Form 10-K
Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the year ended December 31, 2010

Commission File Number 1-11758

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(Exact name of Registrant as specified in its charter)

 

       

Delaware

(State or other jurisdiction of incorporation or organization)

   1585 Broadway

New York, NY 10036

(Address of principal executive offices,
including zip code)

  36-3145972

(I.R.S. Employer Identification No.)

  (212) 761-4000

(Registrant’s telephone number,
including area code)

Title of each class

   Name of exchange on

which registered

Securities registered pursuant to Section 12(b) of the Act:

  
Common Stock, $0.01 par value    New York Stock Exchange

Depositary Shares, each representing 1/1,000th interest in a share of Floating Rate Non-Cumulative Preferred Stock, Series A, $0.01 par value

   New York Stock Exchange
6 1/4% Capital Securities of Morgan Stanley Capital Trust III (and Registrant’s guaranty with respect thereto)    New York Stock Exchange
6 1/4% Capital Securities of Morgan Stanley Capital Trust IV (and Registrant’s guaranty with respect thereto)    New York Stock Exchange
5 3/4% Capital Securities of Morgan Stanley Capital Trust V (and Registrant’s guaranty with respect thereto)    New York Stock Exchange
6.60% Capital Securities of Morgan Stanley Capital Trust VI (and Registrant’s guaranty with respect thereto)    New York Stock Exchange
6.60% Capital Securities of Morgan Stanley Capital Trust VII (and Registrant’s guaranty with respect thereto)    New York Stock Exchange
6.45% Capital Securities of Morgan Stanley Capital Trust VIII (and Registrant’s guaranty with respect thereto)    New York Stock Exchange
Exchangeable Notes due June 30, 2011    NYSE Amex LLC

Capital Protected Notes due March 30, 2011 (2 issuances); Capital Protected Notes due June 30, 2011; Capital Protected Notes due August 20, 2011; Capital Protected Notes due October 30, 2011; Capital Protected Notes due December 30, 2011; Capital Protected Notes due September 30, 2012

   NYSE Arca, Inc.
MPSSM due March 30, 2012    NYSE Arca, Inc.
Buffered PLUSSM due March 20, 2011    NYSE Arca, Inc.
PROPELSSM due December 30, 2011 (3 issuances)    NYSE Arca, Inc.
Protected Absolute Return Barrier Notes due March 20, 2011    NYSE Arca, Inc.
Strategic Total Return Securities due July 30, 2011    NYSE Arca, Inc.
Market Vectors ETNs due March 31, 2020 (2 issuances); Market Vectors ETNs due April 30, 2020 (2 issuances)    NYSE Arca, Inc.

Targeted Income Strategic Total Return Securities due July 30, 2011; Targeted Income Strategic Total Return Securities due January 15, 2012

   NYSE Arca, Inc.
Targeted Income Strategic Total Return Securities due October 30, 2011    The NASDAQ Stock Market LLC

Indicate by check mark if Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES x NO ¨

Indicate by check mark if Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. YES ¨ NO x

Indicate by check mark whether Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer x

Non-Accelerated Filer ¨

(Do not check if a smaller reporting company)

 

Accelerated Filer ¨

Smaller reporting company ¨

Indicate by check mark whether Registrant is a shell company (as defined in Exchange Act Rule 12b-2). YES ¨ NO x

As of June 30, 2010, the aggregate market value of the common stock of Registrant held by non-affiliates of Registrant was approximately $32,227,567,107. This calculation does not reflect a determination that persons are affiliates for any other purposes.

As of January 31, 2011, there were 1,545,631,781 shares of Registrant’s common stock, $0.01 par value, outstanding.

Documents Incorporated by Reference: Portions of Registrant’s definitive proxy statement for its 2011 annual meeting of shareholders are incorporated by reference in Part III of this Form 10-K.


Table of Contents

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ANNUAL REPORT ON FORM 10-K

for the year ended December 31, 2010

 

Table of Contents         Page  
Part I     

Item 1.

  Business      1   
 

Overview

     1   
 

Available Information

     1   
 

Business Segments

     2   
 

Institutional Securities

     2   
 

Global Wealth Management Group

     5   
 

Asset Management

     6   
 

Research

     7   
 

Competition

     7   
 

Supervision and Regulation

     8   
 

Executive Officers of Morgan Stanley

     21   

Item 1A.

  Risk Factors      23   

Item 1B.

  Unresolved Staff Comments      31   

Item 2.

  Properties      32   

Item 3.

  Legal Proceedings      33   

Item 4.

  [Removed and Reserved]      38   
Part II     

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     39   

Item 6.

  Selected Financial Data      42   

Item 7.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      44   
 

Introduction

     44   
 

Executive Summary

     45   
 

Business Segments

     54   
 

Accounting Developments

     73   
 

Other Matters

     73   
 

Critical Accounting Policies

     76   
 

Liquidity and Capital Resources

     81   

Item 7A.

  Quantitative and Qualitative Disclosures about Market Risk      96   

Item 8.

  Financial Statements and Supplementary Data      119   
 

Report of Independent Registered Public Accounting Firm

     119   
 

Consolidated Statements of Financial Condition

     120   
 

Consolidated Statements of Income

     122   
 

Consolidated Statements of Comprehensive Income

     123   
 

Consolidated Statements of Cash Flows

     124   
 

Consolidated Statements of Changes in Total Equity

     125   

 

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           Page  
 

Notes to Consolidated Financial Statements

     127   
 

Financial Data Supplement (Unaudited)

     252   
Item 9.  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     260   
Item 9A.  

Controls and Procedures

     260   
Item 9B.  

Other Information

     262   

Part III

    
Item 10.  

Directors, Executive Officers and Corporate Governance

     263   
Item 11.  

Executive Compensation

     263   
Item 12.  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     264   
Item 13.  

Certain Relationships and Related Transactions, and Director Independence

     265   
Item 14.  

Principal Accountant Fees and Services

     265   

Part IV

    
Item 15.  

Exhibits and Financial Statement Schedules

     266   

Signatures

     S-1   

Exhibit Index

     E-1   

 

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Table of Contents

Forward-Looking Statements

 

We have included in or incorporated by reference into this report, and from time to time may make in our public filings, press releases or other public statements, certain statements, including (without limitation) those under “Legal Proceedings” in Part I, Item 3, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 and “Quantitative and Qualitative Disclosures about Market Risk” in Part II, Item 7A, that may constitute “forward-looking statements” within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. In addition, our management may make forward-looking statements to analysts, investors, representatives of the media and others. These forward-looking statements are not historical facts and represent only our beliefs regarding future events, many of which, by their nature, are inherently uncertain and beyond our control.

 

The nature of our business makes predicting the future trends of our revenues, expenses and net income difficult. The risks and uncertainties involved in our businesses could affect the matters referred to in such statements, and it is possible that our actual results may differ from the anticipated results indicated in these forward-looking statements. Important factors that could cause actual results to differ from those in the forward-looking statements include (without limitation):

 

   

the effect of political and economic conditions and geopolitical events;

 

   

the effect of market conditions, particularly in the global equity, fixed income and credit markets, including corporate and mortgage (commercial and residential) lending and commercial real estate investments;

 

   

the impact of current, pending and future legislation (including the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”)), regulation (including capital requirements), and legal actions in the U.S. and worldwide;

 

   

the level and volatility of equity, fixed income and commodity prices and interest rates, currency values and other market indices;

 

   

the availability and cost of both credit and capital as well as the credit ratings assigned to our unsecured short-term and long-term debt;

 

   

investor sentiment and confidence in the financial markets;

 

   

our reputation;

 

   

inflation, natural disasters and acts of war or terrorism;

 

   

the actions and initiatives of current and potential competitors;

 

   

technological changes; and

 

   

other risks and uncertainties detailed under “Competition” and “Supervision and Regulation” in Part I, Item 1, “Risk Factors” in Part I, Item 1A and elsewhere throughout this report.

 

Accordingly, you are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date on which they are made. We undertake no obligation to update publicly or revise any forward-looking statements to reflect the impact of circumstances or events that arise after the dates they are made, whether as a result of new information, future events or otherwise except as required by applicable law. You should, however, consult further disclosures we may make in future filings of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K and any amendments thereto or in future press releases or other public statements.

 

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Part I

 

Item 1. Business.

 

Overview.

 

Morgan Stanley is a global financial services firm that, through its subsidiaries and affiliates, provides its products and services to a large and diversified group of clients and customers, including corporations, governments, financial institutions and individuals. Morgan Stanley was originally incorporated under the laws of the State of Delaware in 1981, and its predecessor companies date back to 1924. The Company is a financial holding company regulated by the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHC Act”). The Company conducts its business from its headquarters in and around New York City, its regional offices and branches throughout the U.S. and its principal offices in London, Tokyo, Hong Kong and other world financial centers. At December 31, 2010, the Company had 62,542 employees worldwide. Unless the context otherwise requires, the terms the “Company,” “we,” “us” and “our” mean Morgan Stanley and its consolidated subsidiaries.

 

On December 16, 2008, the Board of Directors of the Company approved a change in the Company’s fiscal year-end from November 30 to December 31 of each year, beginning January 1, 2009. As a result of the change, the Company had a one-month transition reporting period in December 2008. Financial information concerning the Company, its business segments and geographic regions for each of the 12 months ended December 31, 2010 (“2010”), December 31, 2009 (“2009”), November 30, 2008 (“fiscal 2008”) and the one month ended December 31, 2008 is included in the consolidated financial statements and the notes thereto in “Financial Statements and Supplementary Data” in Part II, Item 8.

 

Available Information.

 

The Company files annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (the “SEC”). You may read and copy any document the Company files with the SEC at the SEC’s public reference room at 100 F Street, NE, Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for information on the public reference room. The SEC maintains an internet site that contains annual, quarterly and current reports, proxy and information statements and other information that issuers (including the Company) file electronically with the SEC. The Company’s electronic SEC filings are available to the public at the SEC’s internet site, www.sec.gov.

 

The Company’s internet site is www.morganstanley.com. You can access the Company’s Investor Relations webpage at www.morganstanley.com/about/ir. The Company makes available free of charge, on or through its Investor Relations webpage, its proxy statements, Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. The Company also makes available, through its Investor Relations webpage, via a link to the SEC’s internet site, statements of beneficial ownership of the Company’s equity securities filed by its directors, officers, 10% or greater shareholders and others under Section 16 of the Exchange Act.

 

The Company has a Corporate Governance webpage. You can access information about the Company’s corporate governance at www.morganstanley.com/about/company/governance. The Company posts the following on its Corporate Governance webpage:

 

   

Amended and Restated Certificate of Incorporation;

 

   

Amended and Restated Bylaws;

 

   

Charters for its Audit Committee; Internal Audit Subcommittee; Compensation, Management Development and Succession Committee; Nominating and Governance Committee; and Risk Committee;

 

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Corporate Governance Policies;

 

   

Policy Regarding Communication with the Board of Directors;

 

   

Policy Regarding Director Candidates Recommended by Shareholders;

 

   

Policy Regarding Corporate Political Contributions;

 

   

Policy Regarding Shareholder Rights Plan;

 

   

Code of Ethics and Business Conduct;

 

   

Code of Conduct; and

 

   

Integrity Hotline information.

 

Morgan Stanley’s Code of Ethics and Business Conduct applies to all directors, officers and employees, including its Chief Executive Officer, Chief Financial Officer and Finance Director and Controller. The Company will post any amendments to the Code of Ethics and Business Conduct and any waivers that are required to be disclosed by the rules of either the SEC or the New York Stock Exchange LLC (“NYSE”) on its internet site. You can request a copy of these documents, excluding exhibits, at no cost, by contacting Investor Relations, 1585 Broadway, New York, NY 10036 (212-761-4000). The information on the Company’s internet site is not incorporated by reference into this report.

 

Business Segments.

 

The Company is a global financial services firm that maintains significant market positions in each of its business segments—Institutional Securities, Global Wealth Management Group and Asset Management. A summary of the activities of each of the business segments follows.

 

Institutional Securities provides capital raising; financial advisory services, including advice on mergers and acquisitions, restructurings, real estate and project finance; corporate lending; sales, trading, financing and market-making activities in equity and fixed income securities and related products, including foreign exchange and commodities; and investment activities.

 

Global Wealth Management Group, which includes the Company’s 51% interest in Morgan Stanley Smith Barney Holdings LLC (“MSSB”), provides brokerage and investment advisory services to individual investors and small-to-medium sized businesses and institutions covering various investment alternatives; financial and wealth planning services; annuity and other insurance products; credit and other lending products; cash management services; retirement services; and trust and fiduciary services and engages in fixed income principal trading, which primarily facilitates clients’ trading or investments in such securities.

 

Asset Management provides a broad array of investment strategies that span the risk/return spectrum across geographies, asset classes and public and private markets to a diverse group of clients across the institutional and intermediary channels as well as high net worth clients.

 

Institutional Securities.

 

The Company provides financial advisory and capital-raising services to a diverse group of corporate and other institutional clients globally, primarily through wholly owned subsidiaries that include Morgan Stanley & Co. Incorporated (“MS&Co.”), Morgan Stanley & Co. International plc and Morgan Stanley Asia Limited, and certain joint venture entities that include Morgan Stanley MUFG Securities Co., Ltd. and Mitsubishi UFJ Morgan Stanley Securities Co., Ltd. These entities also conduct sales and trading activities worldwide, as principal and agent, and provide related financing services on behalf of institutional investors.

 

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Investment Banking and Corporate Lending Activities.

 

Capital Raising.    The Company manages and participates in public offerings and private placements of debt, equity and other securities worldwide. The Company is a leading underwriter of common stock, preferred stock and other equity-related securities, including convertible securities and American Depositary Receipts (“ADRs”). The Company is also a leading underwriter of fixed income securities, including investment grade debt, non-investment grade instruments, mortgage-related and other asset-backed securities, tax-exempt securities and commercial paper and other short-term securities.

 

Financial Advisory Services.    The Company provides corporate and other institutional clients globally with advisory services on key strategic matters, such as mergers and acquisitions, divestitures, joint ventures, corporate restructurings, recapitalizations, spin-offs, exchange offers and leveraged buyouts and takeover defenses as well as shareholder relations. The Company also provides advice concerning rights offerings, dividend policy, valuations, foreign exchange exposure, financial risk management strategies and financial planning. In addition, the Company furnishes advice and services regarding project financings and provides advisory services in connection with the purchase, sale, leasing and financing of real estate.

 

Corporate Lending.    The Company provides loans or lending commitments, including bridge financing, to selected corporate clients through its subsidiaries, including Morgan Stanley Bank, N.A (“MSBNA”). These loans and commitments have varying terms, may be senior or subordinated and/or secured or unsecured, are generally contingent upon representations, warranties and contractual conditions applicable to the borrower, and may be syndicated, hedged or traded by the Company*. The borrowers may be rated investment grade or non-investment grade.

 

Sales and Trading Activities.

 

The Company conducts sales, trading, financing and market-making activities on securities and futures exchanges and in over-the-counter (“OTC”) markets around the world. The Company’s Institutional Securities sales and trading activities include Equity Trading; Interest Rates, Credit and Currencies; Commodities; Clients and Services; and Investments.

 

Equity Trading.    The Company acts as principal (including as a market-maker) and agent in executing transactions globally in equity and equity-related products, including common stock, ADRs, global depositary receipts and exchange-traded funds.

 

The Company’s equity derivatives sales, trading and market-making activities cover equity-related products globally, including equity swaps, options, warrants and futures overlying individual securities, indices and baskets of securities and other equity-related products. The Company also issues and makes a principal market in equity-linked products to institutional and individual investors.

 

Interest Rates, Credit and Currencies.    The Company trades, invests and makes markets in fixed income securities and related products globally, including, among other products, investment and non-investment grade corporate debt, distressed debt, bank loans, U.S. and other sovereign securities, emerging market bonds and loans, convertible bonds, collateralized debt obligations, credit, currency, interest rate and other fixed income-linked notes, securities issued by structured investment vehicles, mortgage-related and other asset-backed securities and real estate-loan products, municipal securities, preferred stock and commercial paper, money-market and other short-term securities. The Company is a primary dealer of U.S. federal government securities and a member of the selling groups that distribute various U.S. agency and other debt securities. The Company is also a primary dealer or market-maker of government securities in numerous European, Asian and emerging market countries.

 

The Company trades, invests and makes markets globally in listed futures and OTC swaps, forwards, options and other derivatives referencing, among other things, interest rates, currencies, investment grade and non-investment grade corporate credits, loans, bonds, U.S. and other sovereign securities, emerging market bonds and loans,

* Revenues and expenses associated with the trading of syndicated loans are included in “Sales and Trading Activities.”

 

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credit indexes, asset-backed security indexes, property indexes, mortgage-related and other asset-backed securities and real estate loan products.

 

The Company trades, invests and makes markets in major foreign currencies, such as the British pound, Canadian dollar, euro, Japanese yen and Swiss franc, as well as in emerging markets currencies. The Company trades these currencies on a principal basis in the spot, forward, option and futures markets.

 

Through the use of repurchase and reverse repurchase agreements, the Company acts as an intermediary between borrowers and lenders of short-term funds and provides funding for various inventory positions. The Company also provides financing to customers for commercial and residential real estate loan products and other securitizable asset classes. In addition, the Company engages in principal securities lending with clients, institutional lenders and other broker-dealers.

 

The Company advises on investment and liability strategies and assists corporations in their debt repurchases and tax planning. The Company structures debt securities, derivatives and other instruments with risk/return factors designed to suit client objectives, including using repackaged asset and other structured vehicles through which clients can restructure asset portfolios to provide liquidity or reconfigure risk profiles.

 

Commodities.    The Company invests and makes markets in the spot, forward, physical derivatives and futures markets in several commodities, including metals (base and precious), agricultural products, crude oil, oil products, natural gas, electric power, emission credits, coal, freight, liquefied natural gas and related products and indices. The Company is a market-maker in exchange-traded options and futures and OTC options and swaps on commodities, and offers counterparties hedging programs relating to production, consumption, reserve/inventory management and structured transactions, including energy-contract securitizations and monetization. The Company is an electricity power marketer in the U.S. and owns electricity-generating facilities in the U.S. and Europe.

 

The Company owns TransMontaigne Inc. and its subsidiaries, a group of companies operating in the refined petroleum products marketing and distribution business, and owns a minority interest in Heidmar Holdings LLC, which owns a group of companies that provide international marine transportation and U.S. marine logistics services.

 

Clients and Services.    The Company provides financing services, including prime brokerage, which offers, among other services, consolidated clearance, settlement, custody, financing and portfolio reporting services to clients trading multiple asset classes. In addition, the Company’s institutional distribution and sales activities are overseen and coordinated through Clients and Services.

 

Investments.    The Company from time to time makes investments that represent business facilitation or other investing activities. Such investments are typically strategic investments undertaken by the Company to facilitate core business activities. From time to time, the Company may also make investments and capital commitments to public and private companies, funds and other entities.

 

The Company sponsors and manages investment vehicles and separate accounts for clients seeking exposure to private equity, infrastructure, mezzanine lending and real estate-related and other alternative investments. The Company may also invest in and provide capital to such investment vehicles. See also “Asset Management” herein.

 

Operations and Information Technology.

 

The Company’s Operations and Information Technology departments provide the process and technology platform that supports Institutional Securities sales and trading activity, including post-execution trade processing and related internal controls over activity from trade entry through settlement and custody, such as asset servicing. This is done for transactions in listed and OTC transactions in commodities, equity and fixed

 

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income securities, including both primary and secondary trading, as well as listed, OTC and structured derivatives in markets around the world. This activity is undertaken through the Company’s own facilities, through membership in various clearing and settlement organizations, and through agreements with unaffiliated third parties.

 

Global Wealth Management Group.

 

The Company’s Global Wealth Management Group, which includes the Company’s 51% interest in MSSB, provides comprehensive financial services to clients through a network of more than 18,000 global representatives in approximately 850 locations at year-end. As of December 31, 2010, the Company’s Global Wealth Management Group had $1,669 billion in client assets.

 

Clients.

 

Global Wealth Management Group professionals serve individual investors and small-to-medium sized businesses and institutions with an emphasis on ultra high net worth, high net worth and affluent investors. Global representatives are located in branches across the U.S. and provide solutions designed to accommodate individual investment objectives, risk tolerance and liquidity needs. Call centers are available to meet the needs of emerging affluent clients. Outside the U.S., Global Wealth Management Group offers financial services to clients in Europe, the Middle East, Asia, Australia and Latin America.

 

Products and Services.

 

The Company’s Global Wealth Management Group provides clients with a comprehensive array of financial solutions, including products and services from the Company, Citigroup Inc. (“Citi”) and third-party providers, such as insurance companies and mutual fund families. Global Wealth Management Group provides brokerage and investment advisory services covering various types of investments, including equities, options, futures, foreign currencies, precious metals, fixed income securities, mutual funds, structured products, alternative investments, unit investment trusts, managed futures, separately managed accounts and mutual fund asset allocation programs. Global Wealth Management Group also engages in fixed income principal trading, which primarily facilitates clients’ trading or investments in such securities. In addition, Global Wealth Management Group offers education savings programs, financial and wealth planning services, and annuity and other insurance products.

 

In addition, Global Wealth Management Group offers its clients access to several cash management services through various affiliates, including deposits, debit cards, electronic bill payments and check writing, as well as lending products, including securities based lending, mortgage loans and home equity lines of credit. Global Wealth Management Group also provides trust and fiduciary services, offers access to cash management and commercial credit solutions to qualified small- and medium-sized businesses in the U.S., and provides individual and corporate retirement solutions, including individual retirement accounts and 401(k) plans and U.S. and global stock plan services to corporate executives and businesses.

 

Global Wealth Management Group provides clients a variety of ways to establish a relationship and conduct business, including brokerage accounts with transaction-based pricing and investment advisory accounts with asset-based fee pricing.

 

Operations and Information Technology.

 

As a result of MSSB, most of the operations and technology supporting the Global Wealth Management Group are provided either by the Company’s Operations and Information Technology departments or by Citi. Pursuant to contractual agreements, the Company and Citi perform various broker-dealer related functions, such as execution and clearing of brokerage transactions, margin lending and custody of client assets. For the Company,

 

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these activities are undertaken through its own facilities, through memberships in various clearing and settlement organizations, and through agreements with unaffiliated third parties. The Company and Citi provide certain other services and systems to support the Global Wealth Management Group through transition services agreements with MSSB.

 

Asset Management.

 

The Company’s Asset Management business segment is one of the largest global investment management organizations of any full-service financial services firm and offers clients a diverse array of equity, fixed income and alternative investments and merchant banking strategies. Portfolio managers located in the U.S., Europe and Asia manage investment products ranging from money market funds to equity and fixed income strategies, alternative investment and merchant banking products in developed and emerging markets across geographies and market cap ranges.

 

The Company offers a range of alternative investment, real estate investing and merchant banking products for institutional investors and high net worth individuals. The Company’s alternative investments platform includes hedge funds, funds of hedge funds, funds of private equity funds and portable alpha strategies. The Company’s alternative investments platform also includes minority stakes in Lansdowne Partners, Avenue Capital Group and Traxis Partners LP. The Company’s real estate and merchant banking businesses include its real estate investing business, private equity funds, corporate mezzanine debt investing group and infrastructure investing group. The Company typically acts as general partner of, and investment adviser to, its alternative investment, real estate and merchant banking funds and typically commits to invest a minority of the capital of such funds with subscribing investors contributing the majority.

 

On June 1, 2010, as part of a restructuring of the Company’s Asset Management business segment, the Company sold substantially all of its retail asset management business, including Van Kampen Investments, Inc., to Invesco Ltd. This transaction allows the Company’s Asset Management business segment to focus on its institutional and intermediary client base.

 

Institutional Investors.

 

The Company provides investment management strategies and products to institutional investors worldwide, including corporations, pension plans, endowments, foundations, sovereign wealth funds, insurance companies and banks through a broad range of pooled vehicles and separate accounts. Additionally, the Company provides sub-advisory services to various unaffiliated financial institutions and intermediaries. A Global Sales and Client Service team is engaged in business development and relationship management for consultants to help serve institutional clients.

 

Intermediary Clients and Individual Investors.

 

The Company offers open-end and alternative investment funds and separately managed accounts to individual investors through affiliated and unaffiliated broker-dealers, banks, insurance companies, financial planners and other intermediaries. Closed-end funds managed by the Company are available to individual investors through affiliated and unaffiliated broker-dealers. The Company also distributes mutual funds through numerous retirement plan platforms. Internationally, the Company distributes traditional investment products to individuals outside the U.S. through non-proprietary distributors and distributes alternative investment products through affiliated broker-dealers and banks.

 

Operations and Information Technology.

 

The Company’s Operations and Information Technology departments provide or oversee the process and technology platform required to support its asset management business. Support activities include transfer agency, mutual fund accounting and administration, transaction processing and certain fiduciary services on

 

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behalf of institutional, intermediary and high net worth clients. These activities are undertaken through the Company’s own facilities, through membership in various clearing and settlement organizations, and through agreements with unaffiliated third parties.

 

Research.

 

The Company’s research department (“Research”) coordinates globally across all of the Company’s businesses. Research consists of economists, strategists and industry analysts who engage in equity and fixed income research activities and produce reports and studies on the U.S. and global economy, financial markets, portfolio strategy, technical market analyses, individual companies and industry developments. Research examines worldwide trends covering numerous industries and individual companies, the majority of which are located outside the U.S.; provides analysis and forecasts relating to economic and monetary developments that affect matters such as interest rates, foreign currencies, securities, derivatives and economic trends; and provides analytical support and publishes reports on asset-backed securities and the markets in which such securities are traded and data are disseminated to investors through third-party distributors, proprietary internet sites such as Client Link and the Company’s sales forces.

 

Competition.

 

All aspects of the Company’s businesses are highly competitive, and the Company expects them to remain so. The Company competes in the U.S. and globally for clients, market share and human talent in all aspects of its business segments. The Company’s competitive position depends on its reputation and the quality and consistency of its long-term investment performance. The Company’s ability to sustain or improve its competitive position also depends substantially on its ability to continue to attract and retain highly qualified employees while managing compensation and other costs. The Company competes with commercial banks, brokerage firms, insurance companies, sponsors of mutual funds, hedge funds, energy companies and other companies offering financial services in the U.S., globally and through the internet. Over time, certain sectors of the financial services industry have become more concentrated, as institutions involved in a broad range of financial services have been acquired by or merged into other firms or have declared bankruptcy. Such changes could result in the Company’s remaining competitors gaining greater capital and other resources, such as the ability to offer a broader range of products and services and geographic diversity. See also “Supervision and Regulation” and “Risk Factors” herein.

 

Institutional Securities and Global Wealth Management Group.

 

The Company’s competitive position depends on innovation, execution capability and relative pricing. The Company competes directly in the U.S. and globally with other securities and financial services firms and broker-dealers and with others on a regional or product basis.

 

The Company’s ability to access capital at competitive rates (which is generally dependent on the Company’s credit ratings) and to commit capital efficiently, particularly in its capital-intensive underwriting and sales, trading, financing and market-making activities, also affects its competitive position. Corporate clients may request that the Company provide loans or lending commitments in connection with certain investment banking activities, and such requests are expected to increase in the future.

