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Morgan Stanley (MS - Analyst Report) continues to be embroiled in legal hassles related to the sale of risky residential mortgage backed securities (RMBS). Now, the U.S. regulator for credit unions – National Credit Union Administration (NCUA) – has sued the company to recover losses on $566 million RMBS that were sold to 2 corporate credit unions that have now failed.

The aforesaid RMBS were sold to the U.S. Central and Western Corporate federal credit unions (FCUs) by Morgan Stanley. Later, these 2 FCUs became insolvent and were placed under NCUA conservatorship, and then liquidated owing to the losses from these risky RMBS.

Morgan Stanley has been accused by the NCUA of issuing misleading statements and omitting important details in the offering documents of the RMBS in question. This created obscurity regarding the risks associated with the RMBS when these were sold.

Consequently, the credit unions perceived the RMBS to be less risky when on the contrary, they were considerably risky in nature. Moreover, the NCUA accused Morgan Stanley of ignoring the underwriting guidelines specified in the offering documents.

As a result, when these RMBS lost their value due to defaults in the underlying assets, the value of investments of the credit unions in these securities fell. Subsequently, the 2 credit unions collapsed, triggering a crisis in the credit union industry.

Morgan Stanley is not the first Wall Street giant that has been sued by the NCUA. The regulator has sued nearly 11 banks including JPMorgan Chase & Co. (JPM - Analyst Report), The Goldman Sachs Group, Inc. (GS - Analyst Report) and Credit Suisse Group AG, to retrieve losses from RMBS investments. Moreover, to date, the NCUA reached settlements with Bank of America Corporation (BAC - Analyst Report), Deutsche Bank AG, HSBC Holdings plc and Citigroup Inc. of worth approximately $335 million.

Such cases are inevitably going to result in mounting litigation risks for Morgan Stanley, which will pose a menace for both its image as well as financials. On the other hand, recoveries by the NCUA will result in lowering of the losses that stemmed from the failure of the credit unions.

Currently, Morgan Stanley carries a Zacks Rank #3 (Hold).

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