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Did Morgan Stanley mislead clients too?

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Stacey Vanek-Smith: Federal prosecutors are looking into whether Morgan Stanley bet against its investors and misled clients about derivatives deals. That’s according to the Wall Street Journal this morning. If all that sounds familiar, it’s because that’s almost exactly what lawmakers accused Goldman Sachs of doing. Here with us now is Journal reporter Amir Efrati. He joins us live. Good morning, Amir.

Amir Efrati: Good morning.

Vanek-Smith: Amir, how much do we know about how much prosecutors may have found out about Morgan Stanley?

Efrati: Well, first of all, it’s important to say that this is part of a broader investigation launched by the Securities and Exchange Commission, which is sort of the civil enforcement arm. They work sometimes closely with the Justice Department, the criminal prosecutors, and they have a broad investigation and some of the probes that they have sort of were funneled to the Justice Department. And this is one of those probes looking at whether Morgan Stanley misled anyone about deals that it put together and then bet against while investors lost money because these deals did indeed go sour.

Vanek-Smith: Why Morgan Stanley?

Efrati: Again, this is broader than Morgan Stanley. We know about Goldman and we know about Morgan Stanley. There are others, so we don’t want to focus on one or two firms. This was a street-wide issue where you have lots of deals being put together. People were structuring deals, selling them to investors, and then betting against them. And the question was: Was anyone lied to? For example, if you had a firm that structured a deal and then sold it to investors, saying “hey look, this is a good deal, you can invest in this.” And then our interests are aligned with yours, we feel the same way about it as you do, when in fact they don’t. They bet against it. Those are the kinds of things prosecutors are looking for — whether there were any lies being told to investors who were buying these products.

Vanek-Smith: I’ve heard the dreaded synthetic CDOs are potentially involved in this. Could you remind us what those are and why they’re seen as such a problem?

Efrati: Sure. Synthetic CDOs are basically just a fancy way of saying investments that track the performance of mortgage bonds and other bonds. So, for example, in some of the deals that we talk about that Morgan Stanley designed, these were synthetic CDOs that tracked mortgage bonds and so you had an investor that was basically betting, waging, that the mortgage bonds would do well. And if they did well, they would make money. And then Morgan Stanley basically betting that they would not do well. And if they didn’t do well, Morgan Stanley would make money. So you have two sides of each deal. And in a few instances, Morgan Stanley was betting against the mortgage market and successfully — even though overall, as a whole, the firm didn’t do well. Other parts of the firm did not do well and tried to bet with the mortgage market and ended up taking huge losses.

Vanek-Smith: Wall Street Journal reporter Amir Efrati. Thank you, Amir.

Efrati: Thank you.

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