 

It is possible that competition may become even more intense as the Company continues to compete with financial institutions that may be larger, or better capitalized, or may have a stronger local presence and longer operating history in certain areas. Many of these firms have greater capital than the Company and have the ability to offer a wide range of products and services that may enhance their competitive position and could result in pricing pressure in our businesses. The complementary trends in the financial services industry of consolidation and globalization present, among other things, technological, risk management, regulatory and other infrastructure challenges that require effective resource allocation in order for the Company to remain competitive.

 

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The Company has experienced intense price competition in some of its businesses in recent years. In particular, the ability to execute securities trades electronically on exchanges and through other automated trading markets has increased the pressure on trading commissions. The trend toward direct access to automated, electronic markets will likely continue. It is possible that the Company will experience competitive pressures in these and other areas in the future as some of its competitors may seek to obtain market share by reducing prices.

 

Asset Management.

 

Competition in the asset management industry is affected by several factors, including the Company’s reputation, investment objectives, quality of investment professionals, performance of investment strategies or product offerings relative to peers and an appropriate benchmark index, advertising and sales promotion efforts, fee levels, the effectiveness of and access to distribution channels and investment pipelines, and the types and quality of products offered. The Company’s alternative investment products, such as private equity funds, real estate and hedge funds, compete with similar products offered by both alternative and traditional asset managers.

 

Supervision and Regulation.

 

As a major financial services firm, the Company is subject to extensive regulation by U.S. federal and state regulatory agencies and securities exchanges and by regulators and exchanges in each of the major markets where it operates. Moreover, in response to the financial crisis, legislators and regulators, both in the U.S. and around the world, are in the process of adopting and implementing a wide range of reforms that will result in major changes to the way the Company is regulated and conducts its business. It will take some time for the comprehensive effects of these reforms to emerge and be understood.

 

Regulatory Outlook.

 

On July 21, 2010, President Obama signed the Dodd-Frank Act into law. While certain portions of the Dodd-Frank Act were effective immediately, other portions will be effective only following extended transition periods. At this time, it is difficult to assess fully the impact that the Dodd-Frank Act will have on the Company and on the financial services industry generally. Implementation of the Dodd-Frank Act will be accomplished through numerous rulemakings by multiple governmental agencies. The Dodd-Frank Act also mandates the preparation of studies on a wide range of issues, which could lead to additional legislation or regulatory changes.

 

In addition, legislative and regulatory initiatives continue outside the U.S. which may also affect the Company’s business and operations. For example, the Basel Committee on Banking Supervision (the “Basel Committee”) has issued new capital, leverage and liquidity standards, known as “Basel III,” which U.S. banking regulators are expected to introduce in the U.S. The Financial Stability Board and the Basel Committee are also developing standards designed to apply to systemically important financial institutions, such as the Company. In addition, initiatives are under way in the European Union and Japan, among other jurisdictions, that would require centralized clearing, reporting and recordkeeping with respect to various kinds of financial transactions and other regulatory requirements that are in some cases similar to those required under the Dodd-Frank Act.

 

It is likely that the year 2011 and subsequent years will see further material changes in the way major financial institutions are regulated in both the U.S. and other markets in which the Company operates, though it is difficult to predict which further reform initiatives will become law, how such reforms will be implemented or the exact impact they will have on the Company’s business, financial condition, results of operations and cash flows for a particular future period.

 

Financial Holding Company.

 

The Company has operated as a bank holding company and financial holding company under the BHC Act since September 2008. Effective July 22, 2010, as a bank holding company with $50 billion or more in consolidated assets, the Company became subject to the new systemic risk regime established by the Dodd-Frank Act. It is not yet clear how the regulators will apply the heightened prudential standards on systemically important firms such as the Company.

 

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Consolidated Supervision.

 

On the bank holding company level, the Company is subject to the comprehensive consolidated supervision, regulation and examination by the Federal Reserve. As a result of the Dodd-Frank Act, the Federal Reserve also gains heightened authority to examine, prescribe regulations and take action with respect to all of the Company’s subsidiaries. In addition, a new consumer protection agency, the Bureau of Consumer Financial Protection, will have exclusive rulemaking and primary enforcement and examination authority over the Company and its subsidiaries with respect to federal consumer financial laws to the extent applicable.

 

Because the Company is subject to the systemic risk regime, it is now also subject to the expanded systemic risk powers of the Federal Reserve, including the Federal Reserve’s rulemaking in the area of heightened prudential standards and other requirements under the systemic risk regime. A new systemic risk oversight body, the Financial Stability Oversight Council (the “Council”), can recommend prudential standards, reporting and disclosure requirements to the Federal Reserve with applicability to financial institutions such as the Company, and must approve any finding by the Federal Reserve that a systemically important financial institution poses a grave threat to financial stability and must undertake mitigating actions. The Council is also empowered to designate systemically important payment, clearing and settlement activities of financial institutions, subjecting them to prudential supervision and regulation, and, assisted by the new Office of Financial Research within the U.S. Department of the Treasury (“U.S. Treasury”) (established by the Dodd-Frank Act), can gather data and reports from financial institutions, including the Company. See also “—Systemic Risk Regime” below.

 

Scope of Permitted Activities.    As a financial holding company, Morgan Stanley is currently able to engage in any activity that is financial in nature or incidental to a financial activity, as defined in accordance with the BHC Act. Unless otherwise required by the Federal Reserve, the Company is permitted to begin any new financial activity, and generally may acquire any company engaged in any financial activity, as long as it provides after–the–fact notice of such new activity or investment to the Federal Reserve.

 

The Company is, however, subject to prior notice or approval requirements of the Federal Reserve in respect of certain types of transactions, including for the acquisition of more than 5% of any class of voting stock of a U.S. depository institution or depository institution holding company, and, since July 2010, also for certain acquisitions of non-bank financial companies with $10 billion or more in total consolidated assets. The Company’s ability, as a financial holding company, to engage in certain merger transactions could also be impacted by approval requirements on a potentially broader set of transactions that will take effect in July 2011, by a new financial stability factor the Federal Reserve must consider in approving certain transactions, and by concentration limits, to be implemented by October 2011, limiting mergers and acquisitions resulting in control of more than 10% of all consolidated financial liabilities in the U.S. The Dodd-Frank Act will also place heightened requirements on the Company’s ability to acquire control of a bank.

 

The BHC Act gave the Company two years after becoming a financial holding company to conform its existing non-financial activities and investments to the requirements of the BHC Act, with the possibility of three one-year extensions for a total grace period of up to five years. The Company has requested and obtained an extension in order to conform a limited set of activities and make certain divestments. The BHC Act also grandfathers any “activities related to the trading, sale or investment in commodities and underlying physical properties,” provided that the Company was engaged in “any of such activities as of September 30, 1997 in the United States” and provided that certain other conditions that are within the Company’s reasonable control are satisfied. If the Federal Reserve were to determine that any of the Company’s commodities activities did not qualify for the BHC Act grandfather exemption, then the Company would likely be required to divest any such activities that did not otherwise conform to the BHC Act by the end of any extensions of the grace period. The Company does not believe that any such required divestment would have a material adverse impact on its results of operations, cash flows or financial condition.

 

In order to maintain its status as a financial holding company, Morgan Stanley must satisfy certain requirements, including the requirement that its depository institution subsidiaries remain well capitalized and well managed.

 

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Under current regulations implemented by the Federal Reserve, if any depository institution controlled by a financial holding company no longer meets certain capital or management standards, the Federal Reserve may impose corrective capital and/or managerial requirements on the parent financial holding company and place limitations on its ability to make acquisitions or otherwise conduct the broader financial activities permissible for financial holding companies. In addition, as a last resort if the deficiencies persist, the Federal Reserve may order a financial holding company to cease the conduct of or to divest those businesses engaged in activities other than those permissible for bank holding companies that are not financial holding companies. Under the Dodd-Frank Act, beginning in July 2011, the financial holding company status will also depend on remaining well capitalized and well managed at the holding company level. See also “—Capital Standards” below.

 

Current regulations also provide that if any depository institution controlled by a financial holding company fails to maintain a satisfactory rating under the Community Reinvestment Act of 1977, the Federal Reserve must prohibit the financial holding company and its subsidiaries from engaging in any additional activities other than those permissible for bank holding companies that are not financial holding companies.

 

Activities Restrictions under the Volcker Rule.    A provision of the Dodd-Frank Act (the “Volcker Rule”) will, over time, prohibit the Company and its subsidiaries from engaging in “proprietary trading,” as defined by the regulators. The Volcker Rule will also require banking entities to either restructure or unwind certain relationships with “hedge funds” and “private equity funds,” as such terms are defined in the Volcker Rule and by the regulators. Regulators are required to issue regulations implementing the substantive Volcker Rule provisions during the course of 2011. The Volcker Rule is expected to become effective in July 2012, and banking entities will then have a two-year transition period to come into compliance with the Volcker Rule, subject to certain available extensions.

 

While full compliance with the Volcker Rule will likely only be required by July 2014, subject to extensions, the Company’s business and operations are expected to be impacted earlier, as operating models, investments and legal structures must be reviewed and gradually adjusted to the new legal environment. The Company has begun a review of its private equity fund, hedge fund and proprietary trading operations; however, it is too early to predict how the Volcker Rule may impact the Company’s businesses.

 

Systemic Risk Regime.    The Dodd-Frank Act establishes a new regulatory framework applicable to financial institutions deemed to pose systemic risks. Bank holding companies with $50 billion or more in consolidated assets, such as the Company, became automatically subject to the systemic risk regime in July 2010.

 

Under the systemic risk regime, the Federal Reserve must establish enhanced risk-based capital, leverage capital and liquidity requirements. These requirements have to be more stringent than standards for institutions that do not pose systemic risks. Those more broadly applicable U.S. capital and leverage standards will become significantly more onerous, and will be supplemented by liquidity requirements, such as those promulgated by the Basel Committee. The enhanced capital, leverage and liquidity standards under the systemic risk regime are expected to place additional demands, beyond those under Basel III, on systemically important financial institutions including the Company. The exact form, scale and timing of introduction of any such enhanced requirements are unclear and will have to be established by rulemaking. The Financial Stability Board has also announced that it will, together with national authorities, determine in 2011 which financial institutions are “clearly systemic to the global financial system” (“G-SIFIs”), and recommend an additional degree of loss absorbency for these institutions. A peer review council will be established with the aim of ensuring consistent application of measures across G-SIFIs in light of the risks they pose.

 

The systemic risk regime calls for the establishment of extensive, rapid and orderly resolution plans (“resolution plans”). The establishment and maintenance of resolution plans requires systemically important financial institutions, including the Company, to analyze and provide substantial amounts of information regarding their legal entity structure, assets, liabilities, security arrangements and major counterparties and could entail significant restructuring of operations. The Federal Reserve and the Federal Deposit Insurance Corporation (the “FDIC”) will review resolution plans for adequacy and, if they are found to be inadequate, can require changes in

 

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business operations and corporate structure, impose more stringent requirements or restrictions, including more stringent capital requirements or restrictions on growth, and may require divestments of operations or assets as a last resort. The specific requirements of resolution plans will be developed through Federal Reserve and FDIC rulemaking.

 

Systemically important financial institutions are made subject to an early remediation regime to address financial distress, which will include measures ranging from limits on capital distributions, acquisitions and asset growth, to capital restoration plans and capital-raising requirements, and the details of which will be established by rulemaking. It is currently unclear how regulators will define “financial distress,” thereby determining at what level of capital deficiency or other signs of distress the foregoing restrictions would set in. In addition, for institutions posing a grave threat to U.S. financial stability, the Federal Reserve, upon Council vote, must limit that institution’s ability to merge, restrict its ability to offer financial products, require it to terminate activities, impose conditions on activities or, as a last resort, require it to dispose of assets. Upon a grave threat determination by the Council, the Federal Reserve must issue rules that require financial institutions subject to the systemic risk regime to maintain a debt-to-equity ratio of no more than 15-to-1 if the Council considers it necessary to mitigate the risk.

 

Under the systemic risk regime, the Company will be required to conduct regular internal stress tests, and the Company must also submit to annual stress tests conducted by the Federal Reserve, a summary of which will be published. Implementing regulation must be issued by January 2012. The systemic risk regime also calls for heightened risk management standards and credit exposure reporting and, effective by July 2013 at the earliest, for limits on the concentration of risk and credit exposure to non-affiliates. The Federal Reserve also has the ability to establish further standards, including those regarding contingent capital, enhanced public disclosures, required risk committee of the board, and limits on short-term debt, including off-balance sheet exposures.

 

See also “—Capital Standards” and “—Orderly Liquidation Authority” below.

 

Capital Standards.    The Federal Reserve establishes capital requirements for the Company and evaluates its compliance with such capital requirements. The Office of the Comptroller of the Currency (the “OCC”) establishes similar capital requirements and standards for the Company’s national bank subsidiaries.

 

Current U.S. risk-based capital and leverage guidelines require the Company’s capital-to-assets ratios to meet certain minimum standards. Under the current guidelines, in order for the Company to remain a financial holding company its bank subsidiaries must qualify as “well capitalized” and “well managed” by maintaining a total capital ratio (total capital to risk-weighted assets) of at least 10% and a Tier 1 capital ratio of at least 6%. Beginning in July 2011, as required by the Dodd-Frank Act, the capital standards currently applicable to the Company’s bank subsidiaries will apply directly to the Company, as a holding company, and require it to remain “well capitalized” and “well managed” to maintain its status as a financial holding company. Under current standards, the Federal Reserve may require the Company and its peer financial holding companies to maintain risk-based and leverage capital ratios substantially in excess of mandated minimum levels, depending upon general economic conditions and their particular condition, risk profile and growth plans. The Company expects that the new “well capitalized” requirement under the Dodd-Frank Act will similarly be established in excess of minimum capital requirements applicable to bank holding companies.

 

The Company calculates its capital ratios and risk-weighted assets in accordance with the capital adequacy standards for financial holding companies adopted by the Federal Reserve. These standards are based upon a framework described in the “International Convergence of Capital Measurement and Capital Standards,” July 1988, as amended, also referred to as “Basel I.” At December 31, 2010, the Company was in compliance with Basel I capital requirements. See also Management’s Discussion and Analysis of Financial Condition and Results of Operation—Liquidity and Capital Resources—Regulatory Requirements” in Part II, Item 7 herein.

 

In December 2007, the U.S. banking regulators published final U.S. implementing regulation incorporating the Basel II Accord, which requires internationally active banking organizations, as well as certain of their U.S. bank

 

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subsidiaries, to implement Basel II standards over the next several years. The timeline set out in December 2007 for the implementation of Basel II in the U.S. may be impacted by the developments concerning Basel III described below. Starting July 2010, the Company has been reporting on a parallel basis under the current regulatory capital regime (Basel I) and Basel II, which, as currently scheduled, will be followed by a three-year transitional period. In addition, under a provision of the Dodd-Frank Act, capital standards generally applicable to U.S. banks will serve to establish minimum Tier 1 and total capital requirements more broadly, including for bank holding companies such as the Company that otherwise apply different capital standards set by the Federal Reserve. In effect, those generally applicable capital standards, which are currently based on Basel I standards but may themselves change over time, would serve as a permanent floor to minimum capital requirements calculated under the Basel II standard the Company is currently required to implement, as well as future capital standards.

 

Basel III contains new standards that will raise the quality of capital banking institutions must hold, strengthen the risk-weighted asset base and introduce a leverage ratio as a supplemental measure to the risk-based capital ratios. Basel III includes a new capital conservation buffer, which imposes a common equity requirement above the new minimum that can be depleted under stress, subject to restrictions on capital distributions, and a new countercyclical buffer, which regulators can activate during periods of excessive credit growth in their jurisdiction. The use of certain capital instruments, such as trust preferred securities, as Tier 1 capital components will be phased out. Basel III also introduces new liquidity measures designed to monitor banking institutions for their ability to meet short-term cash flow needs and to address longer-term structural liquidity mismatches.

 

National implementation of Basel III risk-based capital requirements, including by U.S. regulators, will begin in 2013, and many of the requirements will be subject to extended phase-in periods. Once fully implemented, the capital requirements would include a new minimum Tier 1 common equity ratio of 4.5%, a minimum Tier 1 equity ratio of 6%, and the minimum total capital ratio which would remain at 8.0% (plus a 2.5% capital conservation buffer consisting of common equity in addition to these ratios). Despite extended phase-in periods, the Company expects some of the new capital requirements to become relevant sooner. For example, on November 17, 2010, the Federal Reserve announced that it will require large U.S. bank holding companies to submit capital plans that show, among other things, the ability to meet Basel III capital requirements over time, and the Company submitted its capital plan to the Federal Reserve on January 7, 2011 in response to such requirements. The Federal Reserve will evaluate capital plans that include a request to increase common stock dividends, implement stock repurchase programs, or redeem or repurchase capital instruments.

 

Concurrently with implementing regulations concerning Basel III, U.S. banking regulators will implement provisions of the Dodd-Frank Act with effect on capital and related requirements, including heightened capital and liquidity requirements for financial institutions subject to the systemic risk regime, including the Company, as well as a mandate to make capital requirements countercyclical, and for capital requirements to address risks posed by certain activities. Pursuant to a provision of the Dodd-Frank Act, over time, trust preferred securities will no longer qualify as Tier 1 capital but will qualify only as Tier 2 capital. This change in regulatory capital treatment will be phased in incrementally during a transition period that will start on January 1, 2013 and end on January 1, 2016. This provision of the Dodd-Frank Act is expected to accelerate the phase-in of disqualification of trust preferred securities provided for by Basel III.

 

Bank holding companies are also subject to a Tier 1 leverage ratio as defined by the Federal Reserve. Under Federal Reserve rules, the minimum leverage ratio is 3% for bank holding companies, including the Company, that are considered “strong” under Federal Reserve guidelines or which have implemented the Federal Reserve’s risk-based capital measure for market risk. Basel III introduces internationally a leverage ratio that could result in more stringent capital requirements than the current minimum U.S. leverage ratio. Bank holding companies such as the Company, over a period of time will also be required to satisfy, at a minimum, the leverage capital requirements currently in effect for U.S. banks, which will thereafter serve as an effective floor. Financial institutions subject to the systemic risk regime under the Dodd-Frank Act, including the Company, will also be required to meet as yet unspecified heightened prudential standards, including possibly higher leverage capital requirements.

 

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See also “Management’s Discussion and Analysis of Financial Condition and Results of Operation—Liquidity and Capital Resources—Regulatory Requirements” in Part II, Item 7 herein.

 

Orderly Liquidation Authority.    Under the Dodd-Frank Act, financial companies, including bank holding companies such as Morgan Stanley and certain covered subsidiaries, can be subjected to a new orderly liquidation authority. The U.S. Treasury must first make certain extraordinary financial distress and systemic risk determinations. Absent such U.S. Treasury determinations, Morgan Stanley as a bank holding company would remain subject to the U.S. Bankruptcy Code.

 

The orderly liquidation authority went into effect in July 2010, but rulemaking is required to render it fully operative. If the Company were subjected to the orderly liquidation authority, the FDIC would be appointed receiver, which would give the FDIC considerable rights and powers that it must exercise with the goal of liquidating and winding up the Company, including (i) the FDIC’s right to assign assets and liabilities and transfer some to a third party or bridge financial company without the need for creditor consent or prior court review; (ii) the ability of the FDIC to differentiate among creditors in exercising its cherry-picking powers, including by treating junior creditors better than senior creditors, subject to a minimum recovery right to receive at least what they would have received in bankruptcy liquidation; and (iii) the broad powers given the FDIC to administer the claims process to determine which creditor receives what, and in which order, from assets not transferred to a third party or bridge financial institution.

 

The FDIC can provide a broad range of financial assistance for the resolution process, and, if it does so, it must ensure that unsecured creditors bear losses up to the amount they would have suffered in liquidation (or as otherwise determined by the FDIC), and that management or board members of the financial company responsible for the failed condition are removed. Amounts owed to the U.S. are generally given priority over claims of general creditors. In addition, to the extent the FDIC funds the liquidation of a financial company with borrowings from the U.S. Treasury, it is authorized to assess claimants that receive benefits in excess of their claims in a bankruptcy liquidation, as well as systemically important or other large financial institutions, to repay such borrowings.

 

A number of creditor rights in the orderly liquidation authority have been modeled after the Bankruptcy Code, and the FDIC must promulgate implementing regulation in a manner that further reduces the gap in treatment between the two regimes and increases legal certainty. However, the orderly resolution authority is untested and differs in material respects from the Bankruptcy Code, including in the broad powers granted to the FDIC as receiver. As a result, the Company cannot exclude the possibility that shareholders, creditors and other counterparties of the Company and similarly situated financial companies will reassess the credit risk posed by the possibility that the Company could be subjected to the orderly liquidation authority, and could seek to be compensated for any perceived risk of greater credit losses in such event.

 

In addition to the orderly liquidation authority, the Dodd-Frank Act also eliminates some of the regulatory authorities used in the recent financial crisis to intervene and support individual financial institutions. As a result of these developments, credit rating agencies have announced that they would review financial institutions’ ratings to potentially adjust the previously assumed level of government support as a factor in their ratings. These developments may have potential negative implications for such institutions’ ratings to the extent the credit rating agencies’ assessment of the impact of systemic risk regulation on the assumed level of government support negatively influences the Company’s credit ratings, that in turn could negatively impact the Company’s funding costs. See also “Management’s Discussion and Analysis of Financial Condition and Results of Operation—Liquidity and Capital Resources—Credit Ratings” in Part II, Item 7 herein.

 

Dividends.    In addition to certain dividend restrictions that apply by law to certain of the Company’s subsidiaries, as described below, the OCC, the Federal Reserve and the FDIC have authority to prohibit or to limit the payment of dividends by the banking organizations they supervise, including the Company, MSBNA and other depository institution subsidiaries of the Company, if, in the banking regulator’s opinion, payment of a dividend would constitute an unsafe or unsound practice in light of the financial condition of the banking

 

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organization. It is Federal Reserve policy that bank holding companies should generally pay dividends on common stock only out of income available from the past year, and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. It is also Federal Reserve policy that bank holding companies should not maintain dividend levels that undermine the company’s ability to be a source of strength to its banking subsidiaries. Under the Dodd-Frank Act, all companies that own or control an insured depository institution will be required to serve as a source of strength to such institution; i.e., be able to provide financial assistance to such institution when it experiences financial distress. Implementing regulations must be issued by July 2012. Like the Federal Reserve policy currently in place, as well as periodic stress tests, the new statutory source of strength requirement could influence the Company’s ability to pay dividends, or require it to provide capital assistance to MSBNA or Morgan Stanley Private Bank, National Association (“MS Private Bank”) (formerly Morgan Stanley Trust FSB) under circumstances under which the Company would not otherwise decide to do so.

 

See also “—Capital Standards” above.

 

U.S. Bank Subsidiaries.

 

U.S. Banking Institutions.    MSBNA, primarily a wholesale commercial bank, offers consumer lending and commercial lending services in addition to deposit products. As an FDIC-insured national bank, MSBNA is subject to supervision, regulation and examination by the OCC.

 

MS Private Bank conducts certain mortgage lending activities primarily for customers of its affiliate retail broker Morgan Stanley Smith Barney LLC (“MSSB LLC”). MS Private Bank also offers certain deposit products. It changed its charter to a national association on July 1, 2010, and is an FDIC-insured national bank whose activities are subject to supervision, regulation and examination by the OCC.

 

Morgan Stanley Trust National Association is a non-depository national bank whose activities are limited to fiduciary and custody activities, primarily personal trust and prime brokerage custody services. It is subject to supervision, regulation and examination by the OCC. Morgan Stanley Trust National Association is not FDIC-insured.

 

Prompt Corrective Action.    The Federal Deposit Insurance Corporation Improvement Act of 1991 provides a framework for regulation of depository institutions and their affiliates, including parent holding companies, by their federal banking regulators. Among other things, it requires the relevant federal banking regulator to take “prompt corrective action” with respect to a depository institution if that institution does not meet certain capital adequacy standards. Current regulations generally apply only to insured banks and thrifts such as MSBNA or MS Private Bank and not to their parent holding companies, such as Morgan Stanley. The Federal Reserve is, however, subject to limitations, authorized to take appropriate action at the holding company level. In addition, under the systemic risk regime, the Company will become subject to an early remediation protocol in the event of financial distress. The Dodd-Frank Act also calls for a study on the effectiveness of, and improvements to, the prompt corrective action regime, which may in the future result in substantial revisions to the prompt corrective action framework.

 

Transactions with Affiliates.    The Company’s U.S. subsidiary banks are subject to Sections 23A and 23B of the Federal Reserve Act, which impose restrictions on any extensions of credit to, purchase of assets from, and certain other transactions with, any affiliates. These restrictions include limits on the total amount of credit exposure that they may have to any one affiliate and to all affiliates, as well as collateral requirements, and they require all such transactions to be made on market terms. Under the Dodd-Frank Act, the affiliate transaction limits will be substantially broadened. Implementing rulemaking is called for by July 2012. At that time, the Company’s U.S. banking subsidiaries will also become subject to more onerous lending limits. Both reforms will place limits on the Company’s U.S. banking subsidiaries’ ability to engage in derivatives, repurchase agreements and securities lending transactions with other affiliates of the Company.

 

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FDIC Regulation.    An FDIC–insured depository institution is generally liable for any loss incurred or expected to be incurred by the FDIC in connection with the failure of an insured depository institution under common control by the same bank holding company. As FDIC-insured depository institutions, MSBNA and MS Private Bank are exposed to each other’s losses. In addition, both institutions are exposed to changes in the cost of FDIC insurance. In 2010, the FDIC adopted a restoration plan to replenish the reserve fund over a multi-year period. Under the Dodd-Frank Act, some of the restoration must be paid for exclusively by large depository institutions, including MSBNA, and assessments are calculated using a new methodology that generally favors banks that are mostly funded by deposits.

 

Institutional Securities and Global Wealth Management Group.

 

Broker-Dealer Regulation.    The Company’s primary U.S. broker-dealer subsidiaries, MS&Co. and MSSB LLC, are registered broker-dealers with the SEC and in all 50 states, the District of Columbia, Puerto Rico and the U.S. Virgin Islands, and are members of various self-regulatory organizations, including the Financial Industry Regulatory Authority, Inc. (“FINRA”), and various securities exchanges and clearing organizations. In addition, MS&Co. and MSSB LLC are registered investment advisers with the SEC. Broker-dealers are subject to laws and regulations covering all aspects of the securities business, including sales and trading practices, securities offerings, publication of research reports, use of customers’ funds and securities, capital structure, recordkeeping and retention, and the conduct of their directors, officers, representatives and other associated persons. Broker-dealers are also regulated by securities administrators in those states where they do business. Violations of the laws and regulations governing a broker-dealer’s actions could result in censures, fines, the issuance of cease-and-desist orders, revocation of licenses or registrations, the suspension or expulsion from the securities industry of such broker-dealer or its officers or employees, or other similar consequences by both federal and state securities administrators.

