Federal prosecutors are investigating whether Morgan Stanley misled investors about mortgage-derivatives deals it helped design and sometimes bet against, people familiar with the matter say, in a step that intensifies Washington's scrutiny of Wall Street in the wake of the financial crisis.
Morgan Stanley arranged and marketed to investors pools of bond-related investments called "collateralized debt obligations," or CDOs, and its trading desk at times placed bets that their value would fall, traders say. Investigators are examining, among other things, whether Morgan Stanley made proper representations about its roles.
Among the deals that have been scrutinized are two named after U.S. Presidents James Buchanan and Andrew Jackson, a person familiar with the matter says. Morgan Stanley helped design the deals and bet against them, but didn't market them to clients. Traders called them the "Dead Presidents" deals.
The probe is at a preliminary stage. Bringing criminal cases involving complex Wall Street deals is a huge challenge for prosecutors. The government must prove beyond a reasonable doubt that a firm or its employees knowingly misled investors, a high bar. The government launches many criminal investigations that end without any charges being filed.
Morgan Stanley wasn't among the biggest players in the CDO market. Although the firm made money on the Dead President deals, any profit was far overshadowed by the $9 billion the firm lost on bullish mortgage bets in 2007, a person familiar with the matter said.
The investigation grew out of an ongoing civil-fraud investigation launched by the Securities and Exchange Commission in 2009, examining the mortgage-bond business of more than a dozen Wall Street firms, the people say. The Manhattan U.S. Attorney's office now is investigating some of those firms' activities in a criminal probe.
A Morgan Stanley spokesman said, "We have not been contacted by the Justice Department about the transactions being raised by The Wall Street Journal and we have no knowledge of a Justice Department investigation into these transactions."