Morgan Stanley in New Mortgage Mess

Allegations against Morgan Stanley (MS - Analyst Report) over the sale of mortgage-backed securities are far from over. Recently, one of the top U.S. life insurers, Prudential Financial Inc. (PRU - Analyst Report), has brought up charges against Morgan Stanley for the sale of $1 billion in residential mortgage-backed securities that the former had bought, according to a Bloomberg report.

The company has been accused of making false statements as well as omitting material facts prior to Prudential’s purchase of the residential mortgage-backed securities which were issued with 41 mortgage-loan securitizations between July 2004 and August 2007.

Prudential alleged that Morgan Stanley had wrongfully asserted that underwriting standards for the mortgages were met and home loans were lawfully assessed. However, a significant part of the mortgage loans, which backed those securities defaulted, were foreclosed or became delinquent.

As a result, the value of these securities plummeted and Prudential incurred significant losses on its investments in such securities which exceeded $350 million. Prudential is claiming for both compensatory as well as punitive damages.

Recent Allegations

Morgan Stanley has encountered similar allegations in the recent past. The company has faced lawsuits from companies such as Asset Management Fund and MetLife Inc. (MET - Analyst Report) which accused Morgan Stanley of fraudulent activities including misrepresentation of facts over the sale of securities.

Asset Management Fund has sued the company over its $122.4 million purchase of residential mortgage backed securities. On the other hand, MetLife has brought forth charges against Morgan Stanley over its acquisition of $757 million in residential mortgage-backed securities in 2006 and 2007.

Moreover, in April, Morgan Stanley has been asked by the Federal Reserve to review the foreclosures made by Saxon mortgage servicer prior to the unit’s sale and subsequently reimburse the affected borrowers.

In Conclusion

The role of residential mortgage backed securities behind the recent financial crisis and the fraudulent activities related to the sale of such instruments have been severely criticized. In fact, several of the Wall Street biggies are stuck with similar allegations. Their code of conduct with respect to the sale of such instruments has been questioned.

We believe that these lawsuits further increase the company’s litigation risk and also represent a threat to scathe the company’s financials to some extent. However, if proved or settled, the investors can breathe some relief.

Currently, the shares of Morgan Stanley have a Zacks #3 Rank, which translates into a short-term Hold rating. Additionally, considering the fundamentals we maintain our long-term Neutral recommendation on the stock.