 

The Dodd-Frank Act includes various provisions that affect the regulation of broker-dealer sales practices and customer relationships. For example, the Dodd-Frank Act provides the SEC authority (which the SEC has not yet exercised) to adopt a fiduciary duty applicable to broker-dealers when providing personalized investment advice to retail customers and creates a new category of regulation for “municipal advisors,” which are subject to a fiduciary duty with respect to certain activities. In addition, the U.S. Department of Labor has proposed revisions to the regulations under the Employee Retirement Income Security Act of 1974 (“ERISA”) that, if adopted, would potentially broaden the category of conduct that could be regarded as “investment advice” under ERISA and could subject broker-dealers to ERISA’s fiduciary duty and prohibited transaction rules with respect to a wider range of interactions with their customers. These developments may impact the manner in which affected businesses are conducted, decrease profitability and increase potential liabilities. The Dodd-Frank Act also provides the SEC authority (which the SEC also has not exercised) to prohibit or limit the use of mandatory arbitration pre-dispute agreements between a broker-dealer and its customers. If the SEC exercises its authority under this provision, it may materially increase litigation costs.

 

Margin lending by broker-dealers is regulated by the Federal Reserve’s restrictions on lending in connection with customer and proprietary purchases and short sales of securities, as well as securities borrowing and lending activities. Broker-dealers are also subject to maintenance and other margin requirements imposed under FINRA and other self-regulatory organization rules. In many cases, the Company’s broker-dealer subsidiaries’ margin policies are more stringent than these rules.

 

As registered U.S. broker-dealers, certain subsidiaries of the Company are subject to the SEC’s net capital rule and the net capital requirements of various exchanges, other regulatory authorities and self-regulatory organizations. Many non-U.S. regulatory authorities and exchanges also have rules relating to capital and, in some cases, liquidity requirements that apply to the Company’s non-U.S. broker-dealer subsidiaries. These rules are generally designed to measure general financial integrity and/or liquidity and require that at least a minimum amount of net and/or more liquid assets be maintained by the subsidiary. See also “Consolidated Supervision” and “Capital Standards” above. Rules of FINRA and other self-regulatory organizations also impose limitations and requirements on the transfer of member organizations’ assets.

 

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Compliance with regulatory capital liquidity requirements may limit the Company’s operations requiring the intensive use of capital. Such requirements restrict the Company’s ability to withdraw capital from its broker-dealer subsidiaries, which in turn may limit its ability to pay dividends, repay debt, or redeem or purchase shares of its own outstanding stock. Any change in such rules or the imposition of new rules affecting the scope, coverage, calculation or amount of capital liquidity requirements, or a significant operating loss or any unusually large charge against capital, could adversely affect the Company’s ability to pay dividends or to expand or maintain present business levels. In addition, such rules may require the Company to make substantial capital liquidity infusions into one or more of its broker-dealer subsidiaries in order for such subsidiaries to comply with such rules.

 

MS&Co. and MSSB LLC are members of the Securities Investor Protection Corporation (“SIPC”), which provides protection for customers of broker-dealers against losses in the event of the insolvency of a broker-dealer. SIPC protects customers’ eligible securities held by a member broker-dealer up to $500,000 per customer for all accounts in the same capacity subject to a limitation of $250,000 for claims for uninvested cash balances. To supplement this SIPC coverage, each of MS&Co. and MSSB LLC have purchased additional protection for the benefit of their customers in the form of an annual policy issued by certain underwriters and various insurance companies that provides protection for each eligible customer above SIPC limits subject to an aggregate firmwide cap of $1 billion with no per client sublimit for securities and a $1.9 million per client limit for the cash portion of any remaining shortfall. As noted under “Systemic Risk Regime,” the Dodd-Frank Act contains special provisions for the orderly liquidation of covered broker-dealers (which could potentially include MS&Co. and/or MSSB LLC). While these provisions are generally intended to provide customers of covered broker-dealers with protections at least as beneficial as they would enjoy in a broker-dealer liquidation proceeding under the Securities Investor Protection Act, the details and implementation of such protections are subject to further rulemaking. In addition, as noted under “Systemic Risk Regime,” the orderly liquidation provisions of Dodd-Frank could affect the nature, priority and enforcement process for other creditor claims against a covered broker-dealer, which could have an impact on the manner in which creditors and potential creditors extend credit to covered broker-dealers or the amount of credit that they extend.

 

The SEC is also undertaking a review of a wide range of equity market structure issues. As a part of this review, the SEC has proposed various rules regarding market transparency, and has adopted rules requiring broker-dealers to maintain risk management controls and supervisory procedures with respect to providing access to securities markets. In addition, in an effort to prevent volatile trading, self-regulatory organizations have adopted trading pauses with respect to certain securities. It is possible that the SEC or self-regulatory organizations could propose or adopt additional market structure rules in the future. Moreover, compliance is required with respect to a new short sale uptick rule as of February 28, 2011, which will limit the ability to sell short securities that have experienced specified price declines.

 

The provisions, new rules and proposals discussed above could result in increased costs and could otherwise adversely affect trading volumes and other conditions in the markets in which we operate.

 

Regulation of Registered Futures Activities.    As registered futures commission merchants, MS&Co. and MSSB LLC are subject to net capital requirements of, and their activities are regulated by, the U.S. Commodity Futures Trading Commission (the “CFTC”) and various commodity futures exchanges. The Company’s futures and options-on-futures businesses also are regulated by the National Futures Association (“NFA”), a registered futures association, of which MS&Co. and MSSB LLC and certain of their affiliates are members. These regulatory requirements differ for clearing and non-clearing firms, and they address obligations related to, among other things, the registration of the futures commission merchant and certain of its associated persons, membership with the NFA, the segregation of customer funds and the holding apart of a secured amount, the receipt of an acknowledgment of certain written risk disclosure statements, the receipt of trading authorizations, the furnishing of daily confirmations and monthly statements, recordkeeping and reporting obligations, the supervision of accounts and antifraud prohibitions. Among other things, the NFA has rules covering a wide variety of areas such as advertising, telephone solicitations, risk disclosure, discretionary trading, disclosure of

 

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fees, minimum capital requirements, reporting and proficiency testing. MS&Co. and MSSB LLC have affiliates that are registered as commodity trading advisers and/or commodity pool operators, or are operating under certain exemptions from such registration pursuant to CFTC rules and other guidance. Under CFTC and NFA rules, commodity trading advisers who manage accounts must distribute disclosure documents and maintain specified records relating to their activities, and clients and commodity pool operators have certain responsibilities with respect to each pool they operate. For each pool, a commodity pool operator must prepare and distribute a disclosure document; distribute periodic account statements; prepare and distribute audited annual financial reports; and keep specified records concerning the participants, transactions and operations of each pool, as well as records regarding transactions of the commodity pool operator and its principals. Violations of the rules of the CFTC, the NFA or the commodity exchanges could result in remedial actions, including fines, registration restrictions or terminations, trading prohibitions or revocations of commodity exchange memberships.

 

Derivatives Regulation.    Through the Dodd-Frank Act, the Company will face a comprehensive U.S. regulatory regime for its activities in certain over-the-counter derivatives. The regulation of “swaps” and “security-based swaps” (collectively, “Swaps”) in the U.S. will be effected and implemented through CFTC, SEC and other agency regulations, which are required to be adopted by July 2011.

 

The Dodd-Frank Act requires, with limited exceptions, central clearing of certain types of Swaps and also mandates that trading of such Swaps, with limited exceptions, be done on regulated exchanges or execution facilities. As a result, market participants, including the Company’s entities engaging in Swaps, will have to centrally clear and trade on an exchange or execution facility certain Swap transactions that are currently uncleared and executed bilaterally. Also, the Dodd-Frank Act requires the registration of “swap dealers” and “major swap participants” with the CFTC and “security-based swap dealers” and “major security-based swap participants” with the SEC (collectively, “Swaps Entities”). Certain subsidiaries of the Company will likely be required to register as a swap dealer and security-based swap dealer and it is possible some may register as a major swap participant and major security-based swap participant.

 

Swap Entities will be subject to a comprehensive regulatory regime with respect to the Swap activities for which they are registered. For example, Swaps Entities will be subject to a capital regime, a margin regime for uncleared Swaps and a segregation regime for collateral of counterparties to uncleared Swaps. Swaps Entities also will be subject to business conduct and documentation standards with respect to their Swaps counterparties. Furthermore, Swaps Entities will be subject to significant operational and governance requirements, including reporting and recordkeeping, maintenance of daily trading records, creation of audit trails, monitoring procedures, risk management, conflicts of interest and the requirement to have a chief compliance officer, among others. It is currently unclear to what extent regulation of Swaps Entities might also bring certain activities of the affiliates of such a Swaps Entity under the oversight of the Swaps Entity’s regulator.

 

The specific parameters of these Swaps Entities requirements are being developed through CFTC, SEC and bank regulator rulemakings. Until such time as final rules are adopted, the extent of the regulation Morgan Stanley entities required to register will face remains unclear. It is likely, however, that, regardless of the final rules adopted, the Company will face increased costs due to the registration and regulatory requirements listed above. Complying with the proposed regulation of Swaps Entities could require the Company to restructure its Swaps businesses, require extensive systems changes, require personnel changes, and raise additional potential liabilities and regulatory oversight. Compliance with Swap-related regulatory capital requirements may require the Company to devote more capital to its Swaps business. The Dodd-Frank Act requires reporting of Swap transactions, both to regulators and publicly, under rules and regulations currently being proposed by the CFTC and the SEC, and the extent of these reporting requirements will not be clear until final rules are adopted.

 

The Dodd-Frank Act also requires certain entities receiving customer collateral for cleared Swaps to register with the CFTC as a futures commission merchant or with the SEC as a broker, dealer or security-based swap dealer, as appropriate to the type of activity, and to follow certain segregation requirements for customer collateral. Futures

 

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commission merchants and broker-dealers face their own comprehensive regulatory regimes administered by the CFTC and SEC, respectively. The Dodd-Frank Act also requires adoption of rules regarding position limits, large trader reporting regimes, CFTC whistleblower protection, compensation requirements and anti-fraud and anti-manipulation requirements related to activities in Swaps.

 

The European Union is in the process of establishing its own set of OTC derivatives regulations, and has published a proposal known as the European Market Infrastructure Regulation. Aspects of the regulation, including the scope of derivatives covered, and mandatory clearing and reporting requirements, are likely to be substantially similar to derivatives regulation under the Dodd-Frank Act. It is unclear at present how European and U.S. derivatives regulation will interact.

 

Regulation of Certain Commodities Activities.    The Company’s commodities activities are subject to extensive and evolving energy, commodities, environmental, health and safety and other governmental laws and regulations in the U.S. and abroad. Intensified scrutiny of certain energy markets by U.S. federal, state and local authorities in the U.S. and abroad and by the public has resulted in increased regulatory and legal enforcement and remedial proceedings involving energy companies, including those engaged in power generation and liquid hydrocarbons trading. Terminal facilities and other assets relating to the Company’s commodities activities also are subject to environmental laws both in the U.S. and abroad. In addition, pipeline, transport and terminal operations are subject to state laws in connection with the cleanup of hazardous substances that may have been released at properties currently or previously owned or operated by us or locations to which we have sent wastes for disposal. See also “—Scope of Permitted Activities” above.

 

The Dodd-Frank Act provides the CFTC with additional authority to adopt position limits with respect to certain futures or options on futures, and the CFTC has proposed to adopt such limits. New position limits may affect trading strategies and affect the profitability of various businesses and transactions.

 

Non-U.S. Regulation.    The Company’s businesses also are regulated extensively by non-U.S. regulators, including governments, securities exchanges, commodity exchanges, self-regulatory organizations, central banks and regulatory bodies, especially in those jurisdictions in which the Company maintains an office. Certain Morgan Stanley subsidiaries are regulated as broker-dealers under the laws of the jurisdictions in which they operate. Subsidiaries engaged in banking and trust activities outside the U.S. are regulated by various government agencies in the particular jurisdiction where they are chartered, incorporated and/or conduct their business activity. For instance, the U.K. Financial Services Authority (“FSA”) and several U.K. securities and futures exchanges, including the London Stock Exchange and Euronext.liffe, regulate the Company’s activities in the U.K.; the Deutsche Bôrse AG and the Bundesanstalt für Finanzdienstleistungsaufsicht (the Federal Financial Supervisory Authority) regulate its activities in the Federal Republic of Germany; Eidgenôssische Finanzmarktaufsicht regulates its activities in Switzerland; the Financial Services Agency, the Bank of Japan, the Japanese Securities Dealers Association and several Japanese securities and futures exchanges, including the Tokyo Stock Exchange, the Osaka Securities Exchange and the Tokyo International Financial Futures Exchange, regulate its activities in Japan; the Hong Kong Securities and Futures Commission and the Hong Kong Exchanges and Clearing Limited regulate its operations in Hong Kong; and the Monetary Authority of Singapore and the Singapore Exchange Limited regulate its business in Singapore.

 

Asset Management.

 

Many of the subsidiaries engaged in the Company’s asset management activities are registered as investment advisers with the SEC and, in certain states, some employees or representatives of subsidiaries are registered as investment adviser representatives. Many aspects of the Company’s asset management activities are subject to federal and state laws and regulations primarily intended to benefit the investor or client. These laws and regulations generally grant supervisory agencies and bodies broad administrative powers, including the power to limit or restrict the Company from carrying on its asset management activities in the event that it fails to comply with such laws and regulations. Sanctions that may be imposed for such failure include the suspension of

 

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individual employees, limitations on the Company engaging in various asset management activities for specified periods of time or specified types of clients, the revocation of registrations, other censures and significant fines. As a result of the passage of the Dodd-Frank Act, the Company’s asset management activities will be subject to certain additional laws and regulations, including, but not limited to, additional reporting and recordkeeping requirements, restrictions on sponsoring or investing in, or maintaining certain other relationships with, hedge funds and private equity funds under the Volcker Rule (subject to certain limited exceptions) and certain rules and regulations regarding trading activities, including trading in derivatives markets. Many of these new requirements may increase the expenses associated with the Company’s asset management activities and/or reduce the investment returns the Company is able to generate for its asset management clients. Many important elements of the Dodd-Frank Act will not be known until rulemaking is finalized and certain final regulations are adopted. See also “—Activities Restrictions under the Volcker Rule” and “—Derivatives Regulation” above.

 

The Company’s Asset Management business is also regulated outside the U.S. For example, the FSA regulates the Company’s business in the U.K.; the Financial Services Agency regulates the Company’s business in Japan; the Securities and Exchange Board of India regulates the Company’s business in India; and the Monetary Authority of Singapore regulates the Company’s business in Singapore.

 

Anti-Money Laundering.

 

The Company’s Anti-Money Laundering (“AML”) program is coordinated on an enterprise-wide basis. In the U.S., for example, the Bank Secrecy Act, as amended by the USA PATRIOT Act of 2001 (the “BSA/USA PATRIOT Act”), imposes significant obligations on financial institutions to detect and deter money laundering and terrorist financing activity, including requiring banks, bank holding company subsidiaries, broker-dealers, futures commission merchants, and mutual funds to verify the identity of customers that maintain accounts. The BSA/USA PATRIOT Act also mandates that financial institutions have policies, procedures and internal processes in place to monitor and report suspicious activity to appropriate law enforcement or regulatory authorities. A financial institution subject to the BSA/USA PATRIOT Act also must designate a BSA/AML compliance officer, provide employees with training on money laundering prevention, and undergo an annual, independent audit to assess the effectiveness of its AML program. Outside the U.S., applicable laws, rules and regulations similarly require designated types of financial institutions to implement AML programs. The Company has implemented policies, procedures and internal controls that are designed to comply with all applicable AML laws and regulations. The Company has also implemented policies, procedures, and internal controls that are designed to comply with the regulations and economic sanctions programs administered by the U.S. Treasury’s Office of Foreign Assets Control (“OFAC”), which enforces economic and trade sanctions against targeted foreign countries, entities and individuals based on external threats to the U.S. foreign policy, national security, or economy, by other governments, or by global or regional multilateral organizations.

 

Anti-Corruption.

 

The Company is subject to the Foreign Corrupt Practices Act (“FCPA”), which prohibits offering, promising, giving, or authorizing others to give anything of value, either directly or indirectly, to a non-U.S. government official in order to influence official action or otherwise gain an unfair business advantage, such as to obtain or retain business. The Company is also subject to applicable anti-corruption laws in the jurisdictions in which it operates. The Company has implemented policies, procedures, and internal controls that are designed to comply with the FCPA and other applicable anti-corruption laws, rules, and regulations in the jurisdictions in which it operates.

 

Protection of Client Information.

 

Many aspects of the Company’s business are subject to legal requirements concerning the use and protection of certain customer information, including those adopted pursuant to the Gramm-Leach-Bliley Act and the Fair and Accurate Credit Transactions Act of 2003 in the U.S., the European Union (“EU”) Data Protection Directive in

 

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the EU and various laws in Asia, including the Japanese Personal Information (Protection) Law, the Hong Kong Personal Data (Protection) Ordinance and the Australian Privacy Act. The Company has adopted measures designed to comply with these and related applicable requirements in all relevant jurisdictions.

 

Research.

 

Both U.S. and non-U.S. regulators continue to focus on research conflicts of interest. Research-related regulations have been implemented in many jurisdictions. New and revised requirements resulting from these regulations and the global research settlement with U.S. federal and state regulators (to which the Company is a party) have necessitated the development or enhancement of corresponding policies and procedures.

 

Compensation Practices and Other Regulation.

 

The Company’s compensation practices are subject to oversight by the Federal Reserve. In June 2010, the Federal Reserve and other federal regulators issued final guidance applicable to all banking organizations, including those supervised by the Federal Reserve, promulgated in accordance with compensation principles and standards for banks and other financial companies designed to encourage sound compensation practices established by the Financial Stability Board at the direction of the leaders of the Group of Twenty Finance Ministers and Central Bank Governors. The guidance was designed to help ensure that incentive compensation paid by banking organizations does not encourage imprudent risk-taking that threatens the organizations’ safety and soundness. The scope and content of the Federal Reserve’s policies on executive compensation are continuing to develop, and the Company expects that these policies will evolve over a number of years.

 

The Company is subject to the compensation-related provisions of the Dodd-Frank Act, which may impact its compensation practices. Pursuant to the Dodd-Frank Act, among other things, federal regulators, including the Federal Reserve, must prescribe regulations to require covered financial institutions, including the Company, to report the structures of all of their incentive-based compensation arrangements and prohibit incentive-based payment arrangements that encourage inappropriate risks by providing employees, directors or principal shareholders with excessive compensation or that could lead to material financial loss to the covered financial institution. In February 2011, the FDIC was the first federal regulator to propose an interagency rule implementing this requirement. Further, the SEC must direct listing exchanges to require companies to implement policies relating to disclosure of incentive-based compensation that is based on publicly reported financial information and the clawback of such compensation from current or former executive officers following certain accounting restatements.

 

In addition to the guidelines issued by the Federal Reserve and referenced above, the Company’s compensation practices may also be impacted by other regulations promulgated in accordance with the Financial Stability Board compensation principles and standards. These standards are to be implemented by local regulators. For instance, in December 2010, the FSA published a policy statement outlining amendments to the Remuneration Code, which governs remuneration of employees at certain banks, to address compensation-related rules under the EU Capital Requirements Directive. In another example, the United Kingdom has implemented a non-deductible 50% tax on certain financial institutions in respect of discretionary bonuses in excess of £25,000 awarded during the period starting on December 9, 2009 and ending on April 5, 2010 to “relevant banking employees.”

 

The Dodd-Frank Act also provides a bounty to whistleblowers who present the SEC with information related to securities laws violations that leads to a successful enforcement action. The Dodd-Frank Act requires the SEC to establish a Whistleblower Office to administer the SEC’s whistleblower program, and prohibits retaliation by employers against individuals that provide the SEC with information about potential securities violations. As a result of the potential of a bounty, it is possible the Company could face an increased number of investigations by the SEC.

 

For a discussion of certain risks relating to the Company’s regulatory environment, see “Risk Factors” herein.

 

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Executive Officers of Morgan Stanley.

 

The executive officers of Morgan Stanley and their ages and titles as of February 28, 2011 are set forth below. Business experience for the past five years is provided in accordance with SEC rules.

 

Francis P. Barron (59).    Chief Legal Officer of Morgan Stanley (since September 2010). Partner at the law firm of Cravath, Swaine & Moore LLP (December 1985 to August 2010).

 

Kenneth deRegt (55).    Global Head of Fixed Income Sales and Trading (excluding Commodities) of Morgan Stanley (since January 2011). Chief Risk Officer of Morgan Stanley (February 2008 to January 2011). Managing Director of Aetos Capital, LLC, an investment management firm (December 2002 to February 2008).

 

Gregory J. Fleming (48).    Executive Vice President and President of Asset Management (since February 2010) and President of Global Wealth Management of Morgan Stanley (since January 2011). President of Research of Morgan Stanley (February 2010 to January 2011). Senior Research Scholar at Yale Law School and Distinguished Visiting Fellow of the Center for the Study of Corporate Law at Yale Law School (January 2009 to December 2009). President of Merrill Lynch & Co., Inc. (“Merrill Lynch”) (February 2008 to January 2009). Co-President of Merrill Lynch (May 2007 to February 2008). Executive Vice President and Co-President of the Global Markets and Investment Banking Group of Merrill Lynch (August 2003 to May 2007).

 

James P. Gorman (52).    President and Chief Executive Officer and Director of Morgan Stanley (since January 2010) and Chairman of Morgan Stanley Smith Barney (since June 2009). Co-President (December 2007 to December 2009) and Co-Head of Strategic Planning (October 2007 to December 2009). President and Chief Operating Officer of the Global Wealth Management Group (February 2006 to April 2008). Head of Corporate Acquisitions Strategy and Research at Merrill Lynch (July 2005 to August 2005) and President of the Global Private Client business at Merrill Lynch (December 2002 to July 2005).

 

Keishi Hotsuki (48).    Interim Chief Risk Officer of Morgan Stanley (since January 2011) and Head of the Market Risk Department of Morgan Stanley (since March 2008). Global Head of Market Risk Management at Merrill Lynch (June 2005 to September 2007). Director of Mitsubishi UFJ Morgan Stanley Securities Co., Ltd. (since May 2010).

 

Colm Kelleher (53).    Executive Vice President and Co-President of Institutional Securities of Morgan Stanley (since January 2010). Chief Financial Officer and Co-Head of Strategic Planning (October 2007 to December 2009). Head of Global Capital Markets (February 2006 to October 2007). Co-Head of Fixed Income Europe (May 2004 to February 2006).

 

John J. Mack (66).    Executive Chairman of the Board of Directors of Morgan Stanley (since June 2005). Chief Executive Officer (June 2005 to December 2009). Chairman of Pequot Capital Management (June 2005). Co-Chief Executive Officer of Credit Suisse Group (January 2003 to June 2004). President, Chief Executive Officer and Director of Credit Suisse First Boston (July 2001 to June 2004). President and Chief Operating Officer of Morgan Stanley (May 1997 to March 2001).

 

Ruth Porat (53).    Executive Vice President and Chief Financial Officer of Morgan Stanley (since January 2010). Vice Chairman of Investment Banking (September 2003 to December 2009). Global Head of Financial Institutions Group (September 2006 to December 2009) and Chairman of the Financial Sponsors Group (July 2004 to September 2006) within the Investment Banking Division.

 

James A. Rosenthal (57).    Chief Operating Officer of Morgan Stanley (since January 2011) and Chief Operating Officer of Morgan Stanley Smith Barney and Head of Corporate Strategy of Morgan Stanley (since January 2010). Head of Firmwide Technology and Operations (March 2008 to January 2010). Chief Financial Officer of Tishman Speyer (May 2006 to March 2008).

 

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Paul J. Taubman (50).    Executive Vice President and Co-President of Institutional Securities of Morgan Stanley (since January 2010). Global Head of Investment Banking (January 2008 to December 2009). Global Co-Head of Investment Banking (July 2007 to January 2008), Global Head of Mergers and Acquisitions Department (May 2005 to July 2007) and Global Co-Head of Mergers and Acquisitions Department (December 2003 to May 2005).

 

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Item 1A.    Risk Factors.

 

Liquidity and Funding Risk.

 

Liquidity and funding risk refers to the risk that we will be unable to finance our operations due to a loss of access to the capital markets or difficulty in liquidating our assets. Liquidity and funding risk also encompasses our ability to meet our financial obligations without experiencing significant business disruption or reputational damage that may threaten our viability as a going concern. For more information on how we monitor and manage liquidity and funding risk, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” in Part II, Item 7 herein.

 

Liquidity is essential to our businesses and we rely on external sources to finance a significant portion of our operations.

 

Liquidity is essential to our businesses. Our liquidity could be substantially affected negatively by our inability to raise funding in the long-term or short-term debt capital markets or the equity capital markets or our inability to access the secured lending markets. Factors that we cannot control, such as disruption of the financial markets or negative views about the financial services industry generally, could impair our ability to raise funding. In addition, our ability to raise funding could be impaired if lenders develop a negative perception of our long-term or short-term financial prospects. Such negative perceptions could be developed if we incur large trading losses, we are downgraded or put on negative watch by the rating agencies, we suffer a decline in the level of our business activity, regulatory authorities take significant action against us, or we discover significant employee misconduct or illegal activity, among other reasons. If we are unable to raise funding using the methods described above, we would likely need to finance or liquidate unencumbered assets, such as our investment and trading portfolios, to meet maturing liabilities. We may be unable to sell some of our assets, or we may have to sell assets at a discount from market value, either of which could adversely affect our results of operations, cash flows and financial condition.

 

Our borrowing costs and access to the debt capital markets depend significantly on our credit ratings.

 

The cost and availability of unsecured financing generally are dependent on our short-term and long-term credit ratings. Factors that are important to the determination of our credit ratings include the level and quality of our earnings, capital adequacy, liquidity, risk appetite and management, asset quality, business mix and actual and perceived levels of government support.

 

Our debt ratings also can have a significant impact on certain trading revenues, particularly in those businesses where longer term counterparty performance is critical, such as OTC derivative transactions, including credit derivatives and interest rate swaps. In connection with certain OTC trading agreements and certain other agreements associated with the Institutional Securities business segment, we may be required to provide additional collateral to certain counterparties in the event of a credit ratings downgrade. In addition, we may be required to pledge additional collateral to certain exchanges and clearing organizations in the event of a credit ratings downgrade. The rating agencies are considering the impact of the Dodd-Frank Act’s resolution authority provisions on large banking institutions and it is possible that they could downgrade our ratings and those of similar institutions.

 

We are a holding company and depend on payments from our subsidiaries.

 

The parent holding company depends on dividends, distributions and other payments from its subsidiaries to fund dividend payments and to fund all payments on its obligations, including debt obligations. Regulatory and other legal restrictions may limit our ability to transfer funds freely, either to or from our subsidiaries. In particular, many of our subsidiaries, including our broker-dealer subsidiaries, are subject to laws, regulations and self-regulatory organization rules that authorize regulatory bodies to block or reduce the flow of funds to the parent

 

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holding company, or that prohibit such transfers altogether in certain circumstances. These laws, regulations and rules may hinder our ability to access funds that we may need to make payments on our obligations. Furthermore, as a bank holding company, we may become subject to a prohibition or to limitations on our ability to pay dividends or repurchase our stock. The OCC, the Federal Reserve and the FDIC have the authority, and under certain circumstances the duty, to prohibit or to limit the payment of dividends by the banking organizations they supervise, including us and our bank holding company subsidiaries.

