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

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(Reuters) — The U.S. Securities and Exchange Commission said on Thursday it had charged Morgan Stanley with misleading investors about two 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 in the securities, which were called Morgan Stanley ABS Capital I Inc. Trust 2007-NC4 and Morgan Capital I Inc. Trust 2007-HE7, the correct information about how many of the mortgages they contained were delinquent, the release said.

The market for residential mortgage-backed securities 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 economic 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.

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

The two RMBS issues in the case were the last subprime RMBS Morgan Stanley sponsored, issued and underwrote. According to the SEC, the two deals' offering documents said less than 1% of their loan pools' principal balances were delinquent at the time the securities were formed. In reality, 17% of the loans in one of the issues and 4.5% of the loans in the other were delinquent at that time.

The SEC said Morgan Stanley had a chart showing the 17% delinquency rate for one of the two issues. And it did not tell investors it had had to delay the closing of the other one by a month, at which time it had received updated information on the number of delinquent loans showing they made up 4.5% of the total.

The SEC said it would return the money collected in the settlement to investors who were harmed by the bank's misrepresentations. Its announcement did not include the names of the investors.

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