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Form 10-Q
(9-30-2009)
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v1.0.0.5
Statement Of Financial Position Unclassified - Deposit Based Operations (USD $)
In Millions
 9 Months Ended
Sep. 30, 2009
Dec. 31, 2008
Nov. 30, 2008
Assets
Cash and due from banks $ 6,218 $ 13,354 $ 11,276
Interest bearing deposits with banks 22,392 65,316 67,378
Cash deposited with clearing organizations or segregated under federal and other regulations or requirements 21,753 24,039 25,446
Financial instruments owned, at fair value (approximately $114 billion, $73 billion and $62 billion were pledged to various parties at September 30, 2009, December 31, 2008 and November 30, 2008, respectively):
U.S. government and agency securities 82,881 28,012 20,251
Other sovereign government obligations 39,576 21,084 20,071
Corporate and other debt 94,794 87,294 88,484
Corporate equities 52,310 42,321 37,174
Derivative and other contracts 55,265 89,418 99,766
Investments 9,252 10,385 10,598
Physical commodities 4,418 2,126 2,204
Total financial instruments owned, at fair value 338,496 280,640 278,548
Securities received as collateral, at fair value 16,414 5,231 5,217
Federal funds sold and securities purchased under agreements to resell 146,985 122,709 106,419
Securities borrowed 128,922 88,052 85,785
Receivables:
Customers 25,854 29,265 31,294
Brokers, dealers and clearing organizations 4,937 6,250 7,259
Other loans 6,557 6,547 6,528
Fees, interest and other 11,330 7,258 7,034
Other investments 3,899 3,709 3,309
Premises, equipment and software costs (net of accumulated depreciation of $3,532, $3,073 and $3,003 at September 30, 2009, December 31, 2008 and November 30, 2008, respectively) 6,765 5,095 5,057
Goodwill 6,977 2,256 2,243
Intangible assets (net of accumulated amortization of $390, $208 and $200 at September 30, 2009, December 31, 2008 and November 30, 2008, respectively) (includes $144, $184 and $220 at fair value at September 30, 2009, December 31, 2008 and November 30, 2008, respectively) 5,679 906 947
Other assets 16,325 16,137 15,295
Total assets 769,503 676,764 659,035
Liabilities and Equity
Commercial paper and other short-term borrowings (includes $1,179, $1,246 and $1,412 at fair value at September 30, 2009, December 31, 2008 and November 30, 2008, respectively) 2,913 10,102 10,483
Deposits (includes $7,784, $9,993 and $6,008 at fair value at September 30, 2009, December 31, 2008 and November 30, 2008, respectively) 62,415 51,355 42,755
Financial instruments sold, not yet purchased, at fair value:
U.S. government and agency securities 23,646 11,902 10,156
Other sovereign government obligations 24,020 9,511 9,360
Corporate and other debt 7,743 9,927 9,361
Corporate equities 23,658 16,840 16,547
Derivative and other contracts 39,526 68,554 73,521
Physical commodities 0 33 0
Total financial instruments sold, not yet purchased, at fair value 118,593 116,767 118,945
Obligation to return securities received as collateral, at fair value 16,414 5,231 5,217
Securities sold under agreements to repurchase 147,344 92,213 102,401
Securities loaned 26,182 14,580 14,821
Other secured financings, at fair value 10,278 12,539 12,527
Payables:
Customers 110,765 123,617 115,225
Brokers, dealers and clearing organizations 4,381 1,585 3,141
Interest and dividends 3,143 3,305 2,584
Other liabilities and accrued expenses 18,414 16,179 15,963
Long-term borrowings (includes $37,049, $30,766 and $28,830 at fair value at September 30, 2009, December 31, 2008 and November 30, 2008, respectively) 196,437 179,835 163,437
Liabilities, Total 717,279 627,308 607,499
Commitments and contingencies - - -
Morgan Stanley shareholders' equity:
Preferred stock 9,597 19,168 19,155
Common stock, $0.01 par value; Shares authorized: 3,500,000,000 at September 30, 2009, December 31, 2008 and November 30, 2008; Shares issued: 1,487,850,163 at September 30, 2009, 1,211,701,552 at December 31, 2008 and November 30, 2008; Shares outstanding: 1,358,900,574 at September 30, 2009, 1,074,497,565 at December 31, 2008 and 1,047,598,394 at November 30, 2008 15 12 12
Paid-in capital 8,441 459 1,619
Retained earnings 34,726 36,154 38,096
Employee stock trust 4,058 4,312 3,901
Accumulated other comprehensive loss (299) (420) (125)
Common stock held in treasury, at cost, $0.01 par value; 128,949,589 shares at September 30, 2009, 137,203,987 shares at December 31, 2008 and 164,103,158 shares at November 30, 2008 (6,131) (6,620) (7,926)
Common stock issued to employee trust (4,058) (4,312) (3,901)
Total Morgan Stanley shareholders' equity 46,349 48,753 50,831
Non-controlling interests 5,875 703 705
Total equity 52,224 49,456 51,536
Total liabilities and equity $ 769,503 $ 676,764 $ 659,035

v1.0.0.5
Statement Of Financial Position Unclassified - Deposit Based Operations (Parenthetical) (USD $)
Sep. 30, 2009
Dec. 31, 2008
Nov. 30, 2008
Financial instruments owned, at fair value, pledged to various parties $ 114,000,000,000 $ 73,000,000,000 $ 62,000,000,000
Premises, equipment and software costs, accumulated depreciation 3,532,000,000 3,073,000,000 3,003,000,000
Intangible assets, accumulated amortization 390,000,000 208,000,000 200,000,000
Intangible assets, fair value 144,000,000 184,000,000 220,000,000
Commercial paper and other short-term borrowings, fair value 1,179,000,000 1,246,000,000 1,412,000,000
Deposits, fair value 7,784,000,000 9,993,000,000 6,008,000,000
Long-term borrowings, fair value $ 37,049,000,000 $ 30,766,000,000 $ 28,830,000,000
Common stock, par value $ 0.01 $ 0.01 $ 0.01
Common stock, Shares authorized 3,500,000,000 3,500,000,000 3,500,000,000
Common stock, Shares issued 1,487,850,163 1,211,701,552 1,211,701,552
Common stock, Shares outstanding 1,358,900,574 1,074,497,565 1,047,598,394
Common stock held in treasury, shares 128,949,589 137,203,987 164,103,158

v1.0.0.5
Statement Of Income Interest Based Revenue (USD $)
In Millions, except Share data
 3 Months Ended 9 Months Ended
Sep. 30, 2009
Sep. 30, 2008
Sep. 30, 2009
Sep. 30, 2008
Revenues:
Investment banking $ 1,226 $ 1,025 $ 3,393 $ 3,284
Principal transactions:
Trading 3,242 13,185 6,304 18,073
Investments 99 (733) (1,288) (1,557)
Commissions 1,247 1,107 2,994 3,488
Asset management, distribution and administration fees 2,023 1,379 4,289 4,325
Other 257 1,271 1,093 2,495
Total non-interest revenues 8,094 17,234 16,785 30,108
Interest and dividends 1,989 9,626 5,906 31,532
Interest expense 1,408 8,849 5,659 29,700
Net interest 581 777 247 1,832
Net revenues 8,675 18,011 17,032 31,940
Non-interest expenses:
Compensation and benefits 4,961 5,059 10,872 11,970
Occupancy and equipment 424 316 1,139 930
Brokerage, clearing and exchange fees 309 394 868 1,285
Information processing and communications 360 298 963 903
Marketing and business development 126 166 370 557
Professional services 403 401 1,130 1,253
Other 877 696 2,002 1,472
Total non-interest expenses 7,460 7,330 17,344 18,370
Income (losses) from continuing operations before income taxes 1,215 10,681 (312) 13,570
Provision for (benefit from) income taxes 422 2,974 (615) 3,759
Income from continuing operations 793 7,707 303 9,811
Discontinued operations:
Gain from discontinued operations (including gain on disposal of $499 million in the nine months ended September 30, 2009) 0 756 537 1,553
Provision for income taxes 0 292 204 602
Gain on discontinued operations 0 464 333 951
Net income 793 8,171 636 10,762
Net income (loss) applicable to non-controlling interests 36 20 (93) 55
Net income (loss) applicable to Morgan Stanley 757 8,151 729 10,707
Earnings (losses) applicable to Morgan Stanley common shareholders 498 7,684 (1,301) 10,030
Amounts applicable to Morgan Stanley:
Income from continuing operations 757 7,700 412 9,784
Net gain from discontinued operations after tax 0 451 317 923
Net income (loss) applicable to Morgan Stanley $ 757 $ 8,151 $ 729 $ 10,707
Earnings (losses) per basic common share:
Income (loss) from continuing operations $ 0.39 $ 6.97 $ (1.41) $ 8.82
Gain on discontinued operations $ 0 $ 0.41 $ 0.28 $ 0.84
Earnings (losses) per basic common share $ 0.39 $ 7.38 $ (1.13) $ 9.66
Earnings (losses) per diluted common share:
Income (loss) from continuing operations $ 0.38 $ 6.97 $ (1.41) $ 8.8
Gain on discontinued operations $ 0 $ 0.41 $ 0.28 $ 0.83
Earnings (losses) per diluted common share $ 0.38 $ 7.38 $ (1.13) $ 9.63
Average common shares outstanding:
Basic 1,294,298,229 1,040,887,906 1,148,161,310 1,038,803,052
Diluted 1,300,070,107 1,041,677,018 1,148,161,310 1,041,808,270