 

Our liquidity and financial condition have in the past been, and in the future could be, adversely affected by U.S. and international markets and economic conditions.

 

Our ability to raise funding in the long-term or short-term debt capital markets or the equity markets, or to access secured lending markets, has in the past been, and could in the future be, adversely affected by conditions in the U.S. and international markets and economy. Global market and economic conditions have been particularly disrupted and volatile during the past three years, with volatility reaching unprecedented levels in the Fall of 2008 and into 2009. In particular, our cost and availability of funding have been, and may in the future be, adversely affected by illiquid credit markets and wider credit spreads. Renewed turbulence in the U.S. and international markets and economy could adversely affect our liquidity and financial condition and the willingness of certain counterparties and customers to do business with us.

 

Market Risk.

 

Market risk refers to the risk that a change in the level of one or more market prices of commodities or securities, rates, indices, implied volatilities (the price volatility of the underlying instrument imputed from option prices), correlations or other market factors, such as liquidity, will result in losses for a position or portfolio. For more information on how we monitor and manage market risk, see “Qualitative and Quantitative Disclosure about Market Risk” in Part II, Item 7A herein.

 

Our results of operations may be materially affected by market fluctuations and by global and economic conditions and other factors.

 

Our results of operations may be materially affected by market fluctuations due to global and economic conditions and other factors. The results of operations in the past have been, and in the future may continue to be, materially affected by many factors, including the effect of political and economic conditions and geopolitical events; the effect of market conditions, particularly in the global equity, fixed income and credit markets, including corporate and mortgage (commercial and residential) lending and commercial real estate investments; the impact of current, pending and future legislation (including the Dodd-Frank Act), regulation (including capital requirements), and legal actions in the U.S. and worldwide; the level and volatility of equity, fixed income and commodity prices and interest rates, currency values and other market indices; the availability and cost of both credit and capital as well as the credit ratings assigned to our unsecured short-term and long-term debt; investor sentiment and confidence in the financial markets; the performance of the Company’s acquisitions, joint ventures, strategic alliances or other strategic arrangements (including MSSB and with Mitsubishi UFJ Financial Group, Inc.); our reputation; inflation, natural disasters, and acts of war or terrorism; the actions and initiatives of current and potential competitors and technological changes; or a combination of these or other factors. In addition, legislative, legal and regulatory developments related to our businesses are likely to increase costs, thereby affecting results of operations. These factors also may have an impact on our ability to achieve our strategic objectives.

 

The results of our Institutional Securities business segment, particularly results relating to our involvement in primary and secondary markets for all types of financial products, are subject to substantial fluctuations due to a variety of factors, such as those enumerated above that we cannot control or predict with great certainty. These fluctuations impact results by causing variations in new business flows and in the fair value of securities and other financial products. Fluctuations also occur due to the level of global market activity, which, among other things, affects the size, number and timing of investment banking client assignments and transactions and the realization of returns from our principal investments. During periods of unfavorable market or economic

 

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conditions, the level of individual investor participation in the global markets, as well as the level of client assets, may also decrease, which would negatively impact the results of our Global Wealth Management Group business segment. In addition, fluctuations in global market activity could impact the flow of investment capital into or from assets under management or supervision and the way customers allocate capital among money market, equity, fixed income or other investment alternatives, which could negatively impact our Asset Management business segment.

 

We may experience further writedowns of our financial instruments and other losses related to volatile and illiquid market conditions.

 

Market volatility, illiquid market conditions and disruptions in the credit markets have made it extremely difficult to value certain of our securities particularly during periods of market displacement. Subsequent valuations, in light of factors then prevailing, may result in significant changes in the values of these securities in future periods. In addition, at the time of any sales and settlements of these securities, the price we ultimately realize will depend on the demand and liquidity in the market at that time and may be materially lower than their current fair value. Any of these factors could require us to take further writedowns in the value of our securities portfolio, which may have an adverse effect on our results of operations in future periods.

 

In addition, financial markets are susceptible to severe events evidenced by rapid depreciation in asset values accompanied by a reduction in asset liquidity. Under these extreme conditions, hedging and other risk management strategies may not be as effective at mitigating trading losses as they would be under more normal market conditions. Moreover, under these conditions market participants are particularly exposed to trading strategies employed by many market participants simultaneously and on a large scale, such as crowded trades. Morgan Stanley’s risk management and monitoring processes seek to quantify and mitigate risk to more extreme market moves. Severe market events have historically been difficult to predict, however, and Morgan Stanley could realize significant losses if unprecedented extreme market events were to occur, such as conditions in the global financial markets and global economy that prevailed from 2008 into 2009.

 

Holding large and concentrated positions may expose us to losses.

 

Concentration of risk may reduce revenues or result in losses in our market-making, investing, block trading, underwriting and lending businesses in the event of unfavorable market movements. We commit substantial amounts of capital to these businesses, which often results in our taking large positions in the securities of, or making large loans to, a particular issuer or issuers in a particular industry, country or region.

 

We have incurred, and may continue to incur, significant losses in the real estate sector.

 

We finance and acquire principal positions in a number of real estate and real estate-related products for our own account, for investment vehicles managed by affiliates in which we also may have a significant investment, for separate accounts managed by affiliates and for major participants in the commercial and residential real estate markets. We also originate loans secured by commercial and residential properties. Further, we securitize and trade in a wide range of commercial and residential real estate and real estate-related whole loans, mortgages and other real estate and commercial assets and products, including residential and commercial mortgage-backed securities. These businesses have been, and may continue to be, adversely affected by the downturn in the real estate sector.

 

Credit Risk.

 

Credit risk refers to the risk of loss arising from borrower or counterparty default when a borrower, counterparty or obligor does not meet its obligations. For more information on how we monitor and manage credit risk, see “Qualitative and Quantitative Disclosure about Market Risk—Risk Management—Credit Risk” in Part II, Item 7A herein.

 

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We are exposed to the risk that third parties that are indebted to us will not perform their obligations.

 

We incur significant credit risk exposure through the Institutional Securities business segment. This risk may arise from a variety of business activities, including but not limited to entering into swap or other derivative contracts under which counterparties have obligations to make payments to us; extending credit to clients through various lending commitments; providing short or long-term funding that is secured by physical or financial collateral whose value may at times be insufficient to fully cover the loan repayment amount; and posting margin and/or collateral to clearing houses, clearing agencies, exchanges, banks, securities firms and other financial counterparties. We incur credit risk in traded securities and loan pools whereby the value of these assets may fluctuate based on realized or expected defaults on the underlying obligations or loans.

 

We also incur credit risk in the Global Wealth Management Group business segment lending to individual investors, including, but not limited to, margin and non-purpose loans collateralized by securities, residential mortgage loans and home equity lines of credit.

 

While we believe current valuations and reserves adequately address our perceived levels of risk, there is a possibility that continued difficult economic conditions may further negatively impact our clients and our current credit exposures. In addition, as a clearing member firm, we finance our customer positions and we could be held responsible for the defaults or misconduct of our customers. Although we regularly review our credit exposures, default risk may arise from events or circumstances that are difficult to detect or foresee.

 

Defaults by another large financial institution could adversely affect financial markets generally.

 

The commercial soundness of many financial institutions may be closely interrelated as a result of credit, trading, clearing or other relationships between the institutions. As a result, concerns about, or a default or threatened default by, one institution could lead to significant market-wide liquidity and credit problems, losses or defaults by other institutions. This is sometimes referred to as “systemic risk” and may adversely affect financial intermediaries, such as clearing agencies, clearing houses, banks, securities firms and exchanges, with which we interact on a daily basis, and therefore could adversely affect us.

 

Operational Risk.

 

Operational risk refers to the risk of financial or other loss, or damage to a firm’s reputation, resulting from inadequate or failed internal processes, people, resources, systems or from other internal or external events (e.g., internal or external fraud, legal and compliance risks, damage to physical assets, etc.). We may incur operational risk across our full scope of business activities, including revenue-generating activities (e.g., sales and trading), support functions (e.g., information technology and trade processing) or other strategic decisions (e.g., the integration of MSSB or other joint ventures, acquisitions or strategic alliances). Legal and compliance risk is included in the scope of operational risk and is discussed below under “Legal Risk.” For more information on how we monitor and manage operational risk, see “Operational Risk” in Part II, Item 7A herein.

 

We are subject to operational risk that could adversely affect our businesses.

 

Our businesses are highly dependent on our ability to process, on a daily basis, a large number of transactions across numerous and diverse markets in many currencies. In general, the transactions we process are increasingly complex. We perform the functions required to operate our different businesses either by ourselves or through agreements with third parties. We rely on the ability of our employees, our internal systems and systems at technology centers operated by third parties to process a high volume of transactions.

 

We also face the risk of operational failure or termination of any of the clearing agents, exchanges, clearing houses or other financial intermediaries we use to facilitate our securities transactions. In the event of a breakdown or improper operation of our or a third party’s systems or improper action by third parties or employees, we could suffer financial loss, an impairment to our liquidity, a disruption of our businesses, regulatory sanctions or damage to our reputation.

 

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Our operations rely on the secure processing, storage and transmission of confidential and other information in our computer systems and may be vulnerable to unauthorized access, mishandling or misuse, computer viruses and other events that could have a security impact on such systems. If one or more of such events occur, this potentially could jeopardize our or our clients’ or counterparties’ personal, confidential, proprietary or other information processed and stored in, and transmitted through, our computer systems. Furthermore, such events could cause interruptions or malfunctions in our, our clients’, our counterparties’ or third parties’ operations, which could result in reputational damage, litigation or regulatory fines or penalties not covered by insurance maintained by us, or adversely affect our business, financial condition or results of operations.

 

Despite the business contingency plans we have in place, our ability to conduct business may be adversely affected by a disruption in the infrastructure that supports our business and the communities where we are located. This may include a disruption involving physical site access, terrorist activities, disease pandemics, catastrophic events, electrical, environmental, communications or other services we use, our employees or third parties with whom we conduct business.

 

Legal and Regulatory Risk.

 

Legal and compliance risk includes the risk of exposure to fines, penalties, judgments, damages and/or settlements in connection with regulatory or legal actions as a result of non-compliance with applicable legal or regulatory requirements or litigation. Legal risk also includes contractual and commercial risk such as the risk that a counterparty’s performance obligations will be unenforceable. In today’s environment of rapid and possibly transformational regulatory change, we also view regulatory change as a component of legal risk. For more information on how we monitor and manage legal risk, see “Risk Management—Legal Risk” in Part II, Item 7A herein.

 

The financial services industry is subject to extensive regulation, which is undergoing major changes that will impact our business.

 

As a major financial services firm, we are subject to extensive regulation by U.S. federal and state regulatory agencies and securities exchanges and by regulators and exchanges in each of the major markets where we operate. We also face the risk of investigations and proceedings by governmental and self-regulatory agencies in all countries in which we conduct our business. Interventions by authorities may result in adverse judgments, settlements, fines, penalties, injunctions or other relief. In addition to the monetary consequences, these measures could, for example, impact our ability to engage in, or impose limitations on, certain of our businesses. The number of these investigations and proceedings, as well as the amount of penalties and fines sought, has increased substantially in recent years with regard to many firms in the financial services industry, including us. Significant regulatory action against us could materially adversely affect our business, financial condition or results of operations or cause us significant reputational harm, which could seriously harm our business. The Dodd-Frank Act also provides a bounty to whistleblowers who present the SEC with information related to securities laws violations that leads to a successful enforcement action. As a result of this bounty, we may face an increased number of investigations by the SEC.

 

In response to the financial crisis, legislators and regulators, both in the U.S. and worldwide, have adopted, or are currently considering to enact, financial market reforms that result in major changes to the way our global operations are regulated. In particular, as a result of the Dodd-Frank Act, we are subject to significantly revised and expanded regulation and supervision, to new activities limitations, to a systemic risk regime which will impose especially high capital and liquidity requirements, and to comprehensive new derivatives regulation. Additional restrictions on our activities would result if we were to no longer meet certain capital or management requirements at the financial holding company level. Certain portions of the Dodd-Frank Act were effective immediately, while other portions will be effective only following extended transition periods, but many of these changes could in the future materially impact the profitability of our businesses, the value of assets we hold, expose us to additional costs, require changes to business practices or force us to discontinue businesses, could adversely affect our ability to pay dividends, or could require us to raise capital, including in ways that may adversely impact our shareholders or creditors.

 

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The financial services industry faces substantial litigation and is subject to regulatory investigations, and we may face damage to our reputation and legal liability.

 

We have been named, from time to time, as a defendant in various legal actions, including arbitrations, class actions, and other litigation, as well as investigations or proceedings brought by regulatory agencies, arising in connection with our activities as a global diversified financial services institution. Certain of the actual or threatened legal or regulatory actions include claims for substantial compensatory and/or punitive damages, claims for indeterminate amounts of damages, or may result in penalties, fines, or other results adverse to us. In some cases, the issuers that would otherwise be the primary defendants in such cases are bankrupt or in financial distress. Like any large corporation, we are also subject to risk from potential employee misconduct, including non-compliance with policies and improper use or disclosure of confidential information.

 

Substantial legal liability could materially adversely affect our business, financial condition or results of operations or cause us significant reputational harm, which could seriously harm our business. For example, recently, the level of litigation activity focused on residential mortgage and credit crisis related matters has increased materially in the financial services industry. As a result, we may become the subject of increased claims for damages and other relief regarding residential mortgages and related securities in the future and there can be no assurance that additional material losses will not be incurred from residential mortgage claims that have not yet been notified to us or are not yet determined to be material. For more information regarding legal proceedings in which we are involved see “Legal Proceedings” in Part I, Item 3 herein.

 

Our business, financial condition and results of operations could be adversely affected by governmental fiscal and monetary policies.

 

We are affected by fiscal and monetary policies adopted by regulatory authorities and bodies of the U.S. and other governments. For example, the actions of the Federal Reserve and international central banking authorities directly impact our cost of funds for lending, capital raising and investment activities and may impact the value of financial instruments we hold. In addition, such changes in monetary policy may affect the credit quality of our customers. Changes in domestic and international monetary policy are beyond our control and difficult to predict.

 

Our commodities activities subject us to extensive regulation, potential catastrophic events and environmental risks and regulation that may expose us to significant costs and liabilities.

 

In connection with the commodities activities in our Institutional Securities business segment, we engage in the production, storage, transportation, marketing and trading of several commodities, including metals (base and precious), agricultural products, crude oil, oil products, natural gas, electric power, emission credits, coal, freight, liquefied natural gas and related products and indices. In addition, we are an electricity power marketer in the U.S. and own electricity generating facilities in the U.S. and Europe; we own TransMontaigne Inc. and its subsidiaries, a group of companies operating in the refined petroleum products marketing and distribution business; and we have a noncontrolling interest in Heidmar Holdings LLC, which owns a group of companies that provide international marine transportation and U.S. marine logistics services. As a result of these activities, we are subject to extensive and evolving energy, commodities, environmental, health and safety and other governmental laws and regulations. In addition, liability may be incurred without regard to fault under certain environmental laws and regulations for the remediation of contaminated areas. Further, through these activities we are exposed to regulatory, physical and certain indirect risks associated with climate change. Our commodities business also exposes us to the risk of unforeseen and catastrophic events, including natural disasters, leaks, spills, explosions, release of toxic substances, fires, accidents on land and at sea, wars, and terrorist attacks that could result in personal injuries, loss of life, property damage, and suspension of operations.

 

Although we have attempted to mitigate our pollution and other environmental risks by, among other measures, adopting appropriate policies and procedures for power plant operations, monitoring the quality of petroleum storage facilities and transport vessels and implementing emergency response programs, these actions may not prove adequate to address every contingency. In addition, insurance covering some of these risks may not be

 

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available, and the proceeds, if any, from insurance recovery may not be adequate to cover liabilities with respect to particular incidents. As a result, our financial condition, results of operations and cash flows may be adversely affected by these events.

 

Under the BHC Act, there is a grandfather exemption for “activities related to the trading, sale or investment in commodities and underlying physical properties,” provided that we were engaged in “any of such activities as of September 30, 1997 in the United States” and provided that certain other conditions are satisfied. If the Federal Reserve were to determine that any of our commodities activities did not qualify for the BHC Act grandfather exemption, then we would likely be required to divest any such activities that did not otherwise conform to the BHC Act by the end of any extensions of the BHC Act grace period, which would terminate in all events on the fifth anniversary of our becoming a bank holding company.

 

We also expect the other laws and regulations affecting our commodities business to increase in both scope and complexity. During the past several years, intensified scrutiny of certain energy markets by federal, state and local authorities in the U.S. and abroad and the public has resulted in increased regulatory and legal enforcement, litigation and remedial proceedings involving companies engaged in the activities in which we are engaged. For example, the U.S. and the EU have increased their focus on the energy markets which has resulted in increased regulation of companies participating in the energy markets, including those engaged in power generation and liquid hydrocarbons trading. In addition, new regulation of OTC derivatives markets in the U.S. and similar legislation proposed or adopted abroad will impose significant new costs and impose new requirements on our commodities derivatives activities. We may incur substantial costs or loss of revenue in complying with current or future laws and regulations and our overall businesses and reputation may be adversely affected by the current legal environment. In addition, failure to comply with these laws and regulations may result in substantial civil and criminal fines and penalties.

 

A failure to address conflicts of interest appropriately could adversely affect our businesses.

 

As a global financial services firm that provides products and services to a large and diversified group of clients, including corporations, governments, financial institutions and individuals, we face potential conflicts of interest in the normal course of business. For example, potential conflicts can occur when there is a divergence of interests between us and a client, among clients, or between an employee on the one hand and us or a client on the other. We have policies, procedures and controls that are designed to address potential conflicts of interest. However, identifying and mitigating potential conflicts of interest can be complex and challenging, and can become the focus of media and regulatory scrutiny. Indeed, actions that merely appear to create a conflict can put our reputation at risk even if the likelihood of an actual conflict has been mitigated. It is possible that potential conflicts could give rise to litigation or enforcement actions, which may lead to our clients being less willing to enter into transactions in which a conflict may occur and could adversely affect our businesses.

 

Our regulators have the ability to scrutinize our activities for potential conflicts of interest, including through detailed examinations of specific transactions. In addition, our status as a bank holding company supervised by the Federal Reserve subjects us to direct Federal Reserve scrutiny with respect to transactions between our domestic subsidiary banks and their affiliates.

 

Risk Management.

 

Our hedging strategies and other risk management techniques may not be fully effective in mitigating our risk exposure in all market environments or against all types of risk.

 

We have devoted significant resources to develop our risk management policies and procedures and expect to continue to do so in the future. Nonetheless, our hedging strategies and other risk management techniques may not be fully effective in mitigating our risk exposure in all market environments or against all types of risk, including risks that are unidentified or unanticipated. Some of our methods of managing risk are based upon our use of observed historical market behavior. As a result, these methods may not predict future risk exposures, which could be significantly greater than the historical measures indicate. Management of market, credit, liquidity, operational, legal and regulatory risks requires, among other things, policies and procedures to record

 

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properly and verify a large number of transactions and events, and these policies and procedures may not be fully effective. Our trading risk management strategies and techniques also seek to balance our ability to profit from trading positions with our exposure to potential losses. While we employ a broad and diversified set of risk monitoring and risk mitigation techniques, those techniques and the judgments that accompany their application cannot anticipate every economic and financial outcome or the timing of such outcomes. We may, therefore, incur losses in the course of our trading activities. For more information on how we monitor and manage market and certain other risks, see “Quantitative and Qualitative Disclosures about Market Risk—Risk Management—Market Risk” in Part II, Item 7A herein.

 

Competitive Environment.

 

We face strong competition from other financial services firms, which could lead to pricing pressures that could materially adversely affect our revenue and profitability.

 

The financial services industry and all of our businesses are intensely competitive, and we expect them to remain so. We compete with commercial banks, brokerage firms, insurance companies, sponsors of mutual funds, hedge funds, energy companies and other companies offering financial services in the U.S., globally and through the internet. We compete on the basis of several factors, including transaction execution, capital or access to capital, products and services, innovation, reputation, risk appetite and price. Over time, certain sectors of the financial services industry have become more concentrated, as institutions involved in a broad range of financial services have been acquired by or merged into other firms or have declared bankruptcy. These developments could result in our competitors gaining greater capital and other resources, such as a broader range of products and services and geographic diversity. We have experienced and may continue to experience pricing pressures as a result of these factors and as some of our competitors seek to increase market share by reducing prices. For more information regarding the competitive environment in which we operate, see “Competition” and “Supervision and Regulation” in Part I, Item 1 herein.

 

Automated trading markets may adversely affect our business and may increase competition.

 

We have experienced intense price competition in some of our businesses in recent years. In particular, the ability to execute securities trades electronically on exchanges and through other automated trading markets has increased the pressure on trading commissions. The trend toward direct access to automated, electronic markets will likely continue. We have experienced and it is likely that we will continue to experience competitive pressures in these and other areas in the future as some of our competitors may seek to obtain market share by reducing prices.

 

Our ability to retain and attract qualified employees is critical to the success of our business and the failure to do so may materially adversely affect our performance.

 

Our people are our most important resource and competition for qualified employees is intense. In order to attract and retain qualified employees, we must compensate such employees at market levels. Typically, those levels have caused employee compensation to be our greatest expense as compensation is highly variable and changes based on business and individual performance and market conditions. If we are unable to continue to attract and retain highly qualified employees, or do so at rates necessary to maintain our competitive position, or if compensation costs required to attract and retain employees become more expensive, our performance, including our competitive position, could be materially adversely affected. The financial industry has and may continue to experience more stringent regulation of employee compensation, or employee compensation may be made subject to special taxation (as it has already been done in some jurisdictions, including the U.K. and France), which could have an adverse effect on our ability to hire or retain the most qualified employees.

 

International Risk.

 

We are subject to numerous political, economic, legal, operational, franchise and other risks as a result of our international operations which could adversely impact our businesses in many ways.

 

We are subject to political, economic, legal, operational, franchise and other risks that are inherent in operating in many countries, including risks of possible nationalization, expropriation, price controls, capital controls, exchange

 

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controls and other restrictive governmental actions, as well as the outbreak of hostilities or political and governmental instability. In many countries, the laws and regulations applicable to the securities and financial services industries are uncertain and evolving, and it may be difficult for us to determine the exact requirements of local laws in every market. Our inability to remain in compliance with local laws in a particular market could have a significant and negative effect not only on our business in that market but also on our reputation generally. We are also subject to the enhanced risk that transactions we structure might not be legally enforceable in all cases.

 

Various emerging market countries have experienced severe political, economic and financial disruptions, including significant devaluations of their currencies, capital and currency exchange controls, high rates of inflation and low or negative growth rates in their economies. Crime and corruption, as well as issues of security and personal safety, also exist in certain of these countries. These conditions could adversely impact our businesses and increase volatility in financial markets generally.

 

The emergence of a pandemic or other widespread health emergency, or concerns over the possibility of such an emergency as well as terrorist acts or military actions, could create economic and financial disruptions in emerging markets and other areas throughout the world, and could lead to operational difficulties (including travel limitations) that could impair our ability to manage our businesses around the world.

 

As a U.S. company, we are required to comply with the economic sanctions and embargo programs administered by OFAC and similar multi-national bodies and governmental agencies worldwide and the FCPA. A violation of a sanction or embargo program or of the FCPA could subject us, and individual employees, to a regulatory enforcement action as well as significant civil and criminal penalties.

 

Acquisition and Joint Venture Risk.

 

We may be unable to fully capture the expected value from acquisitions, joint ventures, minority stakes and strategic alliances.

 

In connection with past or future acquisitions, joint ventures (including MSSB) or strategic alliances (including with Mitsubishi UFJ Financial Group, Inc.), we face numerous risks and uncertainties combining or integrating the relevant businesses and systems, including the need to combine accounting and data processing systems and management controls and to integrate relationships with clients, trading counterparties and business partners. In the case of joint ventures and minority stakes, we are subject to additional risks and uncertainties because we may be dependent upon, and subject to liability, losses or reputational damage relating to, systems, controls and personnel that are not under our control. In addition, conflicts or disagreements between us and our joint venture partners may negatively impact the benefits to be achieved by the joint venture. There is no assurance that any of our acquisitions will be successfully integrated or yield all of the positive benefits anticipated. If we are not able to integrate successfully our past and future acquisitions, there is a risk that our results of operations, financial condition and cash flows may be materially and adversely affected.

 

Certain of our business initiatives, including expansions of existing businesses, may bring us into contact, directly or indirectly, with individuals and entities that are not within our traditional client and counterparty base and may expose us to new asset classes and new markets. These business activities expose us to new and enhanced risks, greater regulatory scrutiny of these activities, increased credit-related, sovereign and operational risks, and reputational concerns regarding the manner in which these assets are being operated or held.

 

For more information regarding the regulatory environment in which we operate, see also “Supervision and Regulation” in Part I, Item 1 herein.

 

Item 1B.    Unresolved Staff Comments.

 

The Company, like other well-known seasoned issuers, from time to time receives written comments from the staff of the SEC regarding its periodic or current reports under the Exchange Act. There are no comments that remain unresolved that the Company received not less than 180 days before the end of the year to which this report relates that the Company believes are material.

 

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Item 2.    Properties.

 

The Company and its subsidiaries have offices, operations and data centers located around the world. The Company’s properties that are not owned are leased on terms and for durations that are reflective of commercial standards in the communities where these properties are located. The Company believes the facilities it owns or occupies are adequate for the purposes for which they are currently used and are well maintained. Our principal offices consist of the following properties:

 

Location   

Owned/

Leased

    Lease Expiration     Approximate Square Footage
as of December 31, 2010(A)
 
 

U.S. Locations

  

       

1585 Broadway

New York, New York

(Global Headquarters and Institutional Securities Headquarters)

     Owned        N/A        894,600 square feet   
     

2000 Westchester Avenue

Purchase, New York

(Global Wealth Management Group Headquarters)

     Owned        N/A        597,400 square feet   
     

522 Fifth Avenue

New York, New York

(Asset Management Headquarters)

     Owned        N/A        581,250 square feet   
     

New York, New York

(Several locations)

     Leased        2012 – 2018        2,581,600 square feet   
     

Brooklyn, New York

(Several locations)

     Leased        2011 – 2016        637,300 square feet   
     

Jersey City, New Jersey

(Several locations)

     Leased        2011 – 2014        511,695 square feet   
   

International Locations

                        
     

20 Bank Street

(London Headquarters)

     Leased        2038        546,400 square feet   
     

Canary Wharf

(Several locations)

     Leased(B)        2036        625,700 square feet   
     

1 Austin Road West

Kowloon

(Hong Kong Headquarters)

     Leased        2019        572,600 square feet   
     

Sapporo’s Yebisu Garden Place,

Ebisu, Shibuya-ku

(Tokyo Headquarters)

     Leased        2011 (C)      350,700 square feet   

 

(A) The indicated total aggregate square footage leased does not include space occupied by Morgan Stanley branch offices.
(B) The Company holds the freehold interest in the land and building.
(C) Option to return any amount of space up to the full space after April 2011.

