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Investments

Morgan Stanley: California AG thinks we misrepresented our mortgage bonds

Discloses legal action in earnings report

Morgan Stanley
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[Correction: An earlier version of this article referred to Pam Bondi as the Attorney General of California. She is the AG of Florida, Kamala Harris is the California AG.]

The California Attorney General’s office came to the conclusion that Morgan Stanley (MS) missold bonds backed by residential mortgage securities to California Public Employees Retirement System.

According to the second quarter filing from the investment bank, on May 8, the California AG indicated to Morgan Stanley that the office run by Kamala Harris “made certain preliminary conclusions that the Company made knowing and material misrepresentations regarding RMBS and that it knowingly caused material misrepresentations to be made regarding the Cheyne SIV.”

These structured investment vehicles were at one time considered feats of fixed income innovation.

The entities kept firms, such as Morgan Stanley, both rich in liquidity and bankruptcy-remote from the SIV.

However, the vehicles issues short-term paper backed by long-term debt.

The mismatch accelerated in huge losses when the long-term debt, in this case residential mortgages, began to experience heightened levels of default.

The California AG suggested Morgan Stanley knew this risk and chose not to disclose it to CalPERS.

“The CAAG has further indicated that it believes the Company’s conduct violated California law and that it may seek treble damages, penalties and injunctive relief," the filing states.

“The Company does not agree with these conclusions and has presented defenses to them to the CAAG,” the earnings report concludes.

Morgan Stanley is currently also finalizing a $275 million agreement with the Securities and Exchange Commission to settle the SEC probe into the bank’s toxic subprime mortgage bond trades going back to 2007.

Morgan Stanley has already said it will pay $1.25 billion to the FHFA to settle charges that it misled investors on the sale of mortgage-backed securities ahead of the housing bust.

Morgan Stanley and a number of other banks and Wall Street firms have been under the SEC probe for their practices leading up to and into the subprime mortgage meltdown, specifically the residential mortgage bonds the firm underwrote.

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