DOJ Catch of the Week -- Morgan Stanley
By the C|C Whistleblower Lawyer Team
This week’s Department of Justice “Catch of the Week” goes to Morgan Stanley. Yesterday, the company agreed to pay a $2.6 billion penalty “for misleading investors about the subprime mortgage loans underlying the securities it sold” in the period leading up to the financial crisis. As part of the agreement, Morgan Stanley admitted that it failed to disclose critical information to prospective investors about the quality of the mortgage loans underlying its residential mortgage-backed securities (RMBS) which ultimately caused investors, including federally insured financial institutions, to lose billions of dollars from investing in Morgan Stanley in the 2006-07 timeframe. See DOJ Press Release
An RMBS is comprised of a pool of mortgage loans with its value determined in large part by the value of the underlying properties. As acknowledged by Morgan Stanley, the company made numerous misrepresentations to prospective investors about the subprime mortgage loans underlying its RMBS, including:
- Telling investors it did not securitize underwater loans (loans that exceeded the value of the property) even though it had expanded its “risk tolerance” in evaluating loans in order to purchase and securitize “everything possible.”
- Telling investors it did not securitize loans that failed to meet originators’ guidelines even though in fact it did securitize loans that neither comported with the underwriting guidelines nor had adequate compensating factors.
- Claiming in presentation materials for potential investors due diligence practices it did not actually follow regarding its review of certain pools of loans prior to securitization.
Despite being aware of the “deteriorating appraisal quality” and “sloppy underwriting” by the sellers of these underlying loans, Morgan Stanley did not engage in appropriate due diligence practices for fear of harming its relationship with its largest subprime originators. The government highlighted that Morgan Stanley’s manager of credit-and-compliance due diligence was actually admonished to “stop fighting and begin recognizing the point that we need monthly volume from our biggest trading partners and that . . . the client [an originator] does not have to sell to Morgan Stanley.”
The $2.6 billion civil penalty resolves claims under the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA). The settlement expressly preserves the government’s ability to bring criminal charges against Morgan Stanley and any of its employees or executives. In addition to the federal settlement, the states of New York and Illinois announced their own settlements with Morgan Stanley for $550 million and $22.5 million, respectively.
Morgan Stanley previously paid $225 million to resolve claims brought by the National Credit Union Administration arising from losses related to corporate credit unions’ purchases of RMBS; $1.25 billion to resolve claims by Federal Housing Finance Agency (FHFA) for RMBS purchased by Fannie Mae and Freddie Mac; and $86.95 million to resolve federal and state securities laws claims brought by the Federal Deposit Insurance Corporation as receiver on behalf of failed financial institutions. Morgan Stanley also previously entered into a consent decree with the SEC to pay $275 million, bringing to almost $5 billion the total payout by Morgan Stanley in connection with its fraudulent sales of RMBS.
In announcing the settlement, a host of government regulators stressed the importance of holding financial institutions accountable for engaging in improper investment practices, particularly those that precipitated the financial crisis. DOJ Civil Chief Benjamin C. Mizer said “[t]hose who contributed to the financial crisis of 2008 cannot evade responsibility for their misconduct.” And Acting U.S. Attorney Brian Stretch of the Northern District of California stated the strong commitment of his office to go after “[a]buses in the mortgage-backed securities industry such as these [which] helped bring about the most devastating financial crisis in our lifetime.”