 

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Item 3. Legal Proceedings.

 

In addition to the matters described below, in the normal course of business, the Company has been named, from time to time, as a defendant in various legal actions, including arbitrations, class actions and other litigation, arising in connection with its activities as a global diversified financial services institution. Certain of the actual or threatened legal actions include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages. In some cases, the entities that would otherwise be the primary defendants in such cases are bankrupt or in financial distress.

 

The Company is also involved, from time to time, in other reviews, investigations and proceedings (both formal and informal) by governmental and self-regulatory agencies regarding the Company’s business, including, among other matters, accounting and operational matters, certain of which may result in adverse judgments, settlements, fines, penalties, injunctions or other relief.

 

The Company contests liability and/or the amount of damages as appropriate in each pending matter. Where available information indicates that it is probable a liability had been incurred at the date of the condensed consolidated financial statements and the Company can reasonably estimate the amount of that loss, the Company accrues the estimated loss by a charge to income.

 

In many proceedings, however, it is inherently difficult to determine whether any loss is probable or even possible or to estimate the amount of any loss. The Company cannot predict with certainty if, how or when such proceedings will be resolved or what the eventual settlement, fine, penalty or other relief, if any, may be, particularly for proceedings that are in their early stages of development or where plaintiffs seek substantial or indeterminate damages. Numerous issues may need to be resolved, including through potentially lengthy discovery and determination of important factual matters, and by addressing novel or unsettled legal questions relevant to the proceedings in question, before a loss or additional loss or range of loss or additional loss can be reasonably estimated for any proceeding. Subject to the foregoing, the Company believes, based on current knowledge and after consultation with counsel, that the outcome of such proceedings will not have a material adverse effect on the consolidated financial condition of the Company, although the outcome of such proceedings could be material to the Company’s operating results and cash flows for a particular period depending on, among other things, the level of the Company’s revenues or income for such period.

 

Recently, the level of litigation activity focused on residential mortgage and credit crisis related matters has increased materially in the financial services industry. As a result, the Company expects that it may become the subject of increased claims for damages and other relief regarding residential mortgages and related securities in the future and, while the Company has identified below certain proceedings that the Company believes to be material, individually or collectively, there can be no assurance that additional material losses will not be incurred from residential mortgage claims that have not yet been notified to the Company or are not yet determined to be material.

 

Residential Mortgage and Credit Crisis Related Matters.

 

Regulatory and Governmental Matters.    The Company is responding to subpoenas and requests for information from certain regulatory and governmental entities concerning the origination, financing, purchase, securitization and servicing of subprime and non-subprime residential mortgages and related matters such as collateralized debt obligations (“CDOs”), structured investment vehicles (“SIVs”) and credit default swaps backed by or referencing mortgage pass through certificates. These matters include, but are not limited to, investigations related to the Company’s due diligence on the loans that it purchased for securitization, the Company’s communications with ratings agencies, the Company’s handling of foreclosure related issues, and the Company’s compliance with the Service Members Civil Relief Act.

 

Class Actions.    Beginning in December 2007, several purported class action complaints were filed in the United States District Court for the Southern District of New York (the “SDNY”) asserting claims on behalf of participants in the Company’s 401(k) plan and employee stock ownership plan against the Company and other

 

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parties, including certain present and former directors and officers, under the Employee Retirement Income Security Act of 1974 (“ERISA”). In February 2008, these actions were consolidated in a single proceeding, which is styled In re Morgan Stanley ERISA Litigation. The consolidated complaint relates in large part to the Company’s subprime and other mortgage related losses, but also includes allegations regarding the Company’s disclosures, internal controls, accounting and other matters. The consolidated complaint alleges, among other things, that the Company’s common stock was not a prudent investment and that risks associated with its common stock and its financial condition were not adequately disclosed. Plaintiffs are seeking, among other relief, class certification, unspecified compensatory damages, costs, interest and fees. On December 9, 2009, the court denied defendants’ motion to dismiss the consolidated complaint.

 

On February 12, 2008, a plaintiff filed a purported class action, which was amended on November 24, 2008, naming the Company and certain present and former senior executives as defendants and asserting claims for violations of the securities laws. The amended complaint, which is styled Joel Stratte-McClure, et al. v. Morgan Stanley, et al., is currently pending in the SDNY. Subject to certain exclusions, the amended complaint asserts claims on behalf of a purported class of persons and entities who purchased shares of the Company’s common stock during the period June 20, 2007 to December 19, 2007 and who suffered damages as a result of such purchases. The allegations in the amended complaint relate in large part to the Company’s subprime and other mortgage related losses, but also include allegations regarding the Company’s disclosures, internal controls, accounting and other matters. Plaintiffs are seeking, among other relief, class certification, unspecified compensatory damages, costs, interest and fees. On April 27, 2009, the Company filed a motion to dismiss the amended complaint.

 

On May 7, 2009, the Company was named as a defendant in a purported class action lawsuit brought under Sections 11, 12 and 15 of the Securities Act of 1933, as amended (the “Securities Act”), alleging, among other things, that the registration statements and offering documents related to the offerings of approximately $17 billion of mortgage pass through certificates in 2006 and 2007 contained false and misleading information concerning the pools of residential loans that backed these securitizations. The plaintiffs sought, among other relief, class certification, unspecified compensatory and rescissionary damages, costs, interest and fees. This case, which was consolidated with an earlier lawsuit and is currently styled In re Morgan Stanley Mortgage Pass-Through Certificate Litigation, is pending in the SDNY. On August 17, 2010, the court dismissed the claims brought by the lead plaintiff, but gave a different plaintiff leave to file a second amended complaint. On September 10, 2010, that plaintiff, together with several new plaintiffs, filed a second amended complaint which purports to assert claims against the Company and others on behalf of a class of investors who purchased approximately $4.7 billion of mortgage pass through certificates issued in 2006 by seven trusts collectively containing residential mortgage loans. The second amended complaint asserts claims under Sections 11, 12 and 15 of the Securities Act, and alleges, among other things, that the registration statements and offering documents related to the offerings contained false and misleading information concerning the pools of residential loans that backed these securitizations. The plaintiffs are seeking, among other relief, class certification, unspecified compensatory and rescissionary damages, costs, interest and fees. On October 11, 2010, defendants filed a motion to dismiss the second amended complaint.

 

Beginning in 2007, the Company was named as a defendant in several putative class action lawsuits brought under Sections 11 and 12 of the Securities Act, related to its role as a member of the syndicates that underwrote offerings of securities and mortgage pass through certificates for certain non-Morgan Stanley related entities that have been exposed to subprime and other mortgage-related losses. The plaintiffs in these actions allege, among other things, that the registration statements and offering documents for the offerings at issue contained various material misstatements or omissions related to the extent to which the issuers were exposed to subprime and other mortgage-related risks and other matters and seek various forms of relief including class certification, unspecified compensatory and rescissionary damages, costs, interest and fees. The Company’s exposure to potential losses in these cases may be impacted by various factors including, among other things, the financial condition of the entities that issued the securities and mortgage pass through certificates at issue, the principal amount of the offerings underwritten by the Company, the financial condition of co-defendants and the

 

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willingness and ability of the issuers (or their affiliates) to indemnify the underwriter defendants. Some of these cases, including In Re Washington Mutual, Inc. Securities Litigation, In re: Lehman Brothers Equity/Debt Securities Litigation and In re IndyMac Mortgage-Backed Securities Litigation, relate to issuers (or their affiliates) that have filed for bankruptcy or have been placed into receivership.

 

In Re Washington Mutual, Inc. Securities Litigation is pending in the United States District Court for the Western District of Washington. On October 12, 2010, the court issued an order certifying a class of plaintiffs asserting claims under the Securities Act related to three offerings by Washington Mutual Inc. in 2006 and 2007 in which the Company participated as an underwriter. The Company underwrote approximately $1.3 billion of the securities covered by the class certified by the court.

 

In re: Lehman Brothers Equity/Debt Securities Litigation is pending in the SDNY and relates to several offerings of debt and equity securities issued by Lehman Brothers Holdings Inc. during 2007 and 2008. The Company underwrote approximately $232 million of the principal amount of the offerings at issue. On June 5, 2010, the underwriter defendants moved to dismiss the amended complaint filed by the lead plaintiffs.

 

In re IndyMac Mortgage-Backed Securities Litigation is pending in the SDNY and relates to offerings of mortgage pass through certificates issued by seven trusts sponsored by affiliates of IndyMac Bancorp during 2006 and 2007. The Company underwrote over $1.4 billion of the principal amount of the offerings originally at issue. On June 21, 2010, the court granted in part and denied in part the underwriter defendants’ motion to dismiss the amended consolidated class action complaint. The Company underwrote approximately $46 million of the principal amount of the offerings at issue following the court’s June 21, 2010 decision. On May 17, 2010, certain putative plaintiffs filed a motion to intervene in the litigation in order to assert claims related to additional offerings. The Company underwrote approximately $1.2 billion of the principal amount of the additional offerings subject to the motion to intervene. The Company is opposing the motion to intervene.

 

On December 24, 2009, the Employees’ Retirement System of the Government of the Virgin Islands filed a purported class action against the Company on behalf of holders of approximately $250 million of AAA rated notes issued by the Libertas III CDO in March 2007. The case is styled Employees’ Retirement System of the Government of the Virgin Islands v. Morgan Stanley & Co. Incorporated, et al. and is pending in the SDNY. The complaint asserts claims for common law fraud and unjust enrichment and alleges that the Company made misrepresentations regarding the AAA ratings of the CDO notes and the credit quality of the collateral held by the Libertas III CDO, and stood to gain if that collateral defaulted. The complaint seeks class certification, unspecified compensatory and punitive damages, equitable relief, fees and costs. On March 19, 2010, the Company filed a motion to dismiss the complaint.

 

Shareholder Derivative Matter.    On November 15, 2007, a shareholder derivative complaint styled Steve Staehr, Derivatively on Behalf of Morgan Stanley v. John J. Mack, et al. was filed in the SDNY asserting claims related in large part to losses caused by certain subprime-related trading positions and related matters. On July 16, 2008, the plaintiff filed an amended complaint, which defendants moved to dismiss on September 19, 2008. The complaint seeks, among other relief, unspecified compensatory damages, restitution, and institution of certain corporate governance reforms.

 

Other Litigation.    On August 25, 2008, the Company and two ratings agencies were named as defendants in a purported class action related to securities issued by a SIV called Cheyne Finance (the “Cheyne SIV”). The case is styled Abu Dhabi Commercial Bank, et al. v. Morgan Stanley & Co. Inc., et al. and is pending in the SDNY. The complaint alleges, among other things, that the ratings assigned to the securities issued by the SIV were false and misleading because the ratings did not accurately reflect the risks associated with the subprime residential mortgage backed securities held by the SIV. On September 2, 2009, the court dismissed all of the claims against the Company except for plaintiffs’ claims for common law fraud. On June 15, 2010, the court denied plaintiffs’ motion for class certification. On July 20, 2010, the Court granted plaintiffs leave to replead their aiding and abetting common law fraud claims against the Company, and those claims were added in an amended complaint filed on August 5, 2010. Since the filing of the initial complaint, various additional plaintiffs have been added to

 

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the case. There are currently 14 plaintiffs asserting individual claims related to securities issued by the SIV. Plaintiffs have not alleged the amount of their alleged investments, and are seeking, among other relief, unspecified compensatory and punitive damages.

 

On January 16, 2009, the Company was named as a defendant in an interpleader lawsuit styled U.S. Bank, N.A. v. Barclays Bank PLC and Morgan Stanley Capital Services Inc., which is pending in the SDNY. The lawsuit relates to credit default swaps between the Company and Tourmaline CDO I LTD (“Tourmaline”), in which Barclays Bank PLC (“Barclays”) is the holder of the most senior and controlling class of notes. At issue is whether, pursuant to the terms of the swap agreements, the Company was required to post collateral to Tourmaline, or take any other action, after the Company’s credit ratings were downgraded in 2008 by certain ratings agencies. The Company and Barclays have a dispute regarding whether the Company breached any obligations under the swap agreements and, if so, whether any such breaches were cured. The trustee for Tourmaline, interpleader plaintiff U.S. Bank, N.A., has refrained from making any further distribution of Tourmaline’s funds pending the resolution of these issues and is seeking a judgment from the court resolving them. On January 11, 2011, the court conducted a bench trial, but has not yet issued its ruling. As of December 31, 2010, the Company believed that it was entitled to receivables from Tourmaline in an amount equal to approximately $273 million.

 

On September 25, 2009, the Company was named as a defendant in a lawsuit styled Citibank, N.A. v. Morgan Stanley & Co. International, PLC, which is pending in the SDNY. The lawsuit relates to a credit default swap referencing the Capmark VI CDO, which was structured by Citibank, N.A. (“Citi N.A.”). At issue is whether, as part of the swap agreement, Citi N.A. was obligated to obtain the Company’s prior written consent before it exercised its rights to liquidate Capmark upon the occurrence of certain contractually-defined credit events. Citi N.A. is seeking approximately $245 million in compensatory damages plus interest and costs. On October 8, 2010, the court issued an order denying Citi N.A.’s motion for judgment on the pleadings as to the Company’s counterclaim for reformation and granting Citi N.A.’s motion for judgment on the pleadings as to the Company’s counterclaim for estoppel. The Company moved for summary judgment on December 17, 2010. Citi N.A. opposed the Company’s motion and cross moved for summary judgment on January 21, 2011.

 

On December 23, 2009, the Federal Home Loan Bank of Seattle filed a complaint against the Company and another defendant in the Superior Court of the State of Washington, styled Federal Home Loan Bank of Seattle v. Morgan Stanley & Co. Inc., et al. An amended complaint was filed on September 28, 2010. The complaint alleges that defendants made untrue statements and material omissions in the sale to plaintiff of certain mortgage pass through certificates backed by securitization trusts containing residential mortgage loans. The total amount of certificates allegedly sold to plaintiff by the Company was approximately $233 million. The complaint raises claims under the Washington State Securities Act and seeks, among other things, to rescind the plaintiff’s purchase of such certificates. On October 18, 2010, defendants filed a motion to dismiss the action.

 

On March 15, 2010, the Federal Home Loan Bank of San Francisco filed two complaints against the Company and other defendants in the Superior Court of the State of California. These actions are styled Federal Home Loan Bank of San Francisco v. Credit Suisse Securities (USA) LLC, et al., and Federal Home Loan Bank of San Francisco v. Deutsche Bank Securities Inc. et al., respectively. Amended complaints were filed on June 10, 2010. The complaints allege that defendants made untrue statements and material omissions in connection with the sale to plaintiff of a number of mortgage pass through certificates backed by securitization trusts containing residential mortgage loans. The amount of certificates allegedly sold to plaintiff by the Company in these cases was approximately $704 million and $276 million, respectively. The complaints raise claims under both the federal securities laws and California law and seek, among other things, to rescind the plaintiff’s purchase of such certificates. On July 12, 2010, defendants removed these actions to the United States District Court for the Northern District of California, and on December 20, 2010, the cases were remanded to the state court.

 

On June 10, 2010, the Company was named as a new defendant in a pre-existing purported class action related to securities issued by a SIV called Rhinebridge plc (“Rhinebridge SIV”). The case is styled King County, Washington, et al. v. IKB Deutsche Industriebank AG, et al. and is pending in the SDNY. The complaint asserts

 

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claims for common law fraud and aiding and abetting common law fraud and alleges, among other things, that the ratings assigned to the securities issued by the SIV were false and misleading, including because the ratings did not accurately reflect the risks associated with the subprime residential mortgage backed securities held by the SIV. On July 15, 2010, the Company moved to dismiss the complaint. That motion was denied on October 29, 2010. The case is pending before the same judge presiding over the litigation concerning the Cheyne SIV, described above. While reserving their ability to act otherwise, plaintiffs have indicated that they do not currently plan to file a motion for class certification. Plaintiffs have not alleged the amount of their alleged investments, and are seeking, among other relief, unspecified compensatory and punitive damages.

 

On July 9, 2010, Cambridge Place Investment Management Inc. filed a complaint against the Company and other defendants in the Superior Court of the Commonwealth of Massachusetts, styled Cambridge Place Investment Management Inc. v. Morgan Stanley & Co., Inc., et al. The complaint asserts claims on behalf of certain of plaintiff’s clients and alleges that defendants made untrue statements and material omissions in the sale of a number of mortgage pass through certificates backed by securitization trusts containing residential mortgage loans. The total amount of certificates allegedly issued by the Company or sold to plaintiff’s clients by the Company was approximately $242 million. The complaint raises claims under the Massachusetts Uniform Securities Act and seeks, among other things, to rescind the plaintiff’s purchase of such certificates. On August 13, 2010, defendants removed this action to the United States District Court for the District of Massachusetts and on September 13, 2010, plaintiff filed a motion to remand the case to the state court. On December 28, 2010, the magistrate judge recommended that the district court grant the motion to remand. The defendants objected to the magistrate’s report and recommendation on January 18, 2011.

 

On July 15, 2010, The Charles Schwab Corp. filed a complaint against the Company and other defendants in the Superior Court of the State of California, styled The Charles Schwab Corp. v. BNP Paribas Securities Corp., et al. The complaint alleges that defendants made untrue statements and material omissions in the sale to one of plaintiff’s subsidiaries of a number of mortgage pass through certificates backed by securitization trusts containing residential mortgage loans. The total amount of certificates allegedly sold to plaintiff’s subsidiary by the Company was approximately $180 million. The complaint raises claims under both the federal securities laws and California law and seeks, among other things, to rescind the plaintiff’s purchase of such certificates. On September 8, 2010, defendants removed this action to the United States District Court for the Northern District of California and on October 1, 2010, plaintiff filed a motion to remand the case to the state court.

 

In July 15, 2010, China Industrial Development Bank (“CIDB”) filed a complaint against the Company, which is styled China Industrial Development Bank v. Morgan Stanley & Co. Incorporated and is pending in the Supreme Court of the State of New York, New York County. The Complaint relates to a $275 million credit default swap referencing the super senior portion of the STACK 2006-1 CDO. The complaint asserts claims for common law fraud, fraudulent inducement and fraudulent concealment and alleges that the Company misrepresented the risks of the STACK 2006-1 CDO to CIDB, and that the Company knew that the assets backing the CDO were of poor quality when it entered into the credit default swap with CIDB. The complaint seeks compensatory damages related to the approximately $228 million that CIDB alleges it has already lost under the credit default swap, rescission of CIDB’s obligation to pay an additional $12 million, punitive damages, equitable relief, fees and costs. On September 30, 2010, the Company filed a motion to dismiss the complaint.

 

On October 15, 2010, the Federal Home Loan Bank of Chicago filed two complaints against the Company and other defendants. One was filed in the Circuit Court of the State of Illinois and is styled Federal Home Loan Bank of Chicago v. Bank of America Funding Corporation et al. The other was filed in the Superior Court of the State of California and is styled Federal Home Loan Bank of Chicago v. Bank of America Securities LLC, et al. The complaints allege that defendants made untrue statements and material omissions in the sale to plaintiff of a number of mortgage pass through certificates backed by securitization trusts containing residential mortgage loans. The total amount of certificates allegedly sold to plaintiff by the Company in the two actions was approximately $203 million and $75 million respectively. The complaint filed in Illinois raises claims

 

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under Illinois law. The complaint filed in California raises claims under the federal securities laws, Illinois law and California law. Both complaints seek, among other things, to rescind the plaintiff’s purchase of such certificates. The defendants removed both actions to federal court, on November 23, 2010 and November 24, 2010, respectively. On January 18, 2011, the United States District Court for the Northern District of Illinois remanded the Illinois action to the state court. On December 23, 2010, the plaintiff filed a motion to remand the California action from the United States District Court for the Central District of California to the state court.

 

On December 6, 2010, MBIA Insurance Corporation (“MBIA”) filed a complaint against the Company related to MBIA’s contract to insure approximately $223 million of residential mortgage backed securities related to a second lien residential mortgage backed securitization sponsored by the Company in June 2007. The complaint is styled MBIA Insurance Corporation v. Morgan Stanley, et al. and is pending in New York Supreme Court, Westchester County. The complaint asserts claims for fraud, breach of contract and unjust enrichment and alleges, among other things, that the Company misled MBIA regarding the quality of the loans contained in the securitization, that loans contained in the securitization breached various representations and warranties and that the loans have been serviced inadequately. The complaint seeks, among other relief, compensatory and punitive damages, an order requiring the Company to comply with the loan breach remedy procedures in the transaction documents and/or to indemnify MBIA for losses resulting from the Company’s alleged breach of the transaction documents, as well as costs, interests and fees. On February 2, 2011, the Company filed a motion to dismiss the complaint.

 

China Matter.

 

As disclosed in February 2009, the Company uncovered actions initiated by an employee based in China in an overseas real estate subsidiary that appear to have violated the Foreign Corrupt Practices Act. The Company terminated the employee, reported the activity to appropriate authorities and is cooperating with investigations by the United States Department of Justice and the SEC.

 

Item 4. [Removed and Reserved]

 

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Part II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

Morgan Stanley’s common stock trades on the NYSE under the symbol “MS.” As of February 22, 2011, the Company had 88,852 holders of record; however, the Company believes the number of beneficial owners of common stock exceeds this number.

 

The table below sets forth, for each of the last eight quarters, the low and high sales prices per share of the Company’s common stock as reported by Bloomberg Financial Markets and the amount of any cash dividends per share of the Company’s common stock declared by its Board of Directors for such quarter.

 

     Low
Sale Price
     High
Sale Price
     Dividends  

2010:

        

Fourth Quarter

   $ 23.95       $ 27.77       $ 0.05   

Third Quarter

   $ 22.40       $ 28.05       $ 0.05   

Second Quarter

   $ 23.14       $ 32.29       $ 0.05   

First Quarter

   $ 26.15       $ 33.27       $ 0.05   

2009:

        

Fourth Quarter

   $ 28.75       $ 35.78       $ 0.05   

Third Quarter

   $ 24.85       $ 33.33       $ 0.05   

Second Quarter

   $ 20.69       $ 31.99       $ 0.05   

First Quarter

   $ 13.10       $ 27.27       $ 0.05   

 

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The table below sets forth the information with respect to purchases made by or on behalf of the Company of its common stock during the fourth quarter of the year ended December 31, 2010.

 

Issuer Purchases of Equity Securities

(dollars in millions, except per share amounts)

 

Period

  Total
Number
of
Shares
Purchased
    Average
Price
Paid Per
Share
    Total Number of
Shares Purchased
As Part of Publicly
Announced Plans
or Programs(C)
    Approximate Dollar
Value of Shares
that May Yet Be
Purchased Under
the Plans or
Programs
 

Month #1 (October 1, 2010—October 31, 2010)

       

Share Repurchase Program(A)

    —          —          —        $ 1,560   

Employee Transactions (B)

    478,452      $ 25.28        —          —     

Month #2 (November 1, 2010—November 30, 2010)

       

Share Repurchase Program(A)

    —          —          —        $ 1,560   

Employee Transactions (B)

    105,160      $ 24.95        —          —     

Month #3 (December 1, 2010—December 31, 2010)

       

Share Repurchase Program(A)

    —          —          —        $ 1,560   

Employee Transactions(B)

    167,571      $ 25.53        —          —     

Total

       

Share Repurchase Program(A)

    —          —          —        $ 1,560   

Employee Transactions(B)

    751,183      $ 25.29        —          —     

(A) On December 19, 2006, the Company announced that its Board of Directors authorized the repurchase of up to $6 billion of the Company’s outstanding stock under a share repurchase program (the “Share Repurchase Program”). The Share Repurchase Program is a program for capital management purposes that considers, among other things, business segment capital needs as well as equity-based compensation and benefit plan requirements. The Share Repurchase Program has no set expiration or termination date. Share repurchases by the Company are subject to regulatory approval.
(B) Includes: (1) shares delivered or attested in satisfaction of the exercise price and/or tax withholding obligations by holders of employee and director stock options (granted under employee and director stock compensation plans) who exercised options; (2) shares withheld, delivered or attested (under the terms of grants under employee and director stock compensation plans) to offset tax withholding obligations that occur upon vesting and release of restricted shares; and (3) shares withheld, delivered and attested (under the terms of grants under employee and director stock compensation plans) to offset tax withholding obligations that occur upon the delivery of outstanding shares underlying restricted stock units. The Company’s employee and director stock compensation plans provide that the value of the shares withheld, delivered or attested, shall be valued using the fair market value of the Company’s common stock on the date the relevant transaction occurs, using a valuation methodology established by the Company.
(C) Share purchases under publicly announced programs are made pursuant to open-market purchases, Rule 10b5-1 plans or privately negotiated transactions (including with employee benefit plans) as market conditions warrant and at prices the Company deems appropriate.

 

***

 

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Stock performance graph.    The following graph compares the cumulative total shareholder return (rounded to the nearest whole dollar) of the Company’s common stock, the S&P 500 Stock Index (“S&P 500”) and the S&P 500 Financials Index (“S5FINL”) for the last five years. The graph assumes a $100 investment at the closing price on December 31, 2005 and reinvestment of dividends on the respective dividend payment dates without commissions. Historical prices are adjusted to reflect the spin-off of Discover Financial Services completed on June 30, 2007. This graph does not forecast future performance of the Company’s common stock.

 

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     MS      S&P 500      S5FINL  

12/30/2005

   $ 100.00       $ 100.00       $ 100.00   

12/29/2006

   $ 145.85       $ 115.78       $ 119.21   

12/31/2007

   $ 116.29       $ 122.14       $ 97.16   

12/31/2008

   $ 36.30       $ 76.96       $ 43.50   

12/31/2009

   $ 68.31       $ 97.33       $ 51.03   

12/31/2010

   $ 63.26       $ 112.01       $ 57.26   

 

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Item 6. Selected Financial Data.