v1.0.0.5
Statement Of Income Interest Based Revenue (Parenthetical) (USD $)
In Millions
 3 Months Ended 9 Months Ended
Sep. 30, 2009
Sep. 30, 2008
Sep. 30, 2009
Sep. 30, 2008
Gain from discontinued operations, gain on disposal $ 0 $ 0 $ 499 $ 0

v1.0.0.5
Statement Of Other Comprehensive Income (USD $)
In Millions
 3 Months Ended 9 Months Ended
Sep. 30, 2009
Sep. 30, 2008
Sep. 30, 2009
Sep. 30, 2008
Net income $ 793 $ 8,171 $ 636 $ 10,762
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments 40 [2] (202) [2] 98 [2] (252) [2]
Net change in cash flow hedges 2 [3] 5 [3] 10 [3] 14 [3]
Amortization of net loss related to pension and postretirement benefits 8 [4] 4 [4] 20 [4] 14 [4]
Amortization of prior service credit related to pension and postretirement benefits (1) [1] (2) [1] (4) [1] (4) [1]
Comprehensive income 842 7,976 760 10,534
Net income (loss) applicable to non-controlling interests 36 20 (93) 55
Other comprehensive income (loss) applicable to non-controlling interests 6 (53) 3 (58)
Comprehensive income applicable to Morgan Stanley $ 800 $ 8,009 $ 850 $ 10,537
[1] Amounts are net of (benefit from) income taxes of $(2) million and $(1) million for the quarters ended September 30, 2009 and September 30, 2008, respectively. Amounts are net of (benefit from) income taxes of $(3) million for the nine month periods ended September 30, 2009 and September 30, 2008.
[2] Amounts are net of (benefit from) provision for income taxes of $(106) million and $279 million for the quarters ended September 30, 2009 and September 30, 2008, respectively. Amounts are net of (benefit from) provision for income taxes of $(317) million and $112 million for the nine month periods ended September 30, 2009 and September 30, 2008, respectively.
[3] Amounts are net of provision for income taxes of $2 million for the quarters ended September 30, 2009 and September 30, 2008. Amounts are net of provision for income taxes of $6 million and $9 million for the nine month periods ended September 30, 2009 and September 30, 2008, respectively.
[4] Amounts are net of provision for income taxes of $3 million for the quarters ended September 30, 2009 and September 30, 2008. Amounts are net of provision for income taxes of $12 million and $9 million for the nine month periods ended September 30, 2009 and September 30, 2008, respectively.

v1.0.0.5
Statement Of Cash Flows Indirect Deposit Based Operations (USD $)
In Millions
 3 Months Ended 9 Months Ended
Sep. 30, 2009
Sep. 30, 2008
Sep. 30, 2009
Sep. 30, 2008
Dec. 31, 2008
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 793 $ 8,171 $ 636 $ 10,762
Adjustments to reconcile net income to net cash (used for) provided by operating activities:
Compensation payable in common stock and options 1,021 1,637
Depreciation and amortization 829 532
Gain on business dispositions (480) (2,232)
Impairment charges 689 0
Changes in assets and liabilities:
Cash deposited with clearing organizations or segregated under federal and other regulations or requirements 2,286 12,482
Financial instruments owned, net of financial instruments sold, not yet purchased (52,560) 2,295
Securities borrowed (40,870) 77,563
Securities loaned 11,602 (79,488)
Receivables and other assets (1,029) 16,488
Payables and other liabilities (3,167) (50,944)
Federal funds sold and securities purchased under agreements to resell (24,276) (13,953)
Securities sold under agreements to repurchase 55,131 87,848
Net cash (used for) provided by operating activities (50,188) 62,990
Net (payments for) proceeds from:
Premises, equipment and software costs (2,307) (1,368)
Business acquisitions, net of cash acquired (2,160) (174)
Business dispositions 565 743
Net cash (used for) investing activities (3,902) (799)
Net (payments for) proceeds from:
Short-term borrowings (7,189) (16,870)
Non-controlling interests 0 1,005
Derivatives financing activities (78) 855
Other secured financings (2,261) (9,616)
Deposits 11,060 2,500
Excess tax benefits associated with stock-based awards 12 0
Net proceeds from:
Morgan Stanley public offerings of common stock 6,212 0
Issuance of common stock 41 296
Issuance of long-term borrowings 36,342 30,159
Payments for:
Long-term borrowings (28,546) (38,506)
Series D Preferred Stock and warrant (10,950) 0
Repurchases of common stock through capital management share repurchase program 0 (487)
Repurchases of common stock for employee tax withholding (37) (1,104)
Cash dividends (1,445) (935)
Net cash provided by (used for) financing activities 3,161 (32,703)
Effect of exchange rate changes on cash and cash equivalents 869 (581)
Net (decrease) increase in cash and cash equivalents (50,060) 28,907
Cash and cash equivalents, at beginning of period 78,670 24,659
Cash and cash equivalents, at end of period 28,610 53,566 28,610 53,566 78,670
Cash and cash equivalents include:
Cash and due from banks 6,218 25,958 13,354
Interest bearing deposits with banks 22,392 27,608 65,316
Cash and cash equivalents, at end of period $ 28,610 $ 53,566 $ 28,610 $ 53,566 $ 78,670

