Less than a month after the Securities and Exchange Commission launched its lawsuit against Goldman Sachs for allegedly defrauding investors into bad investments, U.S. prosecutors are investigating whether Morgan Stanley undertook similar practices. The investigation comes at an especially bad time for Morgan, one of eight banks currently under a separate investigation by the New York Attorney General for allegedly misleading rating agencies. The timing is less problematic for the White House and Congressional Democrats, who are pursuing legislation on financial regulatory reform.

  • What's Being Investigated  The Wall Street Journal summarizes, "U.S. prosecutors are investigating whether Morgan Stanley misled investors about mortgage-derivatives deals it helped design and sometimes bet against. ... 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." By betting against its own CDOs, Morgan Stanley stood to benefit if its CDO performed poorly. But if Morgan knew the CDO would perform poorly, does that mean it defrauded investors it lured into buying those CDOs?
  • Why This Would Be a Tough Case  The New York Times' DealBook explains, "Wall Street deals are notoriously difficult targets for prosecutors to level charges over as it must be demonstrated beyond reasonable doubt that the firm knew what it was doing when clients were misinformed. The investigation into Morgan Stanley is at a very early stage."
  • Ongoing Investigation Since 2009, Now Heightened  The Wall Street Journal's Ashby Jones writes, "federal prosecutors are taking quite the keen interest in Wall Street. ... 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."
  • Criminal, Not SEC?  The Business Insider's Joe Weisenthal points out, "The probe is preliminary, according to the report, and at the level of the Manhattan DA's office, so we're talking criminal, not civil from the SEC."
  • What Wall Street Investigators Are Going After  Reuters' Felix Salmon observes, "The Dead Presidents CDOs now reportedly being investigated by the Justice Department were not your garden-variety synthetics. ... There were lots of synthetic CDOs structured and sold at the end of the subprime boom, but the ones being singled out by regulators and prosecutors seem to be the unusual ones — first the Goldman deal which was created at the behest of John Paulson, and now the Morgan Stanley deal with this mysterious embedded structure."
  • Does This Implicate Citigroup and UBS?  ProPublica's Marian Wang notes, "the CDOs were actually marketed and sold not by Morgan Stanley but by Citigroup and UBS. This leads to questions about whether Citigroup and UBS made the necessary disclosures about Morgan Stanley’s involvement and interests, which were adverse to those of investors." There are two Morgan Stanley CDO deals being investigated, one underwritten by Citi and the other by UBS. Will those banks be investigated as well?