 

MORGAN STANLEY

 

SELECTED FINANCIAL DATA

(dollars in millions, except share and per share data)

 

    2010     2009(1)(2)     Fiscal
2008
    Fiscal
2007
    Fiscal
2006
    One Month
Ended
December 31,
2008(2)
 

Income Statement Data:

           

Revenues:

           

Investment banking

  $ 5,122     $ 5,020     $ 4,057     $ 6,321     $ 4,706     $ 196  

Principal transactions:

           

Trading

    9,406       7,722       6,170       1,723       10,290       (1,491

Investments

    1,825       (1,034     (3,888     3,328       1,791       (205

Commissions

    4,947       4,233       4,443       4,654       3,746       213  

Asset management, distribution and administration fees

    7,957       5,884       4,839       5,486       4,231       292  

Other

    1,501       837       3,851       777       210       109  
                                               

Total non-interest revenues

    30,758       22,662       19,472       22,289       24,974       (886
                                               

Interest income

    7,278       7,477       38,931       61,420       44,270       1,089  

Interest expense

    6,414       6,705       36,263       57,264       40,904       1,140  
                                               

Net interest

    864       772       2,668       4,156       3,366       (51
                                               

Net revenues

    31,622       23,434       22,140       26,445       28,340       (937
                                               

Non-interest expenses:

           

Compensation and benefits

    16,048       14,434       11,851       16,111       13,593       582  

Other

    9,372       8,017       9,035       7,573       6,353       475  
                                               

Total non-interest expenses

    25,420       22,451       20,886       23,684       19,946       1,057  
                                               

Income (loss) from continuing operations before income taxes

    6,202       983       1,254       2,761       8,394       (1,994

Provision for (benefit from) income taxes

    739       (341     16       573       2,469       (725
                                               

Income (loss) from continuing operations

    5,463       1,324       1,238       2,188       5,925       (1,269

Discontinued operations(3):

           

Gain (loss) from discontinued operations

    606       33       1,004       1,697       2,351       (14

Provision for (benefit from) income taxes

    367       (49     464       636       789       2  
                                               

Net gain (loss) from discontinued operations

    239       82       540       1,061       1,562       (16
                                               

Net income (loss)

    5,702       1,406       1,778       3,249       7,487       (1,285

Net income applicable to noncontrolling interests

    999       60       71       40       15       3  
                                               

Net income (loss) applicable to Morgan Stanley

  $ 4,703     $ 1,346     $ 1,707     $ 3,209     $ 7,472     $ (1,288
                                               

Earnings (loss) applicable to Morgan Stanley common shareholders(4)

  $ 3,594     $ (907   $ 1,495     $ 2,976     $ 7,027     $ (1,624
                                               

Amounts applicable to Morgan Stanley:

           

Income (loss) from continuing operations

  $ 4,464     $ 1,280     $ 1,205     $ 2,150     $ 5,913     $ (1,269

Net gain (loss) from discontinued operations

    239       66       502       1,059       1,559       (19
                                               

Net income (loss) applicable to Morgan Stanley

  $ 4,703     $ 1,346     $ 1,707     $ 3,209     $ 7,472     $ (1,288
                                               

 

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    2010     2009(1)(2)     Fiscal 2008     Fiscal 2007     Fiscal 2006     One Month
Ended
December 31,
2008(2)
 

Per Share Data:

           

Earnings (loss) per basic common share(5):

           

Income (loss) from continuing operations

  $ 2.48     $ (0.82   $ 1.00     $ 1.97     $ 5.50     $ (1.60

Net gain (loss) from discontinued operations

    0.16       0.05       0.45       1.00       1.46       (0.02
                                               

Earnings (loss) per basic common share

  $ 2.64     $ (0.77   $ 1.45     $ 2.97     $ 6.96     $ (1.62
                                               

Earnings (loss) per diluted common share(5):

           

Income (loss) from continuing operations

  $ 2.44     $ (0.82   $ 0.95     $ 1.92     $ 5.42     $ (1.60

Net gain (loss) from discontinued operations

    0.19       0.05       0.44       0.98       1.43       (0.02
                                               

Earnings (loss) per diluted common share

  $ 2.63     $ (0.77   $ 1.39     $ 2.90     $ 6.85     $ (1.62
                                               

Book value per common share(6)

  $ 31.49     $ 27.26     $ 30.24     $ 28.56     $ 32.67     $ 27.53  

Dividends declared per common share

  $ 0.20     $ 0.17     $ 1.08     $ 1.08     $ 1.08     $ 0.27  

Balance Sheet and Other Operating Data:

           

Total assets

  $ 807,698     $ 771,462     $ 659,035     $ 1,045,409     $ 1,121,192     $ 676,764  

Total capital(7)

    222,757       213,974       192,297       191,085       162,134       208,008  

Long-term borrowings(7)

    165,546       167,286       141,466       159,816       126,770       159,255  

Morgan Stanley shareholders’ equity

    57,211       46,688       50,831       31,269       35,364       48,753  

Return on average common shareholders’ equity

    8.5     N/M        3.2     6.5     22.0     N/M   

Average common and equivalent shares(4)

    1,361,670,938       1,185,414,871       1,028,180,275       1,001,878,651       1,010,254,255       1,002,058,928  

N/M—Not Meaningful
(1) Information includes Morgan Stanley Smith Barney Holdings LLC effective May 31, 2009 (see Note 3 to the consolidated financial statements).
(2) On December 16, 2008, the Board of Directors of the Company approved a change in the Company’s fiscal year-end from November 30 to December 31 of each year. This change to the calendar year reporting cycle began January 1, 2009. As a result of the change, the Company had a one-month transition period in December 2008.
(3) Prior period amounts have been recast for discontinued operations. See Note 1 to the consolidated financial statements for information on discontinued operations.
(4) Amounts shown are used to calculate earnings per basic common share.
(5) For the calculation of basic and diluted earnings per common share, see Note 16 to the consolidated financial statements.
(6) Book value per common share equals common shareholders’ equity of $47,614 million at December 31, 2010, $37,091 million at December 31, 2009, $31,676 million at November 30, 2008, $30,169 million at November 30, 2007, $34,264 million at November 30, 2006 and $29,585 million at December 31, 2008, divided by common shares outstanding of 1,512 million at December 31, 2010, 1,361 million at December 31, 2009, 1,048 million at November 30, 2008, 1,056 million at November 30, 2007, 1,049 million at November 30, 2006 and 1,074 million at December 31, 2008.
(7) These amounts exclude the current portion of long-term borrowings and include junior subordinated debt issued to capital trusts. At November 30, 2006, capital units were included in total capital.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Introduction.

 

Morgan Stanley, a financial holding company, is a global financial services firm that maintains significant market positions in each of its business segments—Institutional Securities, Global Wealth Management Group and Asset Management. The Company, through its subsidiaries and affiliates, provides a wide variety of products and services to a large and diversified group of clients and customers, including corporations, governments, financial institutions and individuals. Unless the context otherwise requires, the terms “Morgan Stanley” and the “Company” mean Morgan Stanley and its consolidated subsidiaries.

 

A summary of the activities of each of the Company’s business segments is as follows:

 

Institutional Securities provides capital raising; financial advisory services, including advice on mergers and acquisitions, restructurings, real estate and project finance; corporate lending; sales, trading, financing and market-making activities in equity and fixed income securities and related products, including foreign exchange and commodities; and investment activities.

 

Global Wealth Management Group, which includes the Company’s 51% interest in Morgan Stanley Smith Barney Holdings LLC (“MSSB”), provides brokerage and investment advisory services to individual investors and small-to-medium sized businesses and institutions covering various investment alternatives; financial and wealth planning services; annuity and other insurance products; credit and other lending products; cash management services; retirement services; and trust and fiduciary services and engages in fixed income principal trading, which primarily facilitates clients’ trading or investments in such securities.

 

Asset Management provides a broad array of investment strategies that span the risk/return spectrum across geographies, asset classes and public and private markets to a diverse group of clients across the institutional and intermediary channels as well as high net worth clients.

 

See Note 1 to the consolidated financial statements for a discussion of the Company’s discontinued operations.

 

The results of operations in the past have been, and in the future may continue to be, materially affected by many factors, including the effect of political and economic conditions and geopolitical events; the effect of market conditions, particularly in the global equity, fixed income and credit markets, including corporate and mortgage (commercial and residential) lending and commercial real estate investments; the impact of current, pending and future legislation (including the Dodd-Frank Act), regulation (including capital requirements), and legal actions in the United States of America (“U.S.”) and worldwide; the level and volatility of equity, fixed income, and commodity prices and interest rates, currency values and other market indices; the availability and cost of both credit and capital as well as the credit ratings assigned to the Company’s unsecured short-term and long-term debt; investor sentiment and confidence in the financial markets; the performance of the Company’s acquisitions, joint ventures, strategic alliances or other strategic arrangements (including MSSB and with Mitsubishi UFJ Financial Group, Inc. (“MUFG”)); the Company’s reputation; inflation, natural disasters, and acts of war or terrorism; the actions and initiatives of current and potential competitors and technological changes; or a combination of these or other factors. In addition, legislative, legal and regulatory developments related to the Company’s businesses are likely to increase costs, thereby affecting results of operations. These factors also may have an impact on the Company’s ability to achieve its strategic objectives. For a further discussion of these and other important factors that could affect the Company’s business, see “Competition” and “Supervision and Regulation” in Part I, Item 1, and “Risk Factors” in Part I, Item 1A.

 

Change in Fiscal Year-End.

 

On December 16, 2008, the Board of Directors of the Company (the “Board”) approved a change in the Company’s fiscal year-end from November 30 to December 31 of each year. This change to the calendar year reporting cycle began January 1, 2009. As a result of the change, the Company had a one-month transition period in December 2008.

 

The Company’s results of operations for the 12 months ended December 31, 2010 (“2010”), December 31, 2009 (“2009”), November 30, 2008 (“fiscal 2008”) and the one month ended December 31, 2008 are discussed below.

 

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Executive Summary.

 

Financial Information and Statistical Data (dollars in millions, except where noted and per share amounts).

 

     2010     2009(1)     Fiscal
2008
    One Month
Ended
December 31,
2008
 

Net revenues:

        

Institutional Securities

   $ 16,366     $ 12,853     $ 14,768     $ (1,322

Global Wealth Management Group

     12,636       9,390       7,019       409  

Asset Management

     2,723       1,337       547       (9

Intersegment Eliminations

     (103     (146     (194     (15
                                

Consolidated net revenues

   $ 31,622     $ 23,434     $ 22,140     $ (937
                                

Consolidated net income (loss)

   $ 5,702     $ 1,406     $ 1,778     $ (1,285

Net income applicable to noncontrolling interests

     999       60       71       3  
                                

Net income (loss) applicable to Morgan Stanley

   $ 4,703     $ 1,346     $ 1,707     $ (1,288
                                

Income (loss) from continuing operations applicable to Morgan Stanley:

        

Institutional Securities

   $ 3,747     $ 1,393     $ 1,358     $ (1,271

Global Wealth Management Group

     519       283       714       73  

Asset Management

     210       (388     (856     (70

Intersegment Eliminations

     (12     (8     (11     (1
                                

Income (loss) from continuing operations applicable to Morgan Stanley

   $ 4,464     $ 1,280     $ 1,205     $ (1,269
                                

Amounts applicable to Morgan Stanley:

        

Income (loss) from continuing operations applicable to Morgan Stanley

   $ 4,464     $ 1,280     $ 1,205     $ (1,269

Net gain (loss) from discontinued operations applicable to Morgan Stanley(2)

     239       66       502       (19
                                

Net income (loss) applicable to Morgan Stanley

   $ 4,703     $ 1,346     $ 1,707     $ (1,288
                                

Earnings (loss) applicable to Morgan Stanley common shareholders

   $ 3,594     $ (907   $ 1,495     $ (1,624
                                

Earnings (loss) per basic common share:

        

Income (loss) from continuing operations

   $ 2.48     $ (0.82   $ 1.00     $ (1.60

Net gain (loss) from discontinued operations(2)

     0.16       0.05       0.45       (0.02
                                

Earnings (loss) per basic common share(3)

   $ 2.64     $ (0.77   $ 1.45     $ (1.62
                                

Earnings (loss) per diluted common share:

        

Income (loss) from continuing operations

   $ 2.44     $ (0.82   $ 0.95     $ (1.60

Net gain (loss) from discontinued operations(2)

     0.19       0.05       0.44       (0.02
                                

Earnings (loss) per diluted common share(3)

   $ 2.63     $ (0.77   $ 1.39     $ (1.62
                                

Regional net revenues(4):

        

Americas

   $ 21,674     $ 18,909     $ 10,768     $ (766

Europe, Middle East and Africa

     5,628       2,529       8,977       (215

Asia

     4,320       1,996       2,395       44  
                                

Consolidated net revenues

   $ 31,622     $ 23,434     $ 22,140     $ (937
                                

 

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Financial Information and Statistical Data (dollars in millions, except where noted and per share amounts)—(Continued).

 

     2010     2009(1)     Fiscal
2008
    One Month
Ended
December 31,
2008
 

Average common equity (dollars in billions)(5):

        

Institutional Securities

   $ 17.7     $ 18.1     $ 22.9     $ 20.8  

Global Wealth Management Group

     6.8       4.6       1.5       1.3  

Asset Management

     2.1       2.2       3.0       2.4  

Parent capital

     15.5       8.1       4.9       4.9  
                                

Total from continuing operations

     42.1       33.0       32.3       29.4  

Discontinued operations

     0.3       1.1       1.3       1.2  
                                

Consolidated average common equity

   $ 42.4     $ 34.1     $ 33.6     $ 30.6  
                                

Return on average common equity(5):

        

Consolidated

     9     N/M        3     N/M   

Institutional Securities(5)

     19     N/A        N/A        N/A   

Global Wealth Management Group

     7     N/A        N/A        N/A   

Asset Management

     9     N/A        N/A        N/A   

Book value per common share(6)

   $ 31.49     $ 27.26     $ 30.24     $ 27.53  

Tangible common equity(7)

   $ 40,667     $ 29,479       N/A      $ 26,607  

Tangible book value per common share(8)

   $ 26.90     $ 21.67       N/A      $ 24.76  

Effective income tax rate provision (benefit) from continuing operations(9)

     11.9     (34.7 )%      1.3     36.4

Worldwide employees(10)

     62,542       60,494       44,716        44,352   

Average liquidity (dollars in billions)(11):

        

Parent company liquidity

   $ 65     $ 61     $ 69     $ 64  

Bank and other subsidiary liquidity

     94       93       69       78  
                                

Total liquidity

   $ 159     $ 154     $ 138     $ 142  
                                

Capital ratios at December 31, 2010 and 2009(12):

        

Total capital ratio

     16.5     16.4     N/A        N/A   

Tier 1 capital ratio

     16.1     15.3     N/A        N/A   

Tier 1 leverage ratio

     6.6     5.8     N/A        N/A   

Tier 1 common ratio(12)

     10.5     8.2     N/A        N/A   

Consolidated assets under management or supervision (dollars in billions)(13)(14):

        

Asset Management(15)

   $ 279     $ 266     $ 287     $ 290  

Global Wealth Management Group

     477       379       128       129  
                                

Total

   $ 756     $ 645     $ 415     $ 419  
                                

Institutional Securities:

        

Pre-tax profit margin(16)

     27     9     10     N/M   

Global Wealth Management Group:

        

Global representatives(17)

     18,043       18,135       8,426       8,356  

Annualized net revenues per global representative (dollars in thousands)(18)

   $ 698     $ 666     $ 746     $ 585  

Assets by client segment (dollars in billions):

        

$10 million or more

   $ 522     $ 453     $ 152     $ 155  

$1 million to $10 million

     707       637       197       196  
                                

Subtotal $1 million or more

     1,229       1,090       349       351  
                                

$100,000 to $1 million

     399       418       151       155  

Less than $100,000

     41       52       22       22  

Corporate and other accounts(19)

     —          —          24       22  
                                

Total client assets

   $ 1,669     $ 1,560     $ 546     $ 550  
                                

 

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Financial Information and Statistical Data (dollars in millions, except where noted and per share amounts)—(Continued).

 

     2010     2009(1)     Fiscal
2008
    One Month
Ended
December 31,
2008
 

Fee-based assets as a percentage of total client assets

     28     24     25     25

Client assets per global representative(20)

   $ 93     $ 86     $ 65     $ 66  

Bank deposits (dollars in billions)(21)

   $ 113     $ 112     $ 36     $ 39  

Pre-tax profit margin(16)

     9     6     16     29

Asset Management(13):

        

Assets under management or supervision (dollars in billions)

   $ 279     $ 266     $ 287     $ 290  

Pre-tax profit margin(16)

     27     N/M        N/M        N/M   

N/M—Not Meaningful.

N/A—Not Applicable. Information is not comparable.

(1) Information includes MSSB effective from May 31, 2009 (see Note 3 to the consolidated financial statements).
(2) See Note 1 to the consolidated financial statements for information on discontinued operations.
(3) For the calculation of basic and diluted earnings per share (“EPS”), see Note 16 to the consolidated financial statements.
(4) In 2010, regional net revenues, primarily in the Americas, were negatively impacted by the tightening of the Company’s credit spreads, which resulted in the increase in the fair value of certain of the Company’s long-term and short-term structured notes. In 2009, regional net revenues, primarily in Europe, Middle East and Africa, were negatively impacted by the tightening of the Company’s credit spreads. For a discussion of the Company’s methodology used to allocate revenues among the regions, see Note 23 to the consolidated financial statements.
(5) The computation of average common equity for each business segment in 2010 is determined using the Company’s Required Capital framework (“Required Capital Framework”), an internal capital adequacy measure (see “Liquidity and Capital Resources—Required Capital” herein). Business segment capital prior to 2010 has not been restated under this framework. As a result, the business segments’ return on average common equity from continuing operations prior to 2010 is not available. The Required Capital framework will evolve over time in response to changes in the business and regulatory environment and to incorporate enhancements in modeling techniques. The return on average common equity uses income from continuing operations applicable to Morgan Stanley less preferred dividends as a percentage of average common equity. The effective tax rates used in the computation of business segment return on average common equity were determined on a separate entity basis. Excluding the effect of the discrete tax benefits in 2010, the return on average common equity for the Institutional Securities business segment would have been 13% (see “Executive Summary—Significant Items” herein).
(6) Book value per common share equals common shareholders’ equity of $47,614 million at December 31, 2010, $37,091 million at December 31, 2009, $31,676 million at November 30, 2008 and $29,585 million at December 31, 2008, divided by common shares outstanding of 1,512 million at December 31, 2010, 1,361 million at December 31, 2009, 1,048 million at November 30, 2008 and 1,074 million at December 31, 2008. Book value per common share in 2010 included a benefit of approximately $1.40 per share due to the issuance of 116 million shares of common stock corresponding to the mandatory redemption of the junior subordinated debentures underlying $5.6 billion of equity units (see “Other Matters—Redemption of CIC Equity Units and Issuance of Common Stock” herein).
(7) Tangible common equity is a non-Generally Accepted Accounting Principle (“GAAP”) financial measure that the Company considers to be a useful measure that the Company and investors use to assess capital adequacy. For a discussion of tangible common equity, see “Liquidity and Capital Resources—The Balance Sheet” herein.
(8) Tangible book value per common share is a non-GAAP financial measure that the Company considers to be a useful measure that the Company and investors use to assess capital adequacy. Tangible book value per common share equals tangible common equity divided by period-end common shares outstanding.
(9) For a discussion of the effective income tax rate, see “Executive Summary—Significant Items” herein.
(10) Worldwide employees at December 31, 2010 and December 31, 2009 include additional worldwide employees of businesses contributed by Citigroup, Inc. (“Citi”) related to MSSB.
(11) For a discussion of average liquidity, see “Liquidity and Capital Resources—Liquidity Management Policies—Liquidity Reserves” herein.
(12) Tier 1 common ratio is a non-GAAP financial measure that the Company considers to be a useful measure that the Company and investors use to assess capital adequacy. For a discussion of total capital ratio, Tier 1 capital ratio and Tier 1 leverage ratio, see “Liquidity and Capital Resources—Regulatory Requirements” herein. For a discussion of Tier 1 common ratio, see “Liquidity and Capital Resources—The Balance Sheet” herein.
(13) Amount excludes substantially all of the Company’s retail asset management business (“Retail Asset Management”) that was sold to Invesco Ltd. (“Invesco”) (see “Executive Summary—Significant Items” herein).
(14) Revenues and expenses associated with these assets are included in the Company’s Asset Management and Global Wealth Management Group business segments.
(15) Amounts include Asset Management’s proportionate share of assets managed by entities in which it owns a minority stake.

 

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(16) Pre-tax profit margin is a non-GAAP financial measure that the Company considers to be a useful measure that the Company and investors use to assess operating performance. Percentages represent income from continuing operations before income taxes as a percentage of net revenues.
(17) Global representatives at December 31, 2010 and December 31, 2009 include additional global representatives of businesses contributed by Citi related to MSSB.
(18) Annualized net revenues per global representative for 2010, 2009, fiscal 2008 and the one month ended December 31, 2008 equals Global Wealth Management Group’s net revenues (excluding the sale of Morgan Stanley Wealth Management S.V., S.A.U. (“MSWM S.V.”) for fiscal 2008) divided by the quarterly weighted average global representative headcount for 2010, 2009, fiscal 2008 and the one month ended December 31, 2008, respectively.
(19) Beginning in 2009, amounts for Corporate and other accounts are presented in the appropriate client segment.
(20) Client assets per global representative equal total period-end client assets divided by period-end global representative headcount.
(21) Approximately $55 billion and $54 billion of the bank deposit balances at December 31, 2010 and December 31, 2009, respectively, are held at Company-affiliated depositories with the remainder held at Citi-affiliated depositories. These deposit balances are held at certain of the Company’s Federal Deposit Insurance Corporation (the “FDIC”) insured depository institutions for the benefit of the Company’s clients through their accounts.

 

Global Market and Economic Conditions in 2010.

 

Global market and economic conditions continued to improve, and global capital markets continued to recover, during 2010 and 2009, as compared with the severe economic and financial downturn that occurred in the fall of 2008.

 

In the U.S., major equity market indices ended 2010 higher compared with the beginning of the year. The increase was primarily due to better than expected corporate earnings. Positive market and economic developments were partially offset by a persistently high unemployment rate, continued investor concerns about U.S. regulatory reform within the financial services industry, a sharp temporary decline in stock prices on May 6, 2010 (speculated to have been caused by high-speed electronic trading) and the continued sovereign debt crisis within the European region. Government and business spending increased, while certain sectors of the real estate market remained challenged. Consumer spending began to show signs of improvement toward the end of the year. Deficit reductions and balanced budgets remain critical items at the federal, state and local levels of government. The unemployment rate decreased to 9.4% at December 31, 2010 from 9.9% at December 31, 2009. The Federal Open Market Committee (“FOMC”) of the Board of Governors of the Federal Reserve System (the “Federal Reserve”) kept key interest rates at historically low levels, and at December 31, 2010, the federal funds target rate was between zero and 0.25%, and the discount rate was 0.75%. The FOMC pursued quantitative easing policies during 2010 and 2009, in which the FOMC purchased securities with the objective of improving economic conditions by increasing the money supply.

 

In Europe, equity market indices in the United Kingdom (“U.K.”) and Germany ended 2010 higher, while in France, they ended lower, as compared with the beginning of the year. Results in the European equity markets were impacted by adverse economic developments, including investor concerns about the outcome of regulatory stress testing of European banks and the sovereign debt crisis, especially in Greece and Ireland. Industrial output in the region was primarily driven by German exports. The euro area unemployment rate remained relatively unchanged at approximately 10% at December 31, 2010. At December 31, 2010, the European Central Bank’s benchmark interest rate was 1.00% and the Bank of England’s (“BOE”) benchmark interest rate was 0.50%. The BOE pursued quantitative easing policies during 2010 and 2009, in which the BOE purchased securities, including U.K. Government Gilts, with the objective of improving economic conditions by increasing the money supply.

 

In Asia, industrial output was driven by exports from both China and Japan. China’s economy also continued to benefit from government spending for capital projects, a significant amount of foreign currency reserves and a relatively high domestic savings rate. Equity markets in Hong Kong ended 2010 higher compared with the beginning of the year, while results in China and Japan were lower, as compared with the beginning of the year. During 2010, the People’s Bank of China raised the one-year yuan lending rate by 0.50% from 5.31% to 5.81%, and the one-year yuan deposit rate by 0.50% from 2.25% to 2.75% (on two separate occasions: 0.25% in October 2010 and 0.25% in December 2010). In February 2011, the People’s Bank of China raised the one-year yuan lending rate by 0.25% from 5.81% to 6.06% and the one-year yuan deposit rate by 0.25% from 2.75% to 3.00%.

 

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Overview of 2010 Financial Results.

 

Consolidated Review.    The Company recorded net income applicable to Morgan Stanley of $4,703 million in 2010, a 249% increase from $1,346 million in 2009.

 

Net revenues increased 35% to $31,622 million in 2010 from $23,434 million in 2009, primarily driven by the Institutional Securities business segment and MSSB. Net revenues in 2010 included negative revenues of $873 million due to the tightening of the Company’s credit spreads on certain of the Company’s long-term and short-term borrowings, primarily structured notes, for which the fair value option was elected, compared with negative revenues of $5,510 million in 2009 due to the tightening of the Company’s credit spreads on such borrowings. In addition, results for 2010 included a pre-tax gain of $668 million from the sale of the Company’s investment in China International Capital Corporation Limited (“CICC”). Non-interest expenses increased 13% to $25,420 million in 2010. Compensation and benefits expense increased 11% and non-compensation expenses increased 17%, primarily due to increased compensation costs and non-compensation costs in the Global Wealth Management Group business segment, primarily due to MSSB. The increase was also due to a charge of $272 million related to the U.K. government’s payroll tax on discretionary bonuses reflected in 2010 compensation and benefits expense. Diluted EPS were $2.63 in 2010 compared with $(0.77) in 2009. Diluted EPS from continuing operations were $2.44 in 2010 compared with $(0.82) in 2009.

 

The Company’s effective income tax rate from continuing operations was 11.9% in 2010. The effective tax rate for 2010 includes tax benefits of $382 million related to the reversal of U.S. deferred tax liabilities associated with prior-years’ undistributed earnings of certain non-U.S. subsidiaries that were determined to be indefinitely reinvested abroad, $345 million associated with the remeasurement of net unrecognized tax benefits and related interest based on new information regarding the status of federal and state examinations, and $277 million associated with the planned repatriation of non-U.S. earnings at a cost lower than originally estimated. Excluding the benefits noted above, the effective tax rate from continuing operations in 2010 would have been 28.0%. The annual effective tax rate in 2010 is reflective of the geographic mix of earnings.

 

The Company’s effective income tax rate from continuing operations was a benefit of 34.7% in 2009. The effective tax rate for 2009 includes a tax benefit of $331 million resulting from the cost of anticipated repatriation of non-U.S. earnings at lower than previously estimated tax rates. Excluding this benefit, the annual effective tax rate from continuing operations for 2009 would have been a benefit of 1.0%. The annual effective tax rate in 2009 is reflective of the geographic mix of earnings and includes tax benefits associated with the anticipated use of domestic tax credits and the utilization of state net operating losses.

 

Discontinued operations for 2010 included: a loss of $1.2 billion due to a writedown and related costs associated with the planned disposition of Revel Entertainment Group, LLC (“Revel”), a development stage enterprise and subsidiary of the Company that is primarily associated with a development property in Atlantic City, New Jersey; a gain of $775 million related to a legal settlement with Discover Financial Services (“DFS”); and an after-tax gain of approximately $570 million related to the Company’s sale of Retail Asset Management, including Van Kampen Investments, Inc. (“Van Kampen”), to Invesco.