v1.0.0.5
Statement Of Shareholders Equity And Other Comprehensive Income (USD $)
In Millions
Preferred Stock
Common Stock
Paid-in Capital
Retained Earnings
Employee Stock Trust
Accumulated Other Comprehensive Loss
Common Stock Held in Treasury at Cost
Common Stock Issued to Employee Trust
Non-controlling Interest
Other Morgan Stanley Common Equity
Total
BEGINNING BALANCE at Dec. 31, 2007 $ 1,100 $ 12 $ 1,571 $ 30,665 $ 33,348
Net income 55 10,707 10,762
Dividends (39) (914) (953)
Shares issued under employee plans and related tax effects 1,856 1,856
Repurchases of common stock (1,591) (1,591)
Net change in cash flow hedges 14 14 [2]
Pension and other postretirement adjustments 10 10
Foreign currency translation adjustments (58) (194) (252) [1]
Other (74) (74)
Increases in non-controlling interests related to Morgan Stanley Smith Barney transaction 132 132
Decreases in non-controlling interests related to disposition of a subsidiary (514) (514)
Other increases in non-controlling interests (6) (6)
ENDING BALANCE at Sep. 30, 2008 1,100 12 1,141 40,479 42,732
BEGINNING BALANCE at Jun. 30, 2008 1,100 12
ENDING BALANCE at Sep. 30, 2008 1,100 12
BEGINNING BALANCE at Dec. 31, 2008 19,168 12 459 36,154 4,312 (420) (6,620) (4,312) 703 49,456
Net income 729 (93) 636
Dividends (1,023) (17) (1,040)
Shares issued under employee plans and related tax effects 307 (254) 526 254 833
Repurchases of common stock (37) (37)
Morgan Stanley public offerings of common stock 3 6,209 6,212
Preferred stock extinguished and exchanged for common stock (503) 705 (202) 0
Series D preferred stock and warrant (9,068) (950) (932) (10,950)
Gain on Morgan Stanley Smith Barney transaction 1,711 1,711
Net change in cash flow hedges 10 10 [2]
Pension and other postretirement adjustments 16 16
Foreign currency translation adjustments 95 3 98 [1]
Increases in non-controlling interests related to Morgan Stanley Smith Barney transaction 4,821 4,821
Increases in non-controlling interests related to the consolidation of two real estate funds sponsored by the Company 649 649
Decreases in non-controlling interests related to disposition of a subsidiary (229) (229)
Other increases in non-controlling interests 38 38
ENDING BALANCE at Sep. 30, 2009 $ 9,597 $ 15 $ 8,441 $ 34,726 $ 4,058 $ (299) $ (6,131) $ (4,058) $ 5,875 $ 52,224
[1] Amounts are net of (benefit from) provision for income taxes of $(106) million and $279 million for the quarters ended September 30, 2009 and September 30, 2008, respectively. Amounts are net of (benefit from) provision for income taxes of $(317) million and $112 million for the nine month periods ended September 30, 2009 and September 30, 2008, respectively.
[2] Amounts are net of provision for income taxes of $2 million for the quarters ended September 30, 2009 and September 30, 2008. Amounts are net of provision for income taxes of $6 million and $9 million for the nine month periods ended September 30, 2009 and September 30, 2008, respectively.

v1.0.0.5
1.Basis of Presentation and Summary of Significant Accounting Policies.
 9 Months Ended
Sep. 30, 2009
USD / shares
Notes to Financial Statements [Abstract]
1.Basis of Presentation and Summary of Significant Accounting Policies.
1. Basis of Presentation and Summary of Significant Accounting Policies.

The Company.    Morgan Stanley (or 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 Company’s business segments is as follows:

Institutional Securities includes 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”) (see Note 2), provides brokerage and investment advisory services 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.

Asset Management provides global asset management products and services in equity, fixed income, alternative investments, which includes hedge funds and funds of funds, and merchant banking, which includes real estate, private equity and infrastructure, to institutional and retail clients through proprietary and third-party distribution channels. Asset Management also engages in investment activities.

Discontinued Operations.

MSCI.    In May 2009, the Company divested all of its remaining ownership interest in MSCI Inc. (“MSCI”). The results of MSCI are reported as discontinued operations for all periods presented. The results of MSCI were formerly included in the continuing operations of the Institutional Securities business segment.

Crescent.    In addition, discontinued operations in the quarter and nine month period ended September 30, 2008 include operating results and gains (losses) related to the disposition of certain properties previously owned by Crescent Real Estate Equities Limited Partnership (“Crescent”), a real estate subsidiary of the Company. The results of certain Crescent properties previously owned by the Company were formerly included in the Asset Management business segment.

See Note 20 for additional information on discontinued operations.

Basis of Financial Information.    The condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the U.S., which require the Company to make estimates and assumptions regarding the valuations of certain financial instruments, the valuation of goodwill, the outcome of litigation and tax matters, incentive-based accruals and other matters that affect the condensed consolidated financial statements and related disclosures. The Company believes that the estimates utilized in the preparation of the condensed consolidated financial statements are prudent and reasonable. Actual results could differ materially from these estimates.

All material intercompany balances and transactions have been eliminated.

The condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto included in Exhibit 99.1 in the Company’s Current Report on Form 8-K dated August 24, 2009 (the “Form 8-K”). The condensed consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for the fair presentation of the results for the interim period. The results of operations for interim periods are not necessarily indicative of results for the entire year.

Consolidation.    The condensed consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries and other entities in which the Company has a controlling financial interest including certain variable interest entities (“VIEs”). The Company adopted accounting guidance for non-controlling interests on January 1, 2009. Accordingly, for consolidated subsidiaries that are less than wholly owned, the third-party holdings of equity interests are referred to as non-controlling interests. The portion of net income attributable to non-controlling interests for such subsidiaries is presented as Net income (loss) applicable to non-controlling interests on the condensed consolidated statements of income, and the portion of the shareholders’ equity of such subsidiaries is presented as Non-controlling interests on the condensed consolidated statements of financial condition and condensed consolidated statements of changes in total equity.

For entities where (1) the total equity investment at risk is sufficient to enable the entity to finance its activities independently and (2) the equity holders bear the economic residual risks of the entity and have the right to make decisions about the entity’s activities, the Company consolidates those entities it controls through a majority voting interest or otherwise. For entities that do not meet these criteria, commonly known as VIEs, the Company consolidates those entities where the Company is deemed to be the primary beneficiary when it absorbs a majority of the expected losses or a majority of the expected residual returns, or both, of such entities.

Notwithstanding the above, certain securitization vehicles, commonly known as qualifying special purpose entities (“QSPEs”), are not consolidated by the Company if they meet certain criteria regarding the types of assets and derivatives they may hold, the types of sales they may engage in and the range of discretion they may exercise in connection with the assets they hold (see Note 5).

For investments in entities in which the Company does not have a controlling financial interest but has significant influence over operating and financial decisions, the Company generally applies the equity method of accounting with net gains and losses recorded within Other revenues. Where the Company has elected to measure certain eligible investments at fair value in accordance with the fair value option net gains and losses are recorded within Principal transactions—investments (see Note 3).

Equity and partnership interests held by entities qualifying for accounting purposes as investment companies are carried at fair value.

The Company’s regulated significant U.S. and international subsidiaries include Morgan Stanley & Co. Incorporated (“MS&Co.”), Morgan Stanley & Co. International plc (“MSIP”), Morgan Stanley Japan Securities Co., Ltd. (“MSJS”), Morgan Stanley Investment Advisors Inc. and MSSB.

Income Statement Presentation.    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. In connection with the delivery of the various products and services to clients, the Company manages its revenues and related expenses in the aggregate. As such, when assessing the performance of its businesses, the Company considers its principal trading, investment banking, commissions, and interest and dividend income, along with the associated interest expense, as one integrated activity for each of the Company’s separate businesses.

 

Revenue Recognition.

Investment Banking.    Underwriting revenues and advisory fees from mergers, acquisitions and restructuring transactions are recorded when services for the transactions are determined to be completed, generally as set forth under the terms of the engagement. Transaction-related expenses, primarily consisting of legal, travel and other costs directly associated with the transaction, are deferred and recognized in the same period as the related investment banking transaction revenue. Underwriting revenues are presented net of related expenses. Non-reimbursed expenses associated with advisory transactions are recorded within Non-interest expenses.

Commissions.    The Company generates commissions from executing and clearing customer transactions on stock, options and futures markets. Commission revenues are recognized in the accounts on trade date.

Asset Management, Distribution and Administration Fees.    Asset management, distribution and administration fees are recognized over the relevant contract period. Sales commissions paid by the Company in connection with the sale of certain classes of shares of its open-end mutual fund products are accounted for as deferred commission assets. The Company periodically tests the deferred commission assets for recoverability based on cash flows expected to be received in future periods. In certain management fee arrangements, the Company is entitled to receive performance-based fees (also referred to as incentive fees) when the return on assets under management exceeds certain benchmark returns or other performance targets. In such arrangements, performance fee revenue is accrued (or reversed) quarterly based on measuring account/fund performance to date versus the performance benchmark stated in the investment management agreement. Performance-based fees are recorded within Principal transactions—investment revenues or Asset management, distribution and administration fees depending on the nature of the arrangement.

Financial Instruments and Fair Value.

A significant portion of the Company’s financial instruments is carried at fair value with changes in fair value recognized in earnings each period. A description of the Company’s policies regarding fair value measurement and its application to these financial instruments follows.

