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Morgan Stanley to pay $275 million penalty for misleading RMBS investors

By Emily Flitter and Sarah N. Lynch

NEW YORK/WASHINGTON (Reuters) - The U.S. Securities and Exchange Commission said on Thursday it had charged Morgan Stanley with misleading investors about two residential mortgage-backed securities it issued before the 2008 financial crisis, and that the bank would pay $275 million to settle the case, according to a press release.

The SEC found Morgan Stanley had not given investors the correct information about how many of the mortgages they contained were delinquent, the release said.

The RMBS market reached $2.2 trillion in 2007 but a wave of mortgage defaults made the values of many of the securities plunge in 2008, causing the investment banks Bear Stearns and Lehman Brothers to collapse and eventually leading to a credit and liquidity crisis on Wall Street and a deep recession.

"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," said Michael Osnato, the chief of the SEC Enforcement Division’s Complex Financial Instruments Unit, in the release.

As part of the settlement, Morgan Stanley neither admitted nor denied the charges, which were filed as an administrative proceeding, not in federal court.

"We're pleased to settle the matter," said Mark Lake, a spokesman for Morgan Stanley.

The two RMBS issues in the case, Morgan Stanley ABS Capital I Inc. Trust 2007-NC4 and Morgan Capital I Inc. Trust 2007-HE7, were the last subprime RMBS Morgan Stanley sponsored, issued and underwrote. According to the SEC, the two deals' offering documents said less than 1 percent of their loan pools' principal balances were delinquent at the time the securities were formed. In reality, they were much higher.

The SEC said Morgan Stanley had a chart showing 17 percent of the loans in HE7 were delinquent on its cutoff date, but described the issue to investors as containing only 1 percent delinquent loans by using payment data from a different date. And it did not tell investors it had to delay the closing of NC4 by a month, at which time the number of delinquent loans made up 4.5 percent of the total.

The statute the bank allegedly violated prohibits securities issuers from making untrue statements to customers or failing to give them necessary information. The SEC's case focused on Morgan Stanley's failures to reveal the true level of delinquencies in the issues.

Nevertheless, a defense lawyer who was not involved in the case said it was notable that the SEC's announcement did not contain the word "fraud."

"It’s unusual for it not to appear here," said Thomas Gorman, a partner at Dorsey & Whitney in Washington.

"I would imagine that word was negotiated out of these papers." A spokeswoman for the SEC declined to comment.

The SEC said it would give the settlement money to investors who were harmed by the bank's misrepresentations. The spokeswoman declined to disclose the identities of the investors.

(Reporting by Emily Flitter in New York and Sarah N. Lynch in Washington; Editing by James Dalgleish)

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