 

Institutional Securities.    Income from continuing operations before income taxes was $4,338 million in 2010 compared with $1,088 million in 2009. Net revenues were $16,366 million in 2010 compared with $12,853 million in 2009. Investment banking revenues decreased 4%, reflecting lower revenues from equity underwriting and lower advisory fees from merger, acquisition and restructuring transactions, partially offset by higher revenues from fixed income underwriting. Investment banking revenues in 2010 were also impacted by the deconsolidation of the majority of the Company’s Japanese investment banking business as a result of the closing of the transaction between the Company and MUFG to form a joint venture in Japan (the “MUFG Transaction”) (see “Other Matters—Japan Securities Joint Venture” herein). Equity sales and trading revenues increased 31% to $4,840 million in 2010 from $3,690 million in 2009. Equity sales and trading revenues reflected negative revenue of approximately $121 million in 2010 due to the tightening of the Company’s credit spreads resulting

 

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from the increase in the fair value of certain of the Company’s long-term and short-term borrowings, primarily structured notes, for which the fair value option was elected, compared with negative revenues of approximately $1,738 million in 2009. Lower results in the cash and derivatives businesses in 2010 reflected solid customer flows offset by a challenging trading environment. Fixed income sales and trading revenues in 2010 increased 21% to $5,867 million in 2010 from $4,854 million in 2009. Fixed income sales and trading revenues reflected negative revenues of approximately $703 million in 2010 due to the tightening of the Company’s credit spreads resulting from the increase in the fair value of certain of the Company’s long-term and short-term borrowings, primarily structured notes, for which the fair value option was elected compared with negative revenues of approximately $3,321 million in 2009. Interest rate and currency product revenues decreased 38% in 2010 reflecting lower trading results across most businesses. Results for 2010 primarily reflected solid customer flows in interest rate, credit and currency products, which were partly offset by a challenging trading environment. Principal transaction net investment gains of $809 million were recognized in 2010 compared with net investment losses of $864 million in 2009. Non-interest expenses increased 2% to $12,028 million in 2010 from $11,765 million in 2009. Compensation and benefits expenses decreased 2% in 2010.

 

Global Wealth Management Group.    Income from continuing operations before income taxes was $1,156 million in 2010 compared with $559 million in 2009. Net revenues were $12,636 million compared with $9,390 million in 2009. Investment banking revenues increased 39% in 2010, primarily benefiting from a full year of MSSB and higher closed-end fund activity. Principal transactions trading revenues increased 8% in 2010, primarily benefiting from a full year of MSSB, net gains related to investments associated with certain employee deferred compensation plans and gains on certain investments. Commission revenues increased 28% in 2010, primarily benefiting from a full year of MSSB and higher client activity. Asset management, distribution and administration fees increased 39% in 2010 benefiting from a full year of MSSB and improved market conditions. Net interest increased 70% in 2010 primarily resulting from an increase in interest income benefiting from a full year of MSSB, the Securities Available for Sale (“AFS”) portfolio and the change in classification of the bank deposit program, partially offset by increased funding costs (see “Global Wealth Management Group—Asset Management, Distribution and Administration Fees” herein). Non-interest expenses were $11,480 million in 2010 compared with $8,831 million in 2009.

 

Asset Management.    Income from continuing operations before income taxes was $723 million in 2010 compared with a loss of $653 million in 2009. Net revenues were $2,723 million in 2010 compared with $1,337 million in 2009. The Company recorded principal transactions net investment gains of $996 million in 2010 compared with losses of $173 million in 2009. Non-interest expenses were $2,000 million in 2010 compared with $1,990 million in 2009.

 

Significant Items.

 

Mortgage-Related Trading.    The Company recorded mortgage-related trading gains (losses) primarily related to commercial mortgage-backed securities, commercial whole loan positions, U.S. subprime mortgage proprietary trading exposures and non-subprime residential mortgages of $1.2 billion, $(0.6) billion, $(2.6) billion and $(0.1) billion in 2010, 2009, fiscal 2008 and the one month ended December 31, 2008, respectively.

 

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Real Estate Investments.    The Company recorded gains (losses) in the following business segments related to real estate investments. These amounts exclude investments associated with certain deferred compensation and employee co-investment plans.

 

     2010     2009     Fiscal
2008
    One Month
Ended
December 31,
2008
 
     (dollars in billions)  

Institutional Securities

        

Continuing operations(1)

   $ 0.2     $ (0.8   $ (1.2   $ (0.1

Discontinued operations(2)

     (1.2     —          —          —     
                                

Total Institutional Securities

     (1.0     (0.8     (1.2     (0.1

Asset Management:

        

Continuing operations(3)

     0.5       (0.5     (0.6     —     

Discontinued operations(2)

     —          (0.6     (0.5     —     
                                

Total Asset Management

     0.5       (1.1     (1.1     —     

Amounts applicable to noncontrolling interests

     0.5       —          —          —     
                                

Total

   $ (1.0   $ (1.9   $ (2.3   $ (0.1
                                

(1) Gains (losses) related to net realized and unrealized gains (losses) from the Company’s limited partnership investments in real estate funds and are reflected in Principal transactions—Investments in the consolidated statements of income.
(2) On March 31, 2010, the Board of Directors authorized a plan of disposal by sale for Revel. The results of Revel, including the estimated loss from the planned disposal, are reported as discontinued operations for all periods presented within the Institutional Securities business segment. In the Asset Management business segment, amounts related to the disposition of Crescent Real Estate Equities Limited Partnership (“Crescent”), which was disposed in the fourth quarter of 2009 (see Note 1 to the consolidated financial statements).
(3) Gains (losses) related to net realized and unrealized gains (losses) from real estate investments in the Company’s merchant banking business and are reflected in Principal transactions—Investments in the consolidated statements of income.

 

See “Other Matters—Real Estate” herein for further information.

 

Income Tax Benefit.    The Company recognized tax benefits of $382 million related to the reversal of U.S. deferred tax liabilities associated with prior-years’ undistributed earnings of certain non-U.S. subsidiaries that were determined to be indefinitely reinvested abroad, $345 million associated with the remeasurement of net unrecognized tax benefits and related interest based on new information regarding the status of federal and state examinations, and $277 million associated with the planned repatriation of non-U.S. earnings at a cost lower than originally estimated. The Company recognized a tax benefit of $331 million in 2009, resulting from the cost of anticipated repatriation of non-U.S. earnings at lower than previously estimated tax rates.

 

Morgan Stanley Debt.    Net revenues reflected negative revenues of $873 million, $5.5 billion and $0.2 billion in 2010, 2009 and the one month ended December 31, 2008, respectively, from the tightening of the Company’s credit spreads, and gains of $5.6 billion in fiscal 2008 from the widening of the Company’s credit spreads on certain long-term and short-term borrowings, including structured notes and junior subordinated debentures that are accounted for at fair value.

 

In addition, in 2009, fiscal 2008 and the one month ended December 31, 2008, the Company recorded gains of approximately $491 million, $2.3 billion and $73 million, respectively, from repurchasing its debt in the open market. In fiscal 2008, the Company also recorded mark-to-market gains of approximately $1.4 billion on certain swaps previously designated as hedges of a portion of the Company’s long-term debt. These swaps were no longer considered hedges once the related debt was repurchased by the Company (i.e., the swaps were “de-designated” as hedges). During the period the swaps were hedging the debt, changes in fair value of these instruments were generally offset by adjustments to the basis of the debt being hedged.

 

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Monoline Insurers.    Monoline insurers (“Monolines”) provide credit enhancement to capital markets transactions. The current credit environment continues to affect the ability of such financial guarantors to provide enhancement to existing capital market transactions. The Company’s direct exposure to Monolines is limited to bonds that are insured by Monolines and to derivative contracts with a Monoline as counterparty (principally an affiliate of MBIA Inc. (“MBIA”)).

 

The Company’s exposure to Monolines at December 31, 2010 includes $1.5 billion in insured municipal bond securities and $326 million of mortgage and asset-backed securities enhanced by financial guarantees. Excluding MBIA, derivative counterparty exposure includes gross exposures of approximately $440 million, net of cumulative credit valuation adjustments and hedges. The positive net derivative counterparty exposure (the sum of net long positions for each individual counterparty) was insignificant at December 31, 2010. Positive net derivative counterparty exposure is defined as potential loss to the Company over a period of time in an event of 100% default of a Monoline, assuming zero recovery. Amounts related to MBIA derivative counterparty exposure are not included in the above amounts since, at December 31, 2010, the aggregate value of cumulative credit valuation adjustments and hedges exceeded the amount of gross exposure of $4.2 billion by $1.1 billion.

 

The results for 2010 included losses of $865 million related to the Company’s Monoline counterparty credit exposures, principally MBIA, compared with losses of $232 million, $1.7 billion and $203 million in 2009, fiscal 2008 and the one month ended December 31, 2008, respectively. The Company’s hedging program for Monoline counterparty exposure continues to become more costly and difficult to effect, and, as such, the losses in 2010 reflected those additional costs as well as volatility on those hedges caused by the tightening of both MBIA and commercial mortgage-backed spreads. The Company proactively manages its Monoline exposure; however, as market conditions continue to evolve, significant additional losses could be incurred. The Company’s hedging program includes the use of single name and index transactions that mitigate credit exposure to the Monolines as well as certain market risk components of existing underlying commercial mortgage-backed securities transactions with the Monolines and is conducted as part of the Company’s overall market risk management. See “Qualitative and Quantitative Disclosure about Market Risk—Risk Management—Market Risk” in Part II, Item 7A herein.

 

Settlement with DFS.    On June 30, 2007, the Company completed the spin-off of its business segment DFS to its shareholders. On February 11, 2010, DFS paid the Company $775 million in complete satisfaction of its obligations to the Company regarding the sharing of proceeds from a lawsuit against Visa and MasterCard. The payment was recorded as a gain in discontinued operations in the consolidated statement of income for 2010.

 

Gain on Sale of Noncontrolling Interest.    In connection with the MUFG Transaction (see “Other Matters—Japan Securities Joint Venture” herein), the Company recorded an after-tax gain of $731 million from the sale of a noncontrolling interest in its Japanese institutional securities business. This gain was recorded in Paid-in capital in the Company’s consolidated statements of financial condition at December 31, 2010 and changes in total equity for 2010.

 

Gain on Sale of Retail Asset Management.    On June 1, 2010, the Company completed the sale of Retail Asset Management, including Van Kampen, to Invesco. The Company received $800 million in cash and approximately 30.9 million shares of Invesco stock upon sale, resulting in a cumulative after-tax gain of $682 million, of which $570 million was recorded in 2010. The remaining gain, representing tax basis benefits, was recorded in the quarter ended December 31, 2009. The results of Retail Asset Management are reported as discontinued operations within the Asset Management business segment for all periods presented through the date of divestiture. The Company recorded the 30.9 million shares as securities available for sale. In November 2010, the Company sold its investment in Invesco, resulting in a realized gain of approximately $102 million reported within Other revenues in the consolidated statement of income for 2010.

 

Sale of Stake in CICC.    In December 2010, the Company completed the sale of its 34.3% stake in CICC for a pre-tax gain of approximately $668 million, which is included within Other revenues in the consolidated statement of income for 2010. See Note 24 to the consolidated financial statements.

 

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Corporate Lending.    The Company recorded the following amounts primarily associated with loans and lending commitments carried at fair value within the Institutional Securities business segment:

 

     2010(1)     2009(1)     Fiscal
2008(1)
    One Month
Ended
December 31,
2008(1)
 
     (dollars in billions)  

Gains (losses) on loans and lending commitments

   $ 0.3     $ 4.0     $ (6.3   $ (0.5

Gains (losses) on hedges

     (0.7     (3.2     3.0       (0.1
                                

Total gains (losses)

   $ (0.4   $ 0.8     $ (3.3   $ (0.6
                                

(1) Amounts include realized and unrealized gains (losses).

 

U.K. Tax.    During 2010, the Company recognized a charge of approximately $272 million in Compensation and benefits expense representing the final amount paid relating to the U.K. government’s payroll tax on discretionary above-base compensation.

 

OIS Fair Value Measurement.    In the fourth quarter of 2010, the Company began using the overnight indexed swap (“OIS”) curve as an input to value substantially all of its collateralized interest rate derivative contracts. The Company believes using the OIS curve, which reflects the interest rate typically paid on cash collateral, more accurately reflects the fair value of collateralized interest rate derivative contracts. The Company recognized a pre-tax gain of approximately $176 million in Principal transactions—Trading upon application of the OIS curve within the Institutional Securities business segment. Previously, the Company discounted these collateralized interest rate derivative contracts based on London Interbank Offered Rate (“LIBOR”).

 

Goodwill and Intangibles.    Impairment charges related to goodwill and intangible assets were $201 million, $16 million and $725 million in 2010, 2009 and fiscal 2008, respectively (see Note 9 to the consolidated financial statements). The impairment charges for 2010 included $193 million related to FrontPoint Partners LLC (“FrontPoint”), as described below.

 

FrontPoint.    In 2010, the Company reached an agreement with the principals of FrontPoint, whereby FrontPoint senior management and portfolio managers will own a majority equity stake in FrontPoint, and the Company will retain a minority stake. FrontPoint will replace the Company’s affiliates as the investment advisor and general partner of the FrontPoint funds. The Company expects this transaction to close in the first quarter of 2011, subject to closing conditions. The Company recorded impairment charges of approximately $126 million related to the transaction in 2010, which were included in Other revenues in the consolidated statement of income.

 

In addition, the Company recorded approximately $67 million related to the writedown of certain intangible assets in 2010, included in Other expenses in the consolidated statement of income.

 

MSCI.    In May 2009, the Company divested all of its remaining ownership interest in MSCI Inc. (“MSCI”). The gain on sale, net of taxes, was approximately $279 million and $895 million, related to the secondary offerings, for 2009 and fiscal 2008, respectively. The results of MSCI are reported as discontinued operations for all periods presented through the date of divestiture. The results of MSCI were formerly included in the continuing operations of the Institutional Securities business segment.

 

Sale of Bankruptcy Claims.    In 2009, the Company recorded a gain of $319 million related to the sale of undivided participating interests in a portion of the Company’s claims against a derivative counterparty that filed for bankruptcy protection (see Note 18 to the consolidated financial statements).

 

Structured Investment Vehicles.    The Company recognized gains of $164 million in 2009 and losses of $470 million and $84 million in fiscal 2008 and the one month ended December 31, 2008, respectively, related to securities issued by structured investment vehicles (“SIV”). The gains were recorded in the Asset Management business segment.

 

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Subsidiary Banks.    The Company recorded losses of approximately $70 million, gains of approximately $140 million and losses of approximately $900 million in 2010, 2009 and fiscal 2008, respectively, related to securities portfolios in the Company’s domestic subsidiary banks, Morgan Stanley Bank, N.A. and Morgan Stanley Private Bank, National Association (formerly, Morgan Stanley Trust FSB) (the “Subsidiary Banks”).

 

ARS.    Under the terms of various agreements entered into with government agencies and the terms of the Company’s announced offer to repurchase, the Company agreed to repurchase at par certain Auction Rate Securities (“ARS”) held by retail clients that were purchased through the Company. In addition, the Company agreed to reimburse retail clients who have sold certain ARS purchased through the Company at a loss. Fiscal 2008 reflected charges of $532 million for the ARS repurchase program and writedowns of $108 million associated with ARS held in inventory.

 

Sales of Subsidiaries and Other Items.    Results for fiscal 2008 included a pre-tax gain of $687 million related to the sale of MSWM S.V. (see Note 19 to the consolidated financial statements).

 

Business Segments.

 

Substantially all of the Company’s operating revenues and operating expenses can be directly attributed to its business segments. Certain revenues and expenses have been allocated to each business segment, generally in proportion to its respective revenues or other relevant measures.

 

As a result of treating certain intersegment transactions as transactions with external parties, the Company includes an Intersegment Eliminations category to reconcile the business segment results to the Company’s consolidated results. Income before taxes in Intersegment Eliminations primarily represents the effect of timing differences associated with the revenue and expense recognition of commissions paid by the Asset Management business segment to the Global Wealth Management Group business segment associated with sales of certain products and the related compensation costs paid to the Global Wealth Management Group business segment’s global representatives. Intersegment Eliminations also reflect the effect of fees paid by the Institutional Securities business segment to the Global Wealth Management Group business segment related to the bank deposit program. Losses from continuing operations before income taxes recorded in Intersegment Eliminations were $15 million, $11 million, $17 million and $1 million in 2010, 2009, fiscal 2008 and the one month ended December 31, 2008, respectively.

 

From June 2009 until April 1, 2010, in the Global Wealth Management Group business segment, revenues in the bank deposit program were primarily included in Asset management, distribution and administration fees. Prior to June 2009, these revenues were previously reported in Interest income. The change was the result of agreements that were entered into in connection with the MSSB transaction. Beginning on April 1, 2010, revenues in the bank deposit program held at the Company’s depository institutions are recorded as Interest income, due to renegotiations of the revenue sharing agreement as part of the Global Wealth Management Group business segment’s retail banking strategy. The Global Wealth Management Group business segment will continue to earn referral fees for deposits placed with Citi depository institutions, and these fees will continue to be recorded in Asset management, distribution and administration fees until the legacy Smith Barney deposits are migrated to the Company’s depository institutions.

 

Effective January 1, 2010, certain transfer pricing arrangements between the Global Wealth Management Group business segment and the Institutional Securities business segment relating to Global Wealth Management Group business segment’s fixed income trading activities were modified to conform to agreements with Citi in connection with MSSB.

 

In addition, with an effective date of January 1, 2010, the Global Wealth Management Group business segment sold approximately $3 billion of ARS to the Institutional Securities business segment at book value.

 

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The Company changed the allocation methodology in the Institutional Securities business segment for funding costs centrally managed by the Company’s Treasury Department between equity and fixed income sales and trading to more accurately reflect business activity. Effective January 1, 2010, funding costs were allocated 35% to equity sales and trading and 65% to fixed income sales and trading. Prior to January 1, 2010, funding costs were allocated 20% and 80% to equity and fixed income sales and trading, respectively. The Company regularly evaluates the appropriateness of funding cost allocations with respect to business activities and may, in the future, modify further the allocation percentages.

 

Effective January 1, 2010, in the Institutional Securities business segment, Equity sales and trading revenues include Asset management, distribution and administration fees as these fees relate to administrative services primarily provided to the Company’s prime brokerage clients and, therefore, closely align to equity sales and trading revenues. Prior periods have been adjusted to conform to the current presentation.

 

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INSTITUTIONAL SECURITIES

 

INCOME STATEMENT INFORMATION

 

     2010     2009     Fiscal
2008
    One Month
Ended
December 31,
2008
 
     (dollars in millions)  

Revenues:

        

Investment banking

   $ 4,295     $ 4,455     $ 3,630     $ 177  

Principal transactions:

        

Trading

     8,154       6,591       5,897       (1,462

Investments

     809       (864     (2,461     (158

Commissions

     2,274       2,152       3,094       127  

Asset management, distribution and administration fees

     104       98       142       10  

Other

     996       545       2,722       91  
                                

Total non-interest revenues

     16,632       12,977       13,024       (1,215
                                

Interest income

     5,877       6,373       37,604       1,017  

Interest expense

     6,143       6,497       35,860       1,124  
                                

Net interest

     (266     (124     1,744       (107
                                

Net revenues

     16,366       12,853       14,768       (1,322
                                

Compensation and benefits

     7,081       7,212       7,084       280  

Non-compensation expenses

     4,947       4,553       6,144       395  
                                

Total non-interest expenses

     12,028       11,765       13,228       675  
                                

Income (loss) from continuing operations before income taxes

     4,338       1,088       1,540       (1,997

Provision for (benefit from) income taxes

     301       (301     149       (726
                                

Income (loss) from continuing operations

     4,037       1,389       1,391       (1,271
                                

Discontinued operations:

        

Gain (loss) from discontinued operations

     (1,175     396       1,460       (20

Provision for (benefit from) income taxes

     26       229       575       (1
                                

Net gain (loss) on discontinued operations

     (1,201     167       885       (19
                                

Net income (loss)

     2,836       1,556       2,276       (1,290
                                

Net income applicable to noncontrolling interests

     290       12       71       3  
                                

Net income (loss) applicable to Morgan Stanley

   $ 2,546     $ 1,544     $ 2,205     $ (1,293
                                

Amounts applicable to Morgan Stanley:

        

Income (loss) from continuing operations

   $ 3,747     $ 1,393     $ 1,358     $ (1,271

Net gain (loss) from discontinued operations

     (1,201     151       847       (22
                                

Net income (loss) applicable to Morgan Stanley

   $ 2,546     $ 1,544     $ 2,205     $ (1,293
                                

 

In the third quarter of 2010, the Company completed the disposal of CityMortgage Bank (“CMB”), a Moscow-based mortgage bank. Results for CMB are reported as discontinued operations for all periods presented through the date of disposal within the Institutional Securities business segment.

 

On March 31, 2010, the Board authorized a plan of disposal by sale for Revel. The results of Revel are reported as discontinued operations for all periods presented within the Institutional Securities business segment. Results for 2010 include a loss of approximately $1.2 billion in connection with writedowns and related costs of such planned disposition.

 

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Supplemental Financial Information.

 

Investment Banking.

 

Investment banking revenues are composed of fees from advisory services and revenues from the underwriting of securities offerings and syndication of loans, net of syndication expenses.

 

Investment banking revenues were as follows:

 

     2010      2009(1)      Fiscal
2008
     One Month
Ended
December 31,
2008
 
     (dollars in millions)  

Advisory fees from merger, acquisition and restructuring transactions

   $ 1,470      $ 1,488      $ 1,740      $ 68  

Equity underwriting revenues

     1,454        1,695        1,045        47  

Fixed income underwriting revenues

     1,371        1,272        845        62  
                                   

Total investment banking revenues

   $ 4,295      $ 4,455      $ 3,630      $ 177  
                                   

(1) All prior-period amounts have been reclassified to conform to the current period’s presentation.

 

Sales and Trading.

 

Sales and trading revenues are composed of Principal transactions—Trading revenues; Commissions; Asset management, distribution and administration fees; and Net interest revenues (expenses). In assessing the profitability of its sales and trading activities, the Company views Principal transactions—Trading; Commissions; Asset management, distribution and administration fees; and Net interest revenues (expenses) in the aggregate. In addition, decisions relating to principal transactions are based on an overall review of aggregate revenues and costs associated with each transaction or series of transactions. This review includes, among other things, an assessment of the potential gain or loss associated with a transaction, including any associated commissions, dividends, the interest income or expense associated with financing or hedging the Company’s positions, and other related expenses.

 

Sales and trading revenues were as follows:

 

     2010     2009(1)     Fiscal
2008(1)
     One Month
Ended
December 31,
2008(1)
 
     (dollars in millions)  

Principal transactions—Trading

   $ 8,154     $ 6,591     $ 5,897      $ (1,462

Commissions

     2,274       2,152       3,094        127  

Asset management, distribution and administration fees

     104       98       142        10  

Net interest

     (266     (124     1,744        (107
                                 

Total sales and trading revenues

   $ 10,266     $ 8,717     $ 10,877      $ (1,432
                                 

(1) All prior-period amounts have been reclassified to conform to the current period’s presentation. See “Business Segments” and “Other Matters—Dividend Income” herein for further information.

 

The components of the Company’s sales and trading revenues are as follows:

 

Principal Transactions—Trading. Principal transactions—Trading revenues include revenues from customers’ purchases and sales of financial instruments in which the Company acts as principal and gains and losses on the Company’s positions, as well as proprietary trading activities for its own account.

 

Commissions. Commission revenues primarily arise from agency transactions in listed and over-the-counter (“OTC”) equity securities and options.

 

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Asset Management, Distribution and Administration Fees. Asset management, distribution and administration fees include fees associated with administrative services primarily provided to the Company’s prime brokerage clients.

 

Net Interest. Interest income and Interest expense are a function of the level and mix of total assets and liabilities, including financial instruments owned and financial instruments sold, not yet purchased, reverse repurchase and repurchase agreements, trading strategies, customer activity in the Company’s prime brokerage business, and the prevailing level, term structure and volatility of interest rates. Certain Securities purchased under agreements to resell (“reverse repurchase agreements”) and Securities sold under agreements to repurchase (“repurchase agreements”) and Securities borrowed and Securities loaned transactions may be entered into with different customers using the same underlying securities, thereby generating a spread between the interest revenue on the reverse repurchase agreements or securities borrowed transactions and the interest expense on the repurchase agreements or securities loaned transactions.

 

Sales and trading revenues by business were as follows:

 

     2010     2009(1)      Fiscal
2008(1)
    One Month
Ended
December 31,
2008(1)
 
     (dollars in millions)  

Equity

   $ 4,840     $ 3,690      $ 9,881     $ (11

Fixed income

     5,867       4,854        4,115       (858

Other(2)

     (441     173        (3,119     (563
                                 

Total sales and trading revenues

   $ 10,266     $ 8,717      $ 10,877     $ (1,432
                                 

(1) All prior-period amounts have been reclassified to conform to the current period’s presentation.
(2) Other sales and trading net revenues primarily included net gains (losses) from loans and lending commitments and related hedges associated with the Company’s lending and other corporate activities. Other sales and trading net revenues also included net losses associated with costs related to the amount of liquidity (“negative carry”) in the Subsidiary Banks.

 

2010 Compared with 2009.

 

Investment Banking.    Investment banking revenues decreased 4% in 2010 from 2009, reflecting lower revenues from equity underwriting and lower advisory fees from merger, acquisition and restructuring transactions, partially offset by higher revenues from fixed income underwriting. Investment banking revenues in 2010 were also impacted by the deconsolidation of the majority of the Company’s Japanese investment banking business as a result of the MUFG Transaction (see “Other Matters—Japan Securities Joint Venture” herein). Overall, underwriting revenues of $2,825 million decreased 5% from 2009. Equity underwriting revenues decreased 14% to $1,454 million, primarily due to lower market volume. Fixed income underwriting revenues increased 8% to $1,371 million, primarily due to increased high-yield issuance volumes and higher loan syndication fees. Advisory fees from merger, acquisition and restructuring transactions were $1,470 million, a decrease of 1% from 2009.

 

Sales and Trading Revenues.    Total sales and trading revenues increased 18% in 2010 from 2009, reflecting higher equity and fixed income sales and trading revenues, partially offset by losses in other sales and trading.

 

Equity.    Equity sales and trading revenues increased 31% to $4,840 million in 2010 from $3,690 million in 2009. Equity sales and trading revenues reflected negative revenues of approximately $121 million in 2010 due to the tightening of the Company’s credit spreads resulting from the increase in the fair value of certain of the Company’s long-term and short-term borrowings, primarily structured notes, for which the fair value option was elected compared with negative revenues of approximately $1,738 million in 2009. Despite solid customer flows, a challenging trading environment resulted in lower revenues in the cash and derivatives businesses in 2010. Results in 2010 reflected higher revenues in prime brokerage due to higher client balances compared with 2009.

 

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In 2010, equity sales and trading revenues also reflected unrealized gains of approximately $20 million related to changes in the fair value of net derivative contracts attributable to the tightening of counterparties’ credit default swap spreads compared with unrealized gains of approximately $198 million in 2009. The Company also recorded unrealized gains of $31 million in 2010 related to changes in the fair value of net derivative contracts attributable to the widening of the Company’s credit default swap spreads compared with unrealized losses of approximately $154 million in 2009 from the tightening of the Company’s credit default swap spreads. The unrealized gains and losses on credit default swap spreads do not reflect any gains or losses on related hedging instruments.

