U.S. probing Morgan Stanley’s ‘Dead Presidents’ deals: Report

Morgan Stanley Chief Executive Officer James Gorman denied allegations the U.S. bank misled investors about mortgage derivatives it sold them.

The firm is being probed by U.S. prosecutors over whether the bank misled clients when it sold them collateralized debt obligations as its own traders bet that the value of the securities would drop, the Wall Street Journal reported today. The New York-based firm hasn’t been contacted by the Justice Department, Gorman told reporters in Tokyo today.

Wall Street firms are facing unprecedented scrutiny from lawmakers and prosecutors over whether they missold CDOs linked to the subprime mortgages that caused the credit crisis. Goldman Sachs Group Inc. is fighting a lawsuit from the U.S. Securities and Exchange Commission, which alleges the firm misled investors about a mortgage-linked security in 2007.

“We should expect to see a whole slew of cases appear through the rest of the year,” said Ralph Silva, an analyst at London-based Silva Research Network, which specializes in financial services firms. “Because they are near-impossible to prove, I suspect most are going to be settled on the threat of a perp walk.”

Morgan Stanley arranged and sold CDOs backed by home loans, even as its trading desk would sometimes bet that their value would fall, the Journal said, citing traders. The investigation is reviewing whether Morgan Stanley clearly represented its roles, according to the report.

“We have no reason to believe there is any substance behind any supposed investigation that appeared in the Wall Street Journal article,” Gorman said at the press conference, convened to discuss the firm’s Japanese securities and investment banking ventures with Mitsubishi UFJ Financial Group Inc.

Spokesmen for the Manhattan U.S. Attorney’s office and the SEC declined to comment, the Journal said.

Government officials in the U.S. are seeking to assuage public anger over bank bailouts by tightening regulations after the worst financial crisis since the Great Depression. The changes are intended to prevent a repeat of the crisis that led to $1.78 trillion in writedowns and losses by financial firms.

The probe stemmed from an ongoing civil-fraud investigation of more than a dozen Wall Street firms’ mortgage bond businesses by the SEC that began in 2009, the newspaper said. The Manhattan U.S. Attorney’s office is conducting a criminal probe into some of those firms’ activities, it said.

The government frequently begins criminal investigations without filing charges, the Journal said. In bringing criminal charges, the government would need to prove beyond a reasonable doubt that the firm or its employees misled investors, it said.

Two of the transactions being probed were named after U.S. Presidents James Buchanan and Andrew Jackson, and were called the “Dead Presidents” deals by traders, the newspaper said, citing a person familiar with the matter. Morgan Stanley arranged and bet against the deals, and didn’t market them to clients, it said.

The firm made money on the two transactions, though it lost $9 billion on mortgage-related investments in 2007, the newspaper said. Morgan Stanley wasn’t among the biggest firms in the CDO market, it said.