Financial Instruments Measured at Fair Value.    All of the instruments within Financial instruments owned and Financial instruments sold, not yet purchased, are measured at fair value, either through the fair value option election (discussed below) or as required by other accounting pronouncements. These financial instruments primarily represent the Company’s trading and investment activities and include both cash and derivative products. In addition, Securities received as collateral and Obligation to return securities received as collateral are measured at fair value as required by other accounting pronouncements. Additionally, certain Commercial paper and other short-term borrowings (primarily structured notes), certain Deposits, Other secured financings and certain Long-term borrowings (primarily structured notes and certain junior subordinated debentures) are measured at fair value through the fair value option election.

Gains and losses on all of these financial instruments carried at fair value are reflected in Principal transactions—trading revenues, Principal transactions—investment revenues or Investment banking revenues in the condensed consolidated statements of income, except for derivatives accounted for as accounting hedges (see “Hedge Accounting” section herein and Note 8). Interest income and expense and dividend income are recorded within the condensed consolidated statements of income depending on the nature of the instrument and related market conventions. When interest and dividends are included as a component of the instruments’ fair value, interest and dividends are included within Principal transactions—trading revenues or Principal transactions—investment revenues. Otherwise, they are included within Interest and dividend income or Interest expense. The fair value of over-the-counter (“OTC”) financial instruments, including derivative contracts related to financial instruments and commodities, is presented in the accompanying condensed consolidated statements of financial condition on a net-by-counterparty basis, when appropriate. Additionally, the Company nets fair value of cash collateral paid or received against fair value amounts recognized for net derivative positions executed with the same counterparty under the same master netting arrangement.

Fair Value Option.    The fair value option permits the irrevocable fair value option election on an instrument-by-instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument. The Company applies the fair value option for eligible instruments, including certain loans and lending commitments, certain equity method investments, certain structured notes, certain junior subordinated debentures, certain time deposits and certain other secured financings.

Fair Value Measurement—Definition and Hierarchy.    Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date.

In determining fair value, the Company uses various valuation approaches and establishes a hierarchy for inputs used in measuring fair value that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the assumptions of other market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The hierarchy is broken down into three levels based on the observability of inputs as follows:

 

  •  

Level 1—Valuations based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access. Valuation adjustments and block discounts are not applied to Level 1 instruments. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.

 

  •  

Level 2—Valuations based on one or more quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.

 

  •  

Level 3—Valuations based on inputs that are unobservable and significant to the overall fair value measurement.

The availability of observable inputs can vary from product to product and is affected by a wide variety of factors, including, for example, the type of product, whether the product is new and not yet established in the marketplace, the liquidity of markets and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for instruments categorized in Level 3.

The Company uses prices and inputs that are current as of the measurement date, including during periods of market dislocation. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This condition could cause an instrument to be reclassified from Level 1 to Level 2 or Level 2 to Level 3 (see Note 3). In addition, a downturn in market conditions could lead to further declines in the valuation of many instruments.

 

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes the level in the fair value hierarchy within which the fair value measurement falls in its entirety is determined based on the lowest level input that is significant to the fair value measurement in its entirety.

Valuation Techniques.    Many cash and OTC contracts have bid and ask prices that can be observed in the marketplace. Bid prices reflect the highest price that a party is willing to pay for an asset. Ask prices represent the lowest price that a party is willing to accept for an asset. For financial instruments whose inputs are based on bid-ask prices, the Company does not require that the fair value estimate always be a predetermined point in the bid-ask range. The Company’s policy is to allow for mid-market pricing and adjusting to the point within the bid-ask range that meets the Company’s best estimate of fair value. For offsetting positions in the same financial instrument, the same price within the bid-ask spread is used to measure both the long and short positions.

Fair value for many cash and OTC contracts is derived using pricing models. Pricing models take into account the contract terms (including maturity) as well as multiple inputs, including, where applicable, commodity prices, equity prices, interest rate yield curves, credit curves, correlation, creditworthiness of the counterparty, option volatility and currency rates. Where appropriate, valuation adjustments are made to account for various factors such as liquidity risk (bid-ask adjustments), credit quality and model uncertainty. Credit valuation adjustments are applied to both cash instruments and OTC derivatives. For cash instruments, the impact of changes in the Company’s own credit spreads is considered when measuring the fair value of liabilities and the impact of changes in the counterparty’s credit spreads is considered when measuring the fair value of assets. For OTC derivatives, the impact of changes in both the Company’s and the counterparty’s credit standing is considered when measuring fair value. In determining the expected exposure, the Company considers collateral held and legally enforceable master netting agreements that mitigate the Company’s exposure to each counterparty. All valuation adjustments are subject to judgment, are applied on a consistent basis and are based upon observable inputs where available. The Company generally subjects all valuations and models to a review process initially and on a periodic basis thereafter.

Fair value is a market-based measure considered from the perspective of a market participant rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, the Company’s own assumptions are set to reflect those that the Company believes market participants would use in pricing the asset or liability at the measurement date.

See Note 3 for a description of valuation techniques applied to the major categories of financial instruments measured at fair value.

Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis.    Certain of the Company’s assets are measured at fair value on a non-recurring basis. The Company incurs impairment charges for any writedowns of these assets to fair value. A downturn in market conditions could result in impairment charges in future periods.

For assets and liabilities measured at fair value on a non-recurring basis, fair value is determined by using various valuation approaches. The same hierarchy as described above, which maximizes the use of observable inputs and minimizes the use of unobservable inputs by generally requiring that the observable inputs be used when available, is used in measuring fair value for these items.

For further information on financial assets and liabilities that are measured at fair value on a recurring and non-recurring basis, see Note 3.

 

Hedge Accounting.

The Company applies hedge accounting using various derivative financial instruments and non-U.S. dollar-denominated debt used to hedge interest rate and foreign exchange risk arising from assets and liabilities not held at fair value as part of asset and liability management. These derivative financial instruments are included within Financial instruments owned—derivative and other contracts or Financial instruments sold, not yet purchased—derivative and other contracts in the condensed consolidated statements of financial condition.

The Company’s hedges are designated and qualify for accounting purposes as one of the following types of hedges: hedges of changes in fair value of assets and liabilities due to the risk being hedged (fair value hedges), and hedges of net investments in foreign operations whose functional currency is different from the reporting currency of the parent company (net investment hedges).

For further information on derivative instruments and hedging activities, see Note 8.

Condensed Consolidated Statements of Cash Flows.

For purposes of the condensed consolidated statements of cash flows, cash and cash equivalents consist of Cash and due from banks and Interest bearing deposits with banks, which are highly liquid investments with original maturities of three months or less and readily convertible to known amounts of cash. The Company’s significant non-cash activities include assets acquired of $11.0 billion and assumed liabilities, in connection with business acquisitions, of $3.2 billion in the nine month period ended September 30, 2009. The nine month period ended September 30, 2008 included assumed liabilities of $77 million. During the nine month period ended September 30, 2009, the Company consolidated two real estate funds sponsored by the Company with assets of $600 million, liabilities of $18 million and Non-controlling interests of $582 million. During the nine month period ended September 30, 2008, the Company consolidated real estate limited partnership assets and liabilities of approximately $4.7 billion and $3.9 billion, respectively.

Securitization Activities.

The Company engages in securitization activities related to commercial and residential mortgage loans, corporate bonds and loans, U.S. agency collateralized mortgage obligations and other types of financial assets (see Note 5). Generally, such transfers of financial assets are accounted for as sales when the Company has relinquished control over the transferred assets. The gain or loss on sale of such financial assets depends, in part, on the previous carrying amount of the assets involved in the transfer allocated between the assets sold and the retained interests based upon their respective fair values at the date of sale. Transfers that are not accounted for as sales are treated as secured financings (“failed sales”).

Earnings per Common Share.

Basic earnings per common share (“EPS”) is computed by dividing income available to Morgan Stanley common shareholders by the weighted average number of common shares outstanding for the period. Income available to Morgan Stanley common shareholders represents net income applicable to Morgan Stanley reduced by preferred stock dividends, amortization and the acceleration of discounts on preferred stock issued and allocations of earnings to participating securities. Common shares outstanding include common stock and vested restricted stock unit awards where recipients have satisfied either the explicit vesting terms or retirement-eligible requirements. Diluted EPS reflects the assumed conversion of all dilutive securities.

