Morgan Indicted for CDO Fraud

Morgan Stanley (MS) was reportedly accused by the Employees’ Retirement System of the Virgin Islands of swindling its investors by promoting $1.2 billion of risky low-quality mortgage-related notes in 2007 that it had already perceived to be non-profitable. The lawsuit filed on Dec 24, 2009 in Manhattan Federal Court stated that Morgan Stanley has deliberately raised the rating of the mortgage notes to fulfill the collateralized-debt obligation (CDO) known as Libertas.

According to the claim made by the Virgin Islands pension fund, Morgan marketed the fund on a CDO comprising subprime mortagages, which are known to have a larger-than-average risk of defaulting in the market. For this, the company teamed up with credit rating agencies such as Moody's Investors Service, a division of Moody’s Corp. (MCO) and Standard & Poor's (S&P), a division of McGraw-Hill (MHP) to obtain "triple-A" ratings for debt-securities marketed in 2007. The low-quality securities issued by subprime lenders included New Century Financial Corp., which quickly went bankrupt, and Option One Mortgage Corp, then owned by H&R Block Inc. (HRB).

CDO typically repackage bonds and other assets into new securities. According to the allegation, the Libertas CDO entered into credit-default swaps that referenced mortgage-backed securities without actually buying these mortgage-backed securities. Credit-default swaps are financial instruments that function as insurance for bondholders. As the credit-protection buyer, Morgan Stanley was recklessly shorting the securities in response to a decline in their market value.

It appears that the gradual market recovery may now unveil hidden deeds that the companies may have used in the past to paint an overall favorable picture of their business operations. The Libertas CDO matter has highlighted the arguably reckless strategies that investment banks might adopt. This is not the first instance; many banks have reportedly faced similar allegations of misleading investors by inflating or disguising securities that are actually tied to risky subprime mortgages.

We believe that issues like these could severely shatter investors’ confidence as a giant of the ilk of Morgan Stanley is believed to be well-positioned to realize the full benefits of its strategic cost-balancing initiatives and attractive business mix. However, if the CDO charges are proved justified, Morgan Stanley will have to initiate damage control. This could raise a furor in the company’s financials and its market reputation.

Claim Your Free Book "Make real Money On the Internet"