The Securities and Exchange Commission recently charged three Morgan Stanley entities with misleading investors in a two residential mortgage-backed securities (RMBS) securitizations that the firms underwrote, sponsored, and issued. In anticipation of the charges, Morgan Stanley submitted an offer of settlement, which the SEC accepted, wherein Morgan Stanley would pay $275 million to be returned to harmed investors.
According to the SEC charges, the matter concerns Morgan Stanley’s misleading public disclosures regarding the number of delinquent loans in two subprime residential mortgage-backed securities (“RMBS”) transactions offered in 2007–Morgan Stanley ABS Capital I Inc. Trust 2007-NC4 (“NC4”) and Morgan Stanley ABS Capital I Inc. Trust 2007-HE7 (“HE7”). Morgan Stanley sponsored, issued, and underwrote the transactions, which were collateralized by mortgage loans with an aggregate principal value balance of over $2.5 billion.
In an asset-backed securities offering, federal securities laws require disclosure of delinquency information for the mortgage loans serving as collateral. The SEC investigation found that Morgan Stanley misrepresented the current or historical delinquency status of mortgage loans underlying two subprime RMBS securitizations during a time when borrower delinquencies were on the rise, and the subprime market was experiencing extreme distress. Information about current and historical delinquent loans was information that investors would have considered important in deciding whether to invest in the RMBS transactions, according to the SEC. Further, the SEC found that Morgan Stanley knew or should have known that the disclosures concerning current and historical delinquencies were materially inaccurate and would mislead purchasers in two securities offerings.
“The delinquency status of mortgage loans in an RMBS securitization is vital information to investors because those loans are the primary source of funds by which they potentially can recover and profit from their investments,” said Michael Osnato, chief of the SEC Enforcement Division’s Complex Financial Instruments Unit, according to an SEC news release. “Morgan Stanley understated the number of delinquent loans behind these securitizations during a critical juncture of the financial crisis and denied investors the full extent of the facts necessary to make informed investment decisions.”
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