Effective October 13, 2008, as a result of the adjustment to Equity Units sold to a wholly owned subsidiary of China Investment Corporation Ltd. (“CIC”) (see Note 11), the Company calculates EPS in accordance with accounting guidance for determining EPS for participating securities. The accounting guidance for participating securities and the two-class method of calculating EPS addresses the computation of EPS by companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the company along with common shareholders according to a predetermined formula. The two-class method requires the Company to present EPS as if all of the earnings for the period are distributed to Morgan Stanley common shareholders and any participating securities, regardless of whether any actual dividends or distributions are made. The amount allocated to the participating securities is based upon the contractual terms of their respective contract and is reflected as a reduction to “Net income applicable to Morgan Stanley common shareholders” for both the Company’s basic and diluted EPS calculations (see Note 12). The two-class method does not impact the Company’s actual net income applicable to Morgan Stanley or other financial results. Unless contractually required by the terms of the participating securities, no losses are allocated to participating securities for purposes of the EPS calculation under the two-class method.

In June 2008, the FASB issued accounting guidance on whether share-based payment transactions are participating securities. This accounting guidance addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing EPS under the two-class method as described in the accounting guidance for calculating EPS. Under this accounting guidance, unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of EPS pursuant to the two-class method. The accounting guidance on whether share-based payment transactions are participating securities became effective for the Company on January 1, 2009. All prior-period EPS data presented have been adjusted retrospectively. The Company’s adoption of this accounting guidance, which addresses the computation of EPS under the two-class method for share-based payment transactions that are participating securities, reduced basic EPS by $0.44 and $0.61 for the quarter and nine month period ended September 30, 2008, respectively, and reduced diluted EPS by $0.36 and $0.44 for the quarter and nine month period ended September 30, 2008, respectively.

Goodwill and Intangible Assets.

Goodwill and indefinite-lived intangible assets are not amortized and are reviewed annually (or more frequently when certain events or circumstances exist) for impairment. Other intangible assets are amortized over their estimated useful lives and reviewed for impairment.

Deferred Compensation Arrangements.

Deferred Compensation Plans.    The Company also maintains various deferred compensation plans for the benefit of certain employees that provide a return to the participating employees based upon the performance of various referenced investments. The Company often invests directly, as a principal, in such referenced investments related to its obligations to perform under the deferred compensation plans. Changes in value of such investments made by the Company are recorded primarily in Principal transactions—investments. Expenses associated with the related deferred compensation plans are recorded in Compensation and benefits.

Accounting Developments.

Dividends on Share-Based Payment Awards.    In June 2007, the Emerging Issues Task Force reached consensus on accounting for tax benefits of dividends on share-based payment awards to employees. This accounting guidance requires that the tax benefit related to dividend equivalents paid on restricted stock units that are expected to vest be recorded as an increase to additional paid-in capital. The Company adopted this guidance prospectively effective December 1, 2008. The Company previously accounted for this tax benefit as a reduction to its income tax provision. The adoption of this accounting guidance did not have a material impact on the Company’s condensed consolidated financial statements.

Transfers of Financial Assets and Repurchase Financing Transactions.    In February 2008, the FASB issued accounting guidance to provide implementation guidance for accounting for transfers of financial assets and repurchase financing transactions. Under this guidance, there is a presumption that an initial transfer of a financial asset and a repurchase financing are considered part of the same arrangement (i.e., a linked transaction) for purposes of evaluation. If certain criteria are met, however, the initial transfer and repurchase financing shall not be evaluated as a linked transaction and shall be evaluated separately. The adoption of this accounting guidance on December 1, 2008 did not have a material impact on the Company’s condensed consolidated financial statements.

Determination of the Useful Life of Intangible Assets.    In April 2008, the FASB issued accounting guidance to provide guidance on the determination of the useful life of intangible assets. The guidance removes the requirement for an entity to consider, when determining the useful life of an acquired intangible asset, whether the intangible asset can be renewed without substantial cost or material modifications to the existing terms and conditions associated with the intangible asset. This accounting guidance replaces the previous useful-life assessment criteria with a requirement that an entity shall consider its own experience in renewing similar arrangements. If the entity has no relevant experience, it would consider market participant assumptions regarding renewal. The adoption of this accounting guidance on January 1, 2009 did not have a material impact on the Company’s condensed consolidated financial statements.

Instruments Indexed to an Entity’s Own Stock.    In June 2008, the FASB ratified the consensus reached for determining whether an equity-linked financial instrument (or embedded feature) is indexed to an entity’s own stock. This accounting guidance applies to any freestanding financial instrument or embedded feature that has all of the characteristics of a derivative or freestanding instrument that is potentially settled in an entity’s own stock with certain exceptions. To meet the definition of “indexed to own stock,” an instrument’s contingent exercise provisions must not be based on (a) an observable market, other than the market for the issuer’s stock (if applicable), or (b) an observable index, other than an index calculated or measured solely by reference to the issuer’s own operations, and the variables that could affect the settlement amount must be inputs to the fair value of a “fixed-for-fixed” forward or option on equity shares. The adoption of this accounting guidance on January 1, 2009 did not change the classification or measurement of the Company’s financial instruments.

Disclosures about Postretirement Benefit Plan Assets.    In December 2008, the FASB issued guidance on employers’ disclosures about postretirement benefit plan assets. The disclosures about plan assets required by this guidance will be effective December 31, 2009 for the Company.

Subsequent Events.    In May 2009, the FASB issued accounting guidance to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. It requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date—that is, whether that date represents the date the financial statements were issued or were available to be issued. The Company evaluates subsequent events through the date that the Company’s financial statements are issued, which is the date the Company files Quarterly Reports on Form 10-Q and its Annual Reports on Form 10-K with the Securities and Exchange Commission (“SEC”). The Company adopted this accounting guidance in the quarter ended June 30, 2009. Such adoption did not have a material impact on the Company’s condensed consolidated financial statements.

 

Transfers of Financial Assets and Extinguishments of Liabilities and Consolidation of Variable Interest Entities.    In June 2009, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 166, “Accounting for Transfers of Financial Assets” (“SFAS No. 166”), and SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” (“SFAS No. 167”), which change the way entities account for securitizations and special-purpose entities.

SFAS No. 166 amends the accounting for transfers of financial assets and will require additional disclosures about transfers of financial assets, including securitization transactions, and where entities have continuing exposure to the risks related to transferred financial assets. It eliminates the concept of a QSPE and changes the requirements for derecognizing financial assets.

SFAS No. 167 amends the accounting for consolidation and changes how a reporting entity determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a reporting entity is required to consolidate another entity is based on, among other things, the other entity’s purpose and design and the reporting entity’s ability to direct the activities of the other entity that most significantly impact the other entity’s economic performance.

The Company is currently evaluating the potential impact of adopting SFAS No. 166 and SFAS No. 167. The adoption of SFAS No. 166 and SFAS No. 167 may have a significant impact on the Company’s condensed consolidated financial statements as the Company may be required to consolidate QSPEs to which the Company has previously sold assets. In addition, the Company may also be required to consolidate other VIEs that are not currently consolidated or de-consolidate entities currently consolidated based on an analysis under the current accounting guidance. SFAS No. 166 and SFAS No. 167 will be effective for the Company on January 1, 2010.

FASB Accounting Standards CodificationTM.    In July 2009, the FASB issued accounting guidance to establish the FASB Accounting Standards CodificationTM (“Codification”) to become the source of authoritative U.S. generally accepted accounting principles (“U.S. GAAP”) recognized by the FASB to be applied by nongovernmental entities. All other accounting literature not included in the Codification will be considered non-authoritative. The Codification does not change current U.S. GAAP. In the quarter ended September 30, 2009, references to authoritative U.S. GAAP literature in the Company’s condensed consolidated financial statements and the notes thereto in this Quarterly Report on Form 10-Q have been updated to reflect new Codification references.

