doubt that the firm or its employees misled investors, it said.

Two of the transactions being probed were named after U.S. Presidents James Buchanan and Andrew Jackson, and were called the “Dead Presidents” deals by traders, the WSJ said, citing a person familiar with the matter. Morgan Stanley arranged and bet against the deals, and didn’t market them to clients, it said.

The firm made money on the two transactions, though it lost $9 billion on mortgage-related investments in 2007, the newspaper said. Morgan Stanley wasn’t among the biggest firms in the CDO market, it said.