Morgan Stanley finally pays $275 million for subprime RMBS fraud

SEC charged company with misrepresenting loans

Morgan Stanley (MS) agreed to pay $275 million, after months of fine-tuning the deal, to settle charges brought by the Securities and Exchange Commission over defrauding investors in a pair of residential mortgage-backed securities.

The SEC had charged Morgan Stanley with misrepresenting the delinquency status of mortgage loans underlying two subprime RMBSs at the height of the financial crisis.

“The delinquency status of mortgage loans in an RMBS securitization is vital information to investors because those loans are the primary source of funds by which they potentially can recover and profit from their investments,” said Michael Osnato, chief of the SEC Enforcement Division’s Complex Financial Instruments Unit. 

“Morgan Stanley understated the number of delinquent loans behind these securitizations during a critical juncture of the financial crisis and denied investors the full extent of the facts necessary to make informed investment decisions.”

According to the SEC, charges had been filed against Morgan Stanley & Co., as well as affiliates Morgan Stanley ABS Capital 1, and Morgan Stanley Mortgage Capital Holdings.

The securitizations in question were collateralized by mortgage loans with an aggregate principal value balance of more than $2.5 billion. The offerings themselves were called Morgan Stanley ABS Capital 1 Inc. Trust 2007-NC4 and Morgan Capital 1 Inc. Trust 2007-HE7.

They were the last subprime RMBSs that Morgan Stanley sponsored, issued, and underwrote.

The SEC’s order finds that offering documents for the securitizations stated that less than 1% of each pool’s aggregate principal balance was more than 30 days but less than 60 days delinquent as of each securitization’s cut-off date.  

With the exception of these loans, Morgan Stanley told investors that no payment on any mortgage loan was more than 30 days delinquent at any time since origination. 

On the contrary, approximately 17% of the loans in the HE7 securitization had been delinquent at some point since origination, and in the NC4 securitization approximately 4.5% of the loans were currently delinquent rather than the disclosed 1%.

The company initially disclosed that it was in settlement discussions with the SEC in February, but the settlement was finalized on Thursday.

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.

According to the company filing in February, the $275 million fine would be paid out of the company’s 2013 earnings and includes SEC fines and penalties and all proceeds from the bonds in question.

“Without admitting or denying the allegations, the firm agreed to the entry of an order that requires a payment of $160,627,852 in disgorgement, $17,995,437 in prejudgment interest, and a $96,376,711 penalty,” the SEC said in a statement.

The SEC notes that the funds will be returned to the investors that were “harmed” in the securitizations. 

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