Fair Value Measurements and Disclosures.    In April 2009, the FASB issued guidance on determining fair value when the volume and level of activity for the asset or liability have significantly decreased and identifying transactions that are not orderly. This accounting guidance provides additional application guidance in determining fair values when there is no active market or where the price inputs being used represent distressed sales. It reaffirms the objective of fair value measurement—to reflect how much an asset would be sold for in an orderly transaction (as opposed to a distressed or forced transaction) at the date of the financial statements under current market conditions. Specifically, it reaffirms the need to use judgment to ascertain if a formerly active market has become inactive and in determining fair values when markets have become inactive. The Company adopted this guidance in the second quarter of 2009. The adoption did not have a material impact on the Company’s condensed consolidated financial statements.

In April 2009, the FASB issued guidance that requires an entity to provide qualitative and quantitative information on a quarterly basis about fair value estimates for any financial instruments not measured on the balance sheet at fair value. The Company adopted the disclosure requirements in the quarter ended June 30, 2009.

 

In August 2009, the FASB issued Accounting Standards Update (“ASU”) 2009-05 “Fair Value Measurements and Disclosures—Measuring Liabilities at Fair Value” (“ASU 2009-05”). ASU 2009-05 updates the Codification and provides guidance about measuring liabilities at fair value. The adoption of ASU 2009-05 on October 1, 2009 did not have a material impact on the Company’s condensed consolidated financial statements.

In September 2009, the FASB issued ASU 2009-12 “Fair Value Measurements and Disclosures—Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)” (“ASU 2009-12”). ASU 2009-12 updates the Codification and provides additional guidance about measuring the fair value of certain alternative investments, such as hedge funds, private equity funds, real estate funds and venture capital funds. ASU 2009-12 allows companies to determine the fair value of such investments using net asset value (“NAV”) as a practical expedient. ASU 2009-12 also requires new disclosures of the nature and risks of the investments by major category of alternative investments. ASU 2009-12 will be effective for the Company on December 31, 2009. The Company is currently evaluating the potential impact of adopting ASU 2009-12.

v1.0.0.5
2.Morgan Stanley Smith Barney Holdings LLC.
 9 Months Ended
Sep. 30, 2009
USD / shares
Notes to Financial Statements [Abstract]
2.Morgan Stanley Smith Barney Holdings LLC.
2. Morgan Stanley Smith Barney Holdings LLC.

Smith Barney.    On May 31, 2009 (the “Closing Date”), the Company and Citigroup Inc. (“Citi”) consummated the previously announced combination of the Company’s Global Wealth Management Group and the businesses of Citi’s Smith Barney in the U.S., Quilter in the U.K., and Smith Barney Australia (“Smith Barney”). In addition to the Company’s contribution of respective businesses to MSSB, the Company paid Citi $2,755 million in cash. The combined businesses operate as MSSB, which the Company consolidates. Pursuant to the terms of the amended contribution agreement, dated as of May 29, 2009 (“amended contribution agreement”), certain businesses of Smith Barney and Morgan Stanley will be contributed to MSSB subsequent to May 31, 2009 (the “delayed contribution businesses”). Citi will own the delayed contribution businesses until they are transferred to MSSB and gains and losses from such businesses will be allocated to the Company’s and Citi’s respective share of MSSB’s gains and losses.

The Company owns 51% and Citi owns 49% of MSSB, with the Company having appointed four directors to the MSSB board and Citi having appointed two directors. As part of the acquisition, the Company has the option (i) following the third anniversary of the Closing Date to purchase a portion of Citi’s interest in MSSB representing 14% of the total outstanding MSSB interests, (ii) following the fourth anniversary of the Closing Date to purchase a portion of Citi’s interest in MSSB representing an additional 15% of the total outstanding MSSB interests and (iii) following the fifth anniversary of the Closing Date to purchase the remainder of Citi’s interest in MSSB. The Company may call all of Citi’s interest in MSSB upon a change in control of Citi. Citi may put all of its interest in MSSB to the Company upon a change in control of the Company or following the later of the sixth anniversary of the Closing Date and the one-year anniversary of the Company’s exercise of the call described in clause (ii) above. The purchase price for the call and put rights described above is the fair market value of the purchased interests determined pursuant to an appraisal process.

As of May 31, 2009, the Company includes MSSB in its condensed consolidated financial statements. The results of MSSB are included within the Global Wealth Management Group business segment. See Note 11 for further information on MSSB.

The Company accounted for the transaction using the acquisition method of accounting. The fair value of the total consideration transferred to Citi amounted to approximately $6,087 million and the preliminary fair value of Citi’s equity in MSSB was approximately $3,973 million. The acquisition method of accounting prescribes the full goodwill method even in business combinations in which the acquirer holds less than 100% of the equity interests in the acquiree at acquisition date. Accordingly, the full fair value of Smith Barney was allocated to the fair value of assets acquired and liabilities assumed to derive the preliminary goodwill amount of approximately $5,029 million, which represents synergies of combining the two businesses. The Company is still finalizing the valuation of the intangible assets and the fair value of the Company’s contributed businesses into MSSB. When finalized, the amount of total consideration transferred, non-controlling interest, intangible assets and acquisition-related goodwill could change.

The following table summarizes the preliminary allocation of the purchase price to the net assets of Smith Barney as of May 31, 2009 (dollars in millions).

 

Total fair value of consideration transferred

    $ 6,087

Total fair value of non-controlling interest

      3,973
      

Total fair value of Smith Barney(1)

      10,060

Total fair value of net assets acquired

      5,031
      

Preliminary acquisition-related goodwill(2)

    $ 5,029
      

 

(1) Total fair value of Smith Barney is inclusive of control premium.
(2) Goodwill is recorded within the Global Wealth Management business segment. The Company is currently evaluating the amount of goodwill deductible for tax purposes.

Condensed statement of assets acquired and liabilities assumed.    The following table summarizes the preliminary fair values of Smith Barney’s assets acquired and liabilities assumed as of the acquisition date. The allocation of the purchase price is preliminary and subject to further adjustment as the valuation of certain intangible assets is still in process.

 

     At May 31, 2009
     (dollars in millions)

Assets

   

Cash and due from banks

    $ 895

Financial instruments owned

      22

Receivables

      1,891

Intangible assets

      4,890

Other assets

      531
      

Total assets acquired

    $ 8,229
      

Liabilities

   

Financial instrument sold, not yet purchased

    $ 76

Long-term borrowings

      2,320

Other liabilities and accrued expenses

      802
      

Total liabilities assumed

    $ 3,198
      

Net assets acquired

    $ 5,031
      

In addition, the Company recorded a receivable of approximately $1.1 billion relating to the fair value of the Smith Barney delayed contribution businesses as of May 31, 2009 from Citi. Such amount is presented in the condensed consolidated statements of financial condition as a reduction from Non-controlling interests.

 

Amortizable intangible assets included the following as of May 31, 2009:

 

     At May 31, 2009
(dollars in millions)		    Estimated useful
life (in years)

Customer relationships

    $ 4,000    15

Technology

      411    5

Research

      176    5

Intangible lease asset

      24    1-10
         

Total

    $ 4,611   
         

The Company also recorded an indefinite-lived intangible asset of approximately $279 million related to the Smith Barney trade name.

Citi Managed Futures.    Citi contributed its managed futures business and certain related proprietary trading positions to MSSB on July 31, 2009 (“Citi Managed Futures”). The Company paid Citi approximately $300 million in cash in connection with this transfer. As of July 31, 2009, Citi Managed Futures is wholly-owned and consolidated by MSSB, of which the Company owns 51% and Citi owns 49%.

The Company accounted for this transaction using the acquisition method of accounting. The fair value of the total consideration transferred to Citi was approximately $300 million and the preliminary increase in the fair value of Citi’s equity in MSSB was approximately $289 million. The acquisition method of accounting prescribes the full goodwill method even in business combinations in which the acquirer holds less than 100% of the equity interests in the acquiree at acquisition date. Accordingly, the full fair value of Citi Managed Futures was allocated to the fair value of the assets acquired and liabilities assumed to derive the preliminary goodwill amount of approximately $136 million, which represents business synergies of combining the Citi Managed Futures business with MSSB. The Company is still finalizing the valuation of the intangible assets. When finalized, the amount of intangible assets and acquisition-related goodwill could change.

The following table summarizes the preliminary allocation of the purchase price to the net assets of Citi Managed Futures as of July 31, 2009 (dollars in millions).