 

Fixed Income.    Fixed income sales and trading revenues increased 21% to $5,867 million in 2010 from $4,854 million in 2009. Results in 2010 included negative revenues of approximately $703 million due to the tightening of the Company’s credit spreads resulting from the increase in the fair value of certain of the Company’s long-term and short-term borrowings, primarily structured notes, for which the fair value option was elected compared with negative revenues of approximately $3,321 million in 2009. Interest rate, credit and currency product revenues decreased 38% in 2010, reflecting lower trading results across most businesses. Results for 2010 primarily reflected solid customer flows in interest rate, credit and currency products, which were partly offset by a challenging trading environment. Interest rate, credit and currency product net revenues in 2010 were also negatively impacted by losses of $865 million from Monolines compared with losses of $232 million in 2009. Results in interest rate, credit and currency products also included a gain of approximately $123 million related to a change in the fair value measurement methodology to use the OIS curve as an input to value substantially all collateralized interest rate derivative contracts (see “Overview of 2010 Financial Results—Significant Items—OIS Fair Value Measurement” herein and Note 4 to the consolidated financial statements). Commodity net revenues decreased 27% in 2010, primarily due to low levels of client activity and market volatility. Results in 2009 included a gain of approximately $319 million related to the sale of undivided participating interests in a portion of the Company’s claims against a derivative counterparty that filed for bankruptcy protection (see Note 18 to the consolidated financial statements).

 

In 2010, fixed income sales and trading revenues reflected net unrealized gains of $603 million related to changes in the fair value of net derivative contracts attributable to the tightening of counterparties’ credit default swap spreads compared with unrealized gains of approximately $3,462 million in 2009. The Company also recorded unrealized gains of $287 million in 2010 related to changes in the fair value of net derivative contracts attributable to the widening of the Company’s credit default swap spreads compared with unrealized losses of approximately $1,938 million in 2009 from the tightening of the Company’s credit default swap spreads. The unrealized gains and losses on credit default swap spreads do not reflect any gains or losses on related hedging instruments.

 

Other.    In addition to the equity and fixed income sales and trading revenues discussed above, sales and trading revenues included other trading revenues, consisting primarily of certain activities associated with the Company’s corporate activities. In connection with its corporate lending activities, the Company provides to select clients loans or lending commitments (including bridge financing) that are generally classified as either “event-driven” or “relationship-driven.” “Event-driven” loans and lending commitments refer to activities associated with a particular event or transaction, such as to support client merger, acquisition or recapitalization transactions. “Relationship-driven” loans and lending commitments are generally made to expand business relationships with select clients. For further information about the Company’s corporate lending activities, see Item 7A, “Quantitative and Qualitative Disclosures about Market Risk—Credit Risk” herein. The fair value measurement of loans and lending commitments takes into account fee income that is considered an attribute of the contract. The valuation of these commitments could change in future periods depending on, among other things, the extent that they are renegotiated or repriced or if the associated acquisition transaction does not occur. Other sales and trading also includes costs related to negative carry.

 

In 2010, other sales and trading net revenues reflected a net loss of $441 million compared with net gains of $173 million in 2009. Results in 2010 primarily included net losses of approximately $342 million (mark-to-market

 

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valuations and realized gains of approximately $327 million offset by losses on related hedges of approximately $669 million) associated with loans and lending commitments and the costs related to negative carry in the Subsidiary Banks. Results in 2009 included net gains of approximately $804 million (mark-to-market valuations and realized gains of approximately $4,042 million, partially offset by losses on related hedges of approximately $3,238 million) associated with loans and lending commitments. Results in 2009 also included losses of $362 million, reflecting the improvement in the Company’s debt-related credit spreads on certain debt related to China Investment Corporation’s (“CIC”) investment in the Company. Results in 2010 also included a gain of approximately $53 million related to the OIS curve fair value methodology referred to above (see “Overview of 2010 Financial Results—Significant Items—OIS Fair Value Measurement” and Note 4 to the consolidated financial statements).

 

Principal Transactions—Investments.    The Company’s investments generally are held for long-term appreciation and generally are subject to significant sales restrictions. Estimates of the fair value of the investments may involve significant judgment and may fluctuate significantly over time in light of business, market, economic and financial conditions generally or in relation to specific transactions.

 

Principal transaction net investment gains of $809 million were recognized in 2010 compared with net investment losses of $864 million in 2009. The results for 2010 reflected a gain of $313 million on a principal investment held by a consolidated investment partnership, which was sold in 2010. The portion of the gain related to third-party investors amounted to $183 million and was recorded in the net income applicable to noncontrolling interests in the consolidated statement of income. The results in 2010 also reflected gains on principal investments in real estate funds and investments associated with certain employee deferred compensation and co-investment plans compared with losses on such investments in 2009.

 

Other.    Other revenues increased 83% in 2010, primarily reflecting a pre-tax gain of $668 million from the sale of the Company’s investment in CICC. Results in 2009 included gains of approximately $465 million from the Company’s repurchase of its debt in the open market.

 

Non-interest Expenses.    Non-interest expenses increased 2% in 2010, primarily due to higher non-compensation expenses, partially offset by lower compensation expense. Compensation and benefits expenses decreased 2% in 2010, primarily due to lower net revenues, excluding the impact of negative revenues related to the Company’s debt-related credit spreads. Compensation and benefits expenses in 2010 included a charge of approximately $269 million related to the U.K. government’s payroll tax on discretionary above-base compensation. Non-compensation expenses increased 9% in 2010. Brokerage and clearing expense increased 18% in 2010, primarily due to higher levels of business activity. Information processing and communications expense increased 12% in 2010, primarily due to ongoing investments in technology. Marketing and business development expense increased 35% in 2010, primarily due to higher levels of business activity. Professional services expense increased 9% in 2010, primarily due to higher technology consulting expenses and higher legal fees. Other expenses decreased 6% in 2010, primarily related to insurance recoveries reflected in 2010 and a loss provision in deferred compensation plans reflected in 2009. The decrease in 2010 was partially offset by higher provisions for litigation and regulatory proceedings, including $102.7 million related to the Assurance of Discontinuance that was entered into on June 24, 2010 between the Company and the Office of the Attorney General for the Commonwealth of Massachusetts (“Massachusetts OAG”) to resolve the Massachusetts OAG’s investigation of the Company’s financing, purchase and securitization of certain subprime residential mortgages.

 

2009 Compared with Fiscal 2008.

 

Investment banking revenues increased 23% in 2009 from fiscal 2008, as higher revenues from equity and fixed income underwriting transactions were partially offset by lower advisory revenues. Underwriting revenues of $2,967 million increased 57% from fiscal 2008, reflecting higher levels of market activity, as equity underwriting revenues increased 62% to $1,695 million and fixed income underwriting revenues increased 51% to $1,272 million. Underwriting fees in 2009 reflected a significant increase in market activity from 2008 levels, which

 

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were affected by unprecedented market turmoil and challenging market conditions. In 2009, advisory fees from merger, acquisition and restructuring transactions were $1,488 million, a decrease of 14% from fiscal 2008, reflecting lower levels of market activity.

 

Total sales and trading revenues decreased 20% in 2009 from fiscal 2008, reflecting lower equity sales and trading revenues, partially offset by higher other sales and trading revenues and by higher fixed income sales and trading revenues.

 

Equity sales and trading revenues decreased 63% to $3,690 million in 2009 from fiscal 2008. The decrease in 2009 was primarily due to a significant reduction in net revenues from derivative products and equity cash products, reflecting lower levels of market volume and market volatility, reduced levels of client activity and lower average prime brokerage client balances. Equity sales and trading revenues reflected losses of $1,738 million due to the tightening of the Company’s credit spreads during 2009 resulting from the increase in the fair value of certain of the Company’s long-term and short-term borrowings, primarily structured notes, for which the fair value option was elected compared with a benefit of approximately $1,604 million in fiscal 2008 related to the widening of the Company’s credit spreads.

 

In 2009, equity sales and trading revenues also reflected unrealized gains of approximately $198 million related to changes in the fair value of net derivative contracts attributable to the tightening of counterparties’ credit default swap spreads compared with losses of $300 million in fiscal 2008 related to the widening of counterparties’ credit default swap spreads. The Company also recorded unrealized losses of approximately $154 million in 2009 related to changes in the fair value of net derivative contracts attributable to the tightening of the Company’s credit default swap spreads compared with gains of $125 million in fiscal 2008 related to the widening of the Company’s credit default swap spreads. The unrealized losses and gains do not reflect any gains or losses on related hedging instruments.

 

Fixed income sales and trading revenues increased 18% to $4,854 million in 2009 from fiscal 2008. Interest rate, currency and credit products net revenues increased 127% in 2009, primarily due to strong investment grade and distressed debt trading results, partly offset by lower levels of client activity. Results in 2009 also included a gain of $319 million related to the sale of undivided participating interests in a portion of the Company’s claims against a derivative counterparty that filed for bankruptcy protection. Commodity net revenues decreased 31% in 2009, primarily reflecting reduced levels of client activity and unfavorable market conditions.

 

In 2009, fixed income sales and trading revenues reflected net unrealized gains of approximately $3,462 million related to changes in the fair value of net derivative contracts attributable to the tightening of counterparties’ credit default swap spreads compared with unrealized losses of approximately $6,560 million in fiscal 2008 related to the widening of counterparties’ credit default swap spreads. The Company also recorded unrealized losses of approximately $1,938 million in 2009, related to changes in the fair value of net derivative contracts attributable to the tightening of the Company’s credit default swap spreads compared with unrealized gains of approximately $1,968 million in fiscal 2008 related to the widening of the Company’s credit default swap spreads. The unrealized losses and gains on credit default swap spreads do not reflect any gains or losses on related hedging instruments.

 

In addition, fixed income sales and trading revenues in 2009 were negatively impacted by losses of approximately $3,321 million from the tightening of the Company’s credit spreads resulting from the increase in the fair value of certain of the Company’s long-term and short-term borrowings, primarily structured notes, for which the fair value option was elected. Fiscal 2008 reflected a benefit of approximately $3,524 million due to the widening of the Company’s credit spreads on such borrowings.

 

In 2009, other sales and trading net revenues reflected net gains of $173 million compared with net losses of $3,119 million in fiscal 2008. Results for 2009 included net gains of $804 million (mark-to-market valuations and realized gains of $4,042 million, partially offset by losses on related hedges of $3,238 million) associated

 

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with loans and lending commitments. Results for fiscal 2008 included net losses of $3,335 million (negative mark-to-market valuations and losses of $6,311 million, net of gains on related hedges of $2,976 million) associated with loans and lending commitments largely related to certain “event-driven” lending to non-investment grade companies. Results in 2009 also included losses of $362 million, reflecting the improvement in the Company’s debt-related credit spreads on certain debt related to CIC’s investment in the Company compared with gains of $387 million in fiscal 2008.

 

In fiscal 2008, other sales and trading revenues also included writedowns of securities of approximately $1.2 billion in the Company’s Subsidiary Banks and mark-to-market gains of approximately $1.4 billion on certain swaps previously designated as hedges of a portion of the Company’s long-term debt. These swaps were no longer considered hedges once the related debt was repurchased by the Company.

 

Principal transactions net investment losses of $864 million were recognized in 2009 as compared with net investment losses of $2,461 million in fiscal 2008. The losses were primarily related to net realized and unrealized losses from the Company’s limited partnership investments in real estate funds and investments associated with certain employee deferred compensation and co-investment plans.

 

Other revenues decreased 80% in 2009 compared with fiscal 2008. During 2009, the Company recorded gains of approximately $465 million from the Company’s repurchase of debt in the open market compared with approximately $2.1 billion in fiscal 2008 (see “Significant Items—Morgan Stanley Debt” herein for further discussion).

 

Non-interest expenses decreased 11% in 2009, primarily due to lower non-compensation expense. Compensation and benefits expense increased 2% from fiscal 2008. Non-compensation expenses decreased 26% in 2009, partly due to the Company’s initiatives to reduce costs. Occupancy and equipment expense decreased 12% in 2009, primarily due to lower leasing costs associated with office facilities. Brokerage, clearing and exchange fees decreased 20% in 2009, primarily due to decreased trading activity. Marketing and business development expense decreased 43% in 2009, primarily due to lower levels of business activity. Professional services expense decreased 18% in 2009, primarily due to lower consulting and legal fees. Other expenses decreased 50% in 2009. In fiscal 2008, other expenses included $694 million related to the impairment of goodwill and intangible assets related to certain fixed income businesses. Excluding the fiscal 2008 impairment charges, other expenses decreased in 2009, primarily due to lower levels of business activity and lower litigation expense.

 

One Month Ended December 31, 2008 Compared with the One Month Ended December 31, 2007.

 

Institutional Securities recorded losses before income taxes of $1,997 million in the one month ended December 31, 2008 compared with income before income taxes of $938 million in the one month ended December 31, 2007. Net revenues were $(1,322) million in the one month ended December 31, 2008 compared with $2,314 million in the one month ended December 31, 2007. Net revenues in the one month ended December 31, 2008 reflected sales and trading losses as compared with sales and trading revenues in the prior-year period. Non-interest expenses decreased 51% to $675 million, primarily due to lower compensation and benefits expense, reflecting lower net revenues. Non-compensation expenses increased 4%.

 

Investment banking revenues decreased 45% to $177 million in the one month ended December 31, 2008 from the prior-year period due to lower revenues from advisory fees and underwriting transactions, reflecting lower levels of market activity. Advisory fees from merger, acquisition and restructuring transactions were $68 million, a decrease of 58% from the prior-year period. Underwriting revenues decreased 33% from the prior-year period to $109 million.

 

Equity sales and trading losses were $11 million in the one month ended December 31, 2008 compared with revenues of $935 million in the one month ended December 31, 2007. Results in the one month ended December 31, 2008 reflected lower revenues from equity cash and derivative products and prime brokerage.

 

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Equity sales and trading losses also included approximately $75 million of losses from the tightening of the Company’s credit spreads on certain long-term and short-term borrowings accounted for at fair value. Fixed income sales and trading losses were $858 million in the one month ended December 31, 2008 compared with revenues of $944 million in the one month ended December 31, 2007. Results in the one month ended December 31, 2008 reflected losses in interest rate, credit and currency products where continued dislocation in the credit markets contributed to the losses. In addition, fixed income sales and trading included approximately $175 million losses from the tightening of the Company’s credit spreads on certain long-term and short-term borrowings that are accounted for at fair value.

 

Other sales and trading losses were approximately $563 million in the one month ended December 31, 2008 compared with revenues of $60 million in the one month ended December 31, 2007. The one month ended December 31, 2008 included writedowns related to mortgage-related securities portfolios in the Company’s Subsidiary Banks, partially offset by mark-to-market gains on loans and lending commitments and related hedges.

 

Principal transactions net investment losses of $158 million were recognized in the one month ended December 31, 2008 compared with net investment gains of $25 million in the one month ended December 31, 2007. The losses in the one month ended December 31, 2008 were primarily related to net realized and unrealized losses from the Company’s limited partnership investments in real estate funds and investments associated with certain employee deferred compensation and co-investment plans, and other principal investments.

 

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GLOBAL WEALTH MANAGEMENT GROUP

 

INCOME STATEMENT INFORMATION

 

     2010      2009      Fiscal
2008
    One Month
Ended
December 31,
2008
 
     (dollars in millions)  

Revenues:

          

Investment banking

   $ 827      $ 596      $ 427     $ 21  

Principal transactions:

          

Trading

     1,306        1,208        613       54  

Investments

     19        3        (54     (4

Commissions

     2,676        2,090        1,408       89  

Asset management, distribution and administration fees

     6,349        4,583        2,726       183  

Other

     337        249        965       15  
                                  

Total non-interest revenues

     11,514        8,729        6,085       358  
                                  

Interest income

     1,587        1,114        1,239       66  

Interest expense

     465        453        305       15  
                                  

Net interest

     1,122        661        934       51  
                                  

Net revenues

     12,636        9,390        7,019       409  
                                  

Compensation and benefits

     7,843        6,114        3,810       247  

Non-compensation expenses

     3,637        2,717        2,055       44  
                                  

Total non-interest expenses

     11,480        8,831        5,865       291  
                                  

Income from continuing operations before income taxes

     1,156        559        1,154       118  

Provision for income taxes

     336        178        440       45  
                                  

Income from continuing operations

     820        381        714       73  
                                  

Net income

     820        381        714       73  

Net income applicable to noncontrolling interests

     301        98        —          —     
                                  

Net income applicable to Morgan Stanley

   $ 519      $ 283      $ 714     $ 73  
                                  

 

On May 31, 2009, MSSB was formed (see Note 3). The Company owns 51% of MSSB, which is consolidated. As a result, the operating results for MSSB are included in the Global Wealth Management Group business segment since May 31, 2009. Net income applicable to noncontrolling interests of $301 million and $98 million in 2010 and 2009, respectively, primarily represents Citi’s interest in MSSB since May 31, 2009.

 

2010 Compared with 2009.

 

Investment Banking.    Global Wealth Management Group investment banking includes revenues from the distribution of equity and fixed income securities, including initial public offerings, secondary offerings, closed-end funds and unit trusts. Investment banking revenues increased 39% in 2010, primarily benefiting from a full year of MSSB revenues and higher closed-end fund activity.

 

Principal Transactions—Trading.    Principal transactions—Trading include revenues from customers’ purchases and sales of financial instruments in which the Company acts as principal and gains and losses on the Company’s inventory positions which are held primarily to facilitate customer transactions.

 

Principal transactions trading revenues increased 8% in 2010, primarily benefiting from a full year of MSSB revenues, net gains related to investments associated with certain employee deferred compensation plans and gains on certain investments.

 

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Principal Transactions—Investments.    Principal transaction net investment gains were $19 million in 2010 compared with $3 million in 2009. The increase primarily reflected gains related to investments associated with certain employee deferred compensation plans compared with such investments in the prior-year period.

 

Commissions.    Commission revenues primarily arise from agency transactions in listed and OTC equity securities and sales of mutual funds, futures, insurance products and options. Commission revenues increased 28% in 2010, primarily benefiting from a full year of MSSB revenues and higher client activity.

 

Asset Management, Distribution and Administration Fees.    Asset management, distribution and administration fees include revenues from individual investors electing a fee-based pricing arrangement and fees for investment management, account services and administration. The Company also receives shareholder servicing fees and fees for services it provides in distributing certain open-ended mutual funds and other products. Mutual fund distribution fees are based on either the average daily fund net asset balances or average daily aggregate net fund sales and are affected by changes in the overall level and mix of assets under management or supervision.

 

Asset management, distribution and administration fees increased 39% in 2010, primarily benefiting from a full year of MSSB revenues and improved market conditions. From June 2009 until April 1, 2010, revenues in the bank deposit program were primarily included in Asset management, distribution and administration fees. Prior to June 2009, these revenues were reported in Interest income. The change was the result of agreements that were entered into in connection with the MSSB transaction. Beginning on April 1, 2010, revenues in the bank deposit program held at the Company’s U.S. depository institutions were recorded as Interest income due to renegotiations of the revenue sharing agreement as part of the Global Wealth Management Group business segment’s retail banking strategy. The Global Wealth Management Group business segment will continue to earn referral fees for deposits placed with Citi depository institutions, and these fees will continue to be recorded in Asset management, distribution and administration fees until the legacy Smith Barney deposits are migrated to the Company’s U.S. depository institutions. The referral fees for deposits were $381.7 million in 2010 and $659.5 million in 2009.

 

Balances in the bank deposit program increased to $113.3 billion at December 31, 2010 from $112.5 billion at December 31, 2009. The unlimited FDIC program expired on December 31, 2009 for deposits held by Citi depository institutions and June 30, 2010 for deposits held by the Company’s depository institutions. Deposits held by Company-affiliated FDIC-insured depository institutions were $55 billion of the $113.3 billion deposits at December 31, 2010.

 

Client assets in fee-based accounts increased to $470 billion and represented 28% of total client assets at December 31, 2010 compared with $379 billion and 24% at December 31, 2009, respectively. Total client asset balances increased to $1,669 billion at December 31, 2010 from $1,560 billion at December 31, 2009, primarily due to improved market conditions and an increase in net new assets. Net new assets for 2010 were $22.9 billion. Client asset balances in households with assets greater than $1 million increased to $1,229 billion at December 31, 2010 from $1,090 billion at December 31, 2009. Global fee-based asset flows increased to $32.7 billion at December 31, 2010 from $13.4 billion at December 31, 2009.

 

Other.    Other revenues primarily include customer account service fees and other miscellaneous revenues. Other revenues were $337 million in 2010, an increase of 35% from $249 million in 2009. Other revenues in 2010 primarily benefited from a full year of MSSB revenues and increases in proxy and other fee services.

 

Net Interest.    Interest income and Interest expense are a function of the level and mix of total assets and liabilities, including customer bank deposits and margin loans and securities borrowed and securities loaned transactions. Net interest increased 70% in 2010, primarily resulting from an increase in Interest income due to a full year of MSSB net interest, the securities available for sale portfolio (see “Other Matters—Securities Available for Sale” herein) and the change in classification of the bank deposit program noted above, partially offset by increased funding costs.

 

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Non-interest Expenses.    Non-interest expenses increased 30% in 2010, primarily due to higher costs related to a full year of MSSB operating expenses and the amortization of MSSB’s intangible assets. Compensation and benefits expense increased 28% in 2010, primarily due to a full year of MSSB operating expenses. Non-compensation expenses increased 34% in 2010. In 2010, brokerage, clearing and exchange fees expense increased 38%, information processing and communications expense increased 41%, and other expenses increased 51%, primarily due to a full year of MSSB operating expenses. In 2010, professional services expense increased 43%, primarily due to a full year of MSSB operating expenses and increased technology consulting costs related to the MSSB integration.

 

2009 Compared with Fiscal 2008.

 

Investment banking revenues increased 40% in 2009 from fiscal 2008, primarily due to the consolidation of the operating revenues of MSSB and higher equity underwriting activity, partially offset by lower underwriting activity across fixed income and unit trust products. Principal transactions trading revenues increased 97% in 2009 from fiscal 2008, primarily due to the consolidation of the operating revenues of MSSB and higher revenues from municipal and corporate fixed income securities, partially offset by lower revenues from government securities. The results in 2009 also reflected net gains related to investments associated with certain employee deferred compensation plans. Principal transactions net investment gains were $3 million in 2009 compared with net investment losses of $54 million in fiscal 2008. The results in 2009 primarily reflected net gains related to investments associated with certain employee deferred compensation plans compared with losses on such plans in fiscal 2008. Commission revenues increased 48% in 2009 compared with fiscal 2008, reflecting the operating results of MSSB, partially offset by lower client activity. Asset management, distribution and administration fees increased 68% in 2009 compared with fiscal 2008, primarily due to consolidating the operating revenues of MSSB, fees associated with customer account balances in the bank deposit program and the change in classification of the bank deposit program noted above. Balances in the bank deposit program rose to $112.5 billion at December 31, 2009 from $38.8 billion at December 31, 2008, primarily due to MSSB, which include balances held at Citi’s depository institutions. Deposits held by certain of the Company’s FDIC-insured depository institutions were $54 billion of the $112.5 billion deposits at December 31, 2009. Client assets in fee-based accounts increased 175% to $379 billion at December 31, 2009 and represented 24% of total client assets compared with 25% at December 31, 2008. Total client asset balances increased to $1,560 billion at December 31, 2009 from $550 billion at December 31, 2008, primarily due to MSSB. Client asset balances in households greater than $1 million increased to $1,090 billion at December 31, 2009 from $351 billion at December 31, 2008.

 

Other revenues decreased 74% in 2009 compared with fiscal 2008. The results in 2009 included the operating revenues of MSSB. Fiscal 2008 results included $743 million related to the sale of MSWM S.V., the Spanish onshore mass affluent wealth management business, and the Global Wealth Management Group business segment’s share ($43 million) of the Company’s repurchase of debt (see “Overview of 2010 Financial Results—Morgan Stanley Debt” herein for further discussion).

 

Net interest revenues decreased 29% in 2009 compared with fiscal 2008. The decrease was primarily due to the change in the classification of the bank deposit program noted above, a decline in customer margin loan balances and increased funding costs.

 

Non-interest expenses increased 51% in 2009 and included the operating costs of MSSB, the amortization of MSSB’s intangible assets, and a one-time expense of $124 million, primarily for replacement deferred compensation awards. The cost of these replacement awards was fully allocated to Citi within noncontrolling interests. Compensation and benefits expense increased 60% in 2009, primarily reflecting MSSB and the replacement awards noted above. Non-compensation expenses increased 32%. Occupancy and equipment expense increased 91%, primarily due to the consolidation of operating costs of MSSB and real estate abandonment charges. Information processing and communications expense increased 70%, and professional

 

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services expense increased 54% in 2009, primarily due to the consolidation of operating results of MSSB. Other expenses decreased 7% in 2009, primarily due to the charge of $532 million for the ARS repurchase program in fiscal 2008, partially offset by the consolidation of operating costs of MSSB and a charge related to an FDIC assessment on deposits.

 

One Month Ended December 31, 2008 Compared with the One Month Ended December 31, 2007.

 

The Global Wealth Management Group business segment recorded income before income taxes of $118 million in the one month ended December 31, 2008 compared with $103 million in the one month ended December 31, 2007. The one month ended December 31, 2008 included a reversal of a portion of approximately $70 million of the accrual related to the ARS repurchase program. Net revenues were $409 million, a 24% decrease, primarily related to lower asset management, distribution and administration fees, lower commissions and lower investment banking fees. Client assets in fee-based accounts decreased 31% to $138 billion and decreased as a percentage of total client assets to 25% from 27% at December 31, 2007. In addition, total client assets decreased to $550 billion, down 27% from December 31, 2007, primarily due to weakened market conditions.

 

Total non-interest expenses were $291 million in the one month ended December 31, 2008, a 33% decrease from the prior period. Compensation and benefits expense was $247 million, a 21% decrease from the prior-year period, primarily reflecting lower revenues. Non-compensation costs decreased 65%, primarily due to a reversal of approximately $70 million of the accrual related to the ARS repurchase program.

 

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ASSET MANAGEMENT

 

INCOME STATEMENT INFORMATION

 

     2010     2009     Fiscal
2008
    One Month
Ended
December 31,
2008
 
     (dollars in millions)  

Revenues:

        

Investment banking

   $ 20     $ 10     $ 26     $ 1  

Principal transactions:

        

Trading

     (49     (68     (331     (82

Investments

     996       (173     (1,373     (43

Commissions

     —          —          —          1  

Asset management, distribution and administration fees

     1,668       1,605       2,139       112  

Other

     164       46       160       3  
                                

Total non-interest revenues

     2,799       1,420       621       (8
                                

Interest income

     22       17       131       8  

Interest expense

     98       100       205       9  
                                

Net interest

     (76     (83     (74     (1
                                

Net revenues

     2,723       1,337       547       (9
                                

Compensation and benefits

     1,123       1,104       947       54  

Non-compensation expenses

     877       886       1,023       51  
                                

Total non-interest expenses

     2,000       1,990       1,970       105  
                                

Income (loss) from continuing operations before income taxes

     723       (653     (1,423     (114

Provision for (benefit from) income taxes

     105       (215     (567     (44
                                

Income (loss) from continuing operations

     618       (438     (856     (70
                                

Discontinued operations:

        

Gain (loss) from discontinued operations

     994       (376     (383     4  

Provision for (benefit from) income taxes

     335       (277     (122     2