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Understanding the $3.2 Billion Morgan Stanley Settlement

March 29, 2016

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In a major bank settlement claim, Morgan Stanley has agreed to pay out $3.2 billion in order to settle disputes related to mortgage-backed bonds handled during the nation’s financial crisis. In particular, the dispute involves fraud in relation to mortgage-backed securities that eventually turned toxic as the mortgage crisis progressed. The settlement highlights the importance of due diligence in screening out loans, and demonstrates the far-reaching effects of fraud occurring during that critical time period.

Settlement Amounts and Figures

Many years after the mortgage crisis subsided, the consequences of Morgan Stanley’s actions are emerging as the settlement amounts are being released. According to New York Attorney General Eric Schneiderman, the settlement involves $3.2 billion total to settle civil allegations of which:

  • $2.6 billion will be allotted for resolving claims brought by the U.S. Department of Justice
  • $550 will go to New York State ($400 million will go to consumer relief, $150 million in cash to New York)
  • $22.5 million will be allotted for Illinois State

Morgan Stanley did not originate the mortgages themselves, and therefore the settlement amount is relatively small compared to other large consumer bank settlements, such as the $16.6 billion Bank of America settlement. On the other hand, the Morgan Stanley claim still represents a significant settlement amount, and highlights the extent to which fraudulent mortgage-backed loans affected consumers and investors.

Morgan Stanley’s Violations

According to U.S. Attorney Brian Stretch of California’s northern federal district, Morgan Stanley overstated the quality of lenders and also had issues regarding due diligence in screening out bad loans. In countless instances, Morgan Stanley:

  • Prepared loans that were more valuable than the underlying property—which is something Morgan Stanley informed investors that it wouldn’t do.
  • Purchased and bundled underwater loans (i.e., the market value of the loan collateral was less than the outstanding loan balance)
  • Securitized various loans that did not have proper compensating factors and did not comply with underwriting guidelines
  • Did not conduct proper credit reviews on various loans

The settlement documents also reveal very telling details in Morgan Stanley’s employee e-mails in relation to the fraudulent practices. For instance, one employee stated in an e-mail, “Please do not mention the ‘slightly higher risk tolerance’ in these communications...We are running under the radar and do not want to document these types of things.” Other e-mails included similar statements.

All of these translated into increased risk levels for loans, with Morgan Stanley painting a “rosy picture” of the overall quality of loans. As a result, borrowers suffered major losses when the mortgage-backed loans eventually went sour and toxic during the crisis. This is similar to recent securities fraud cases where investors were not fully informed regarding investments, such as the situation with Aequitas’ products.

Are the Morgan Stanley Settlement Amounts Sufficient?

Some consider the $3.6 billion settlement to be a “slap on the wrist” for Morgan Stanley. Morgan Stanley has stated that the settlement would not affect its 2016 earnings on account of financial set-asides in anticipation for such legal issues. Also, many feel that the amount is somewhat small in comparison with similar cases in the lending industry.

On the other hand, AG Schneiderman remarked that the settlement marks a “victory in our efforts to help New Yorkers rebuild in the wake of the financial devastation caused by major banks.” This is an important point—the Morgan Stanley settlement represents continued activity in the efforts to help the nation recover from tumultuous financial times.

In addition, the Morgan Stanley settlement was accomplished under the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA). This act permits the federal government to impose penalties on banks for major offenses. Thus, the settlement demonstrates the continued efficacy of legislative acts in helping to prevent abuses by large consumer banks.

Securities litigation in connection with the subprime mortgage crisis still continues to this day. These cases assist in protecting shareholder rights, and help provide remedies for the losses involved. If you have any questions regarding securities fraud litigation, or would like to speak with an attorney, contact us today at Kessler Topaz. As a national leader in securities fraud litigation, our securities litigation team is committed to eradicating corporate fraud and abuses.