 

Total fair value of consideration transferred

    $ 300

Total fair value of non-controlling interest

      289
      

Total fair value of Citi Managed Futures

      589

Total fair value of net assets acquired

      453
      

Preliminary acquisition-related goodwill(1)

    $ 136
      

 

(1) Goodwill is recorded within the Global Wealth Management business segment. The Company is currently evaluating the amount of goodwill deductible for tax purposes.

 

Condensed statement of assets acquired and liabilities assumed.    The following table summarizes the preliminary fair values of the assets acquired and liabilities assumed as of the acquisition date. The allocation of the purchase price is preliminary and subject to further adjustment as the valuation of certain intangible assets is still in process.

 

     At July 31, 2009
     (dollars in millions)

Assets

   

Financial instruments owned

    $ 83

Receivables

      86

Intangible assets

      275

Other assets

      11
      

Total assets acquired

    $ 455
      

Liabilities

   

Other liabilities and accrued expenses

    $ 2
      

Total liabilities assumed

    $ 2
      

Net assets acquired

    $ 453
      

As of July 31, 2009, amortizable intangible assets in the amount of $275 million were primarily related to management contracts with an estimated useful life of eight to nine years.

 

Pro forma condensed combined financial information

The following unaudited pro forma condensed combined financial information presents the results of operations of the Company as they may have appeared if the closing of MSSB and Citi Managed Futures had been completed on January 1, 2009 and January 1, 2008 (dollars in millions, except share data).

 

     Three Months
Ended
September 30,		    Nine Months
Ended
September 30,
     2009    2008    2009     2008
     (unaudited)    (unaudited)

Net revenues

    $ 8,681    $ 20,013    $ 19,838      $ 38,174

Total non-interest expenses

      7,464      9,225      19,795        24,126
                            

Income from continuing operations before income taxes

      1,217      10,788      43        14,048

Provision for (benefit from) income taxes

      423      3,009      (522 )      3,884
                            

Income from continuing operations

      794      7,779      565        10,164

Discontinued operations:

           

Gain from discontinued operations

      —        756      537        1,553

Provision for income taxes

      —        292      204        602
                            

Gain on discontinued operations

      —        464      333        951
                            

Net income

      794      8,243      898        11,115

Net income applicable to non-controlling interests

      37      100      81        198
                            

Net income applicable to Morgan Stanley

    $ 757    $ 8,143    $ 817      $ 10,917
                            

Earnings (loss) applicable to Morgan Stanley common shareholders

    $ 498    $ 7,677    $ (1,213 )    $ 10,227
                            

Earnings (loss) per basic common share:

           

Income (loss) from continuing operations

    $ 0.39    $ 6.97    $ (1.34 )    $ 9.01

Gain on discontinued operations

      —        0.41      0.28        0.84
                            

Earnings (loss) per basic common share

    $ 0.39    $ 7.38    $ (1.06 )    $ 9.85
                            

Earnings (loss) per diluted common share:

           

Income (loss) from continuing operations

    $ 0.38    $ 6.96    $ (1.34 )    $ 8.98

Gain on discontinued operations

      —        0.41      0.28        0.84
                            

Earnings (loss) per diluted common share

    $ 0.38    $ 7.37    $ (1.06 )    $ 9.82
                            

The unaudited pro forma condensed combined financial information is presented for illustrative purposes only and does not indicate the actual financial results of the Company had the closing of Smith Barney and Citi Managed Futures been completed on January 1, 2009 and January 1, 2008, respectively, nor is it indicative of the results of operations in future periods. Included in the unaudited pro forma combined financial information for the quarters and nine month periods ended September 30, 2009 and September 30, 2008, were pro forma adjustments to reflect the results of operations of both Smith Barney and Citi Managed Futures as well as the impact of amortizing certain acquisition accounting adjustments such as amortizable intangible assets. The pro forma condensed financial information does not indicate the impact of possible business model changes nor does it consider any potential impacts of current market conditions, expense efficiencies or other factors.

v1.0.0.5
3.Fair Value Disclosures.
 9 Months Ended
Sep. 30, 2009
USD / shares
Notes to Financial Statements [Abstract]
3.Fair Value Disclosures.
3. Fair Value Disclosures.

Fair Value Measurements.

A description of the valuation techniques applied to the Company’s major categories of assets and liabilities measured at fair value on a recurring basis follows.

Financial Instruments Owned and Financial Instruments Sold, Not Yet Purchased

U.S. Government and Agency Securities

 

  •  

U.S. Treasury Securities.    U.S. treasury securities are valued using quoted market prices. Valuation adjustments are not applied. Accordingly, U.S. treasury securities are generally categorized in Level 1 of the fair value hierarchy.

 

  •  

U.S. Agency Securities.    U.S. agency securities are comprised of two main categories consisting of agency issued debt and mortgage pass-throughs. Non-callable agency issued debt securities are generally valued using quoted market prices. Callable agency issued debt securities are valued by benchmarking model-derived prices to quoted market prices and trade data for identical or comparable securities. Mortgage pass-throughs include mortgage pass-throughs and forward settling mortgage pools. Fair value of mortgage pass-throughs are model driven with respect to spreads of the comparable To-be-announced (“TBA”) security. Actively traded non-callable agency issued debt securities are categorized in Level 1 of the fair value hierarchy. Callable agency issued debt securities and mortgage pass-throughs are generally categorized in Level 2 of the fair value hierarchy.

Other Sovereign Government Obligations

 

  •  

Foreign sovereign government obligations are valued using quoted prices in active markets when available. To the extent quoted prices are not available, fair value is determined based on a valuation model that has as inputs interest rate yield curves, cross-currency basis index spreads, and country credit spreads for structures similar to the bond in terms of issuer, maturity and seniority. These bonds are generally categorized in Levels 1 or 2 of the fair value hierarchy.

Corporate and Other Debt

 

  •  

State and Municipal Securities.    The fair value of state and municipal securities is estimated using recently executed transactions, market price quotations and pricing models that factor in, where applicable, interest rates, bond or credit default swap spreads and volatility. These bonds are generally categorized in Level 2 of the fair value hierarchy.

 

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Residential Mortgage-Backed Securities (“RMBS”), Commercial Mortgage-Backed Securities (“CMBS”), and other Asset-Backed Securities (“ABS”).    RMBS, CMBS and other ABS may be valued based on external price or spread data. When position-specific external price data are not observable, the valuation is based on prices of comparable bonds. Valuation levels of RMBS and CMBS indices are used as an additional data point for benchmarking purposes or to price outright index positions.

Fair value for retained interests in securitized financial assets (in the form of one or more tranches of the securitization) is determined using observable prices or, in cases where observable prices are not available for certain retained interests, the Company estimates fair value based on the present value of expected future cash flows using its best estimates of the key assumptions, including forecasted credit losses, prepayment rates, forward yield curves and discount rates commensurate with the risks involved.

 

RMBS, CMBS and other ABS, including retained interests in these securitized financial assets, are categorized in Level 3 if external prices or spread inputs are unobservable or if the comparability assessment involves significant subjectivity related to property type differences, cash flows, performance and other inputs; otherwise, they are categorized in Level 2 of the fair value hierarchy.

 

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Corporate Bonds.    The fair value of corporate bonds is estimated using recently executed transactions, market price quotations (where observable), bond spreads or credit default swap spreads adjusted for any basis difference between cash and derivative instruments. The spread data used are for the same maturity as the bond. If the spread data does not reference the issuer, then data that reference a comparable issuer are used. When observable price quotations are not available, fair value is determined based on cash flow models with yield curves, bond or single name credit default swap spreads and recovery rates based on collateral values as significant inputs. Corporate bonds are generally categorized in Level 2 of the fair value hierarchy; in instances where prices, spreads or any of the other aforementioned key inputs are unobservable, they are categorized in Level 3 of the fair value hierarchy.

 

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Collateralized Debt Obligations (“CDOs”).    The Company holds CDOs where the collateral primarily is synthetic and references either a basket credit default swap or CDO-squared. The correlation input between reference credits within the collateral is unobservable and is benchmarked to standardized proxy baskets for which correlation data are available. The other model inputs such as credit spreads, interest rates and recovery rates are observable. CDOs are categorized in Level 2 of the fair value hierarchy when the correlation input is insignificant. In instances where the correlation input is deemed to be significant, these instruments are categorized in Level 3 of the fair value hierarchy.

 

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Corporate Loans and Lending Commitments.    The fair value of corporate loans is estimated using recently executed transactions, market price quotations (where observable) and market observable credit default swap spread levels adjusted for any basis difference between cash and derivative instruments, along with proprietary valuation models and default recovery analysis where such transactions and quotations are unobservable. The fair value of contingent corporate lending commitments is estimated by using executed transactions on comparable loans and the anticipated market price based on pricing indications from syndicate banks and customers. The valuation of these commitments also takes into account certain fee income. Corporate loans and lending commitments are generally categorized in Level 2 of the fair value hierarchy; in instances where prices or significant spread inputs are unobservable, they are categorized in Level 3 of the fair value hierarchy.

 

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Mortgage Loans.    Mortgage loans are valued using prices based on trade data for identical or comparable instruments. Where observable prices are not available, the Company estimates fair value based on benchmarking to prices and rates observed in the primary market for similar loan or borrower types, or based on the present value of expected future cash flows using its best estimates of the key assumptions, including forecasted credit losses, prepayment rates, forward yield curves and discount rates commensurate with the risks involved. Due to the subjectivity involved in comparability assessment related to mortgage loan vintage, geographical concentration, prepayment speed and projected loss assumptions, the majority of loans are classified in Level 3 of the fair value hierarchy.

 

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Auction Rate Securities (“ARS”).    The Company primarily holds investments in Student Loan Auction Rate Securities (“SLARS”) and Municipal Auction Rate Securities (“MARS”) with interest rates that are reset through periodic auctions. SLARS are ABS backed by pools of student loans. MARS are municipal bonds often wrapped by municipal bond insurance. ARS were historically traded and valued as floating rate notes, priced at par due to the auction mechanism. Beginning in fiscal 2008, uncertainties in the credit markets have resulted in auctions failing for certain types of ARS. Once the auctions failed, ARS could no longer be valued using observations of auction market prices. Accordingly, the fair value of ARS is determined using independent external market data where available and an internally developed methodology to discount for the lack of liquidity and non-performance risk in the current market environment.

Inputs that impact the valuation of SLARS are the underlying collateral types, amount of leverage in each structure, credit rating and liquidity considerations. Inputs that impact the valuation of MARS are independent external market data, the maximum rate, quality of underlying issuers/insurers and evidence of issuer calls. MARS are generally categorized in Level 2 as the valuation technique relies on observable external data. The majority of SLARS are generally categorized in Level 3 of the fair value hierarchy.

Corporate Equities

 

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Exchange-Traded Equity Securities.    Exchange-traded equity securities are generally valued based on quoted prices from the exchange. To the extent these securities are actively traded, valuation adjustments are not applied and they are categorized in Level 1 of the fair value hierarchy.

Derivative and Other Contracts

 

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Listed Derivative Contracts.    Listed derivatives that are actively traded are valued based on quoted prices from the exchange and are categorized in Level 1 of the fair value hierarchy. Listed derivatives that are not actively traded are valued using the same approaches as those applied to OTC derivatives; they are generally categorized in Level 2 of the fair value hierarchy.

 

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OTC Derivative Contracts.    OTC derivative contracts include forward, swap and option contracts related to interest rates, foreign currencies, credit standing of reference entities, equity prices or commodity prices.

Depending on the product and the terms of the transaction, the fair value of OTC derivative products can be either observed or modeled using a series of techniques, and model inputs from comparable benchmarks, including closed-form analytic formula, such as the Black-Scholes option-pricing model, and simulation models or a combination thereof. Many pricing models do not entail material subjectivity because the methodologies employed do not necessitate significant judgment, and the pricing inputs are observed from actively quoted markets, as is the case for generic interest rate swaps, certain option contracts and certain credit default swaps. In the case of more established derivative products, the pricing models used by the Company are widely accepted by the financial services industry. A substantial majority of OTC derivative products valued by the Company using pricing models fall into this category and are categorized within Level 2 of the fair value hierarchy.

Other derivative products include complex products that have become illiquid, require more judgment in the implementation of the valuation technique applied due to the complexity of the valuation assumptions and the reduced observability of inputs. This includes derivative interests in certain mortgage-related CDO securities, basket credit default swaps, CDO-squared positions and certain types of ABS credit default swaps where direct trading activity or quotes are unobservable. These instruments involve significant unobservable inputs and are categorized in Level 3 of the fair value hierarchy.

Derivative interests in complex mortgage-related CDOs and credit default swaps, for which observability of external price data is extremely limited, are valued based on an evaluation of the market and model input parameters sourced from similar positions as indicated by primary and secondary market activity. Each position is evaluated independently taking into consideration the underlying collateral performance and pricing, behavior of the tranche under various cumulative loss and prepayment scenarios, deal structures (e.g., non-amortizing reference obligations, call features) and liquidity. While these factors may be supported by historical and actual external observations, the determination of their value as it relates to specific positions nevertheless requires significant judgment.

For basket credit default swaps and CDO-squared positions, the correlation input between reference credits is unobservable for each specific swap and is benchmarked to standardized proxy baskets for which correlation data are available. The other model inputs such as credit spread, interest rates and recovery rates are observable. In instances where the correlation input is deemed to be significant, these instruments are categorized in Level 3 of the fair value hierarchy.

The Company trades various derivative structures with commodity underlyings. Depending on the type of structure, the model inputs generally include interest rate yield curves, commodity underlier curves, implied volatility of the underlying commodities and, in some cases, the implied correlation between these inputs. The fair value of these products is estimated using executed trades and broker and consensus data to provide values for the aforementioned inputs. Where these inputs are unobservable, relationships to observable commodities and data points, based on historic and/or implied observations, are employed as a technique to estimate the model input values. Commodity derivatives are generally categorized in Level 2 of the fair value hierarchy; in instances where significant inputs are unobservable, they are categorized in Level 3 of the fair value hierarchy.

For further information on derivative instruments and hedging activities, see Note 8.

Investments

 

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Investments in Private Equity, Real Estate and Hedge Funds.    The Company’s investments include direct private equity investments and investments in private equity funds, real estate funds and hedge funds. Initially, the transaction price is generally considered by the Company as the exit price and is the Company’s best estimate of fair value. Thereafter, valuation is based on an assessment of each underlying investment, considering rounds of financing and third-party transactions, expected cash flows and market-based information, including comparable company transactions, trading multiples and changes in market outlook, among other factors. In determining the fair value of externally managed funds, the Company also considers the net asset value of the fund provided by the fund manager. These investments are included in Level 3 of the fair value hierarchy because, due to infrequent trading, exit prices tend to be unobservable and reliance is placed on the above methods.

Physical Commodities

 

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The Company trades various physical commodities, including crude oil and refined products, natural gas, base and precious metals and agricultural products. Fair value for physical commodities is determined using observable inputs, including broker quotations and published indices. Physical commodities are categorized in Level 2 of the fair value hierarchy.

Commercial Paper and Other Short-term Borrowings/Long-Term Borrowings

 

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Structured Notes.    The Company issues structured notes that have coupons or repayment terms linked to the performance of debt or equity securities, indices, currencies or commodities. Fair value of structured notes is estimated using valuation models for the derivative and debt portions of the notes. These models incorporate observable inputs referencing identical or comparable securities, including prices that the notes are linked to, interest rate yield curves, option volatility, and currency, commodity or equity rates. The impact of the Company’s own credit spreads is also included based on the Company’s observed secondary bond market spreads. Most structured notes are categorized in Level 2 of the fair value hierarchy.

Deposits

 

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Time Deposits.    The fair value of certificates of deposit is estimated using third-party quotations. These deposits are generally categorized in Level 2 of the fair value hierarchy.

The following fair value hierarchy tables present information about the Company’s assets and liabilities measured at fair value on a recurring basis as of September 30, 2009, December 31, 2008 and November 30, 2008. See Note 1 for a discussion of the Company’s policies regarding this fair value hierarchy.

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis as of September 30, 2009

 

    Quoted Prices in
Active Markets for
Identical Assets
(Level 1)