Form 10-Q

Form 10-Q 10-Q 1 d10q.htm FORM 10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2010

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

Commission File Number 1-11758

LOGO

(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)

Indicate by check mark whether the 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 the 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 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		Accelerated Filer ¨
Non-Accelerated Filer ¨		Smaller reporting company ¨
(Do not check if a smaller reporting company)

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

As of April 30, 2010, there were 1,397,819,191 shares of the Registrant’s Common Stock, par value $0.01 per share, outstanding.

LOGO

QUARTERLY REPORT ON FORM 10-Q

For the quarter ended March 31, 2010


Table of Contents		Page
Part I—Financial Information
Item 1.	Financial Statements (unaudited)	1
	Condensed Consolidated Statements of Financial Condition—March 31, 2010 and December 31, 2009	1
	Condensed Consolidated Statements of Income—Three Months Ended March 31, 2010 and 2009	3
	Condensed Consolidated Statements of Comprehensive Income—Three Months Ended March 31, 2010 and 2009	4
	Condensed Consolidated Statements of Cash Flows—Three Months Ended March 31, 2010 and 2009	5
	Condensed Consolidated Statements of Changes in Total Equity—Three Months Ended March 31, 2010 and 2009	6
	Notes to Condensed Consolidated Financial Statements (unaudited)	8
	Note 1. Basis of Presentation and Summary of Significant Accounting Policies	8
	Note 2. Morgan Stanley Smith Barney Holdings LLC	16
	Note 3. Fair Value Disclosures	18
	Note 4. Securities Available for Sale	36
	Note 5. Collateralized Transactions	36
	Note 6. Variable Interest Entities and Securitization Activities	38
	Note 7. Goodwill and Net Intangible Assets	48
	Note 8. Long-Term Borrowings	49
	Note 9. Derivative Instruments and Hedging Activities	50
	Note 10. Commitments, Guarantees and Contingencies	57
	Note 11. Regulatory Requirements	62
	Note 12. Total Equity	64
	Note 13. Earnings per Common Share	65
	Note 14. Interest Income and Interest Expense	66
	Note 15. Employee Benefit Plans	67
	Note 16. Income Taxes	67
	Note 17. Segment and Geographic Information	68
	Note 18. Discontinued Operations	70
	Note 19. Subsequent Events	71
	Report of Independent Registered Public Accounting Firm	72
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	73
	Introduction	73
	Executive Summary	75
	Certain Factors Affecting Results of Operations	82
	Business Segments	85
	Accounting Developments	95
	Other Matters	96
	Critical Accounting Policies	98
	Liquidity and Capital Resources	103
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	114
	Financial Data Supplement (Unaudited)	125


		i


		Page
Part II—Other Information
Item 1.	Legal Proceedings	128
Item 1A.	Risk Factors	128
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	129
Item 6.	Exhibits	129


		ii

AVAILABLE INFORMATION

Morgan Stanley 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 we file 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 Morgan Stanley) file electronically with the SEC. Morgan Stanley’s electronic SEC filings are available to the public at the SEC’s internet site, www.sec.gov.

Morgan Stanley’s internet site is www.morganstanley.com. You can access Morgan Stanley’s Investor Relations webpage at www.morganstanley.com/about/ir. Morgan Stanley 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. Morgan Stanley also makes available, through its Investor Relations webpage, via a link to the SEC’s internet site, statements of beneficial ownership of Morgan Stanley’s equity securities filed by its directors, officers, 10% or greater shareholders and others under Section 16 of the Exchange Act.

Morgan Stanley has a Corporate Governance webpage. You can access information about Morgan Stanley’s corporate governance at www.morganstanley.com/about/company/governance. Morgan Stanley 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;

•

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. Morgan Stanley 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 Morgan Stanley’s internet site is not incorporated by reference into this report.


		iii

Part I—Financial Information.

Item 1.

Financial Statements.

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(dollars in millions, except share data)

(unaudited)


	March 31, 2010		December 31, 2009
Assets
Cash and due from banks	$	5,979	$	6,988
Interest bearing deposits with banks		29,499		25,003
Cash deposited with clearing organizations or segregated under federal and other regulations or requirements		22,367		23,712
Financial instruments owned, at fair value (approximately $128 billion at March 31, 2010 and $101 billion at December 31, 2009 were pledged to various parties):
U.S. government and agency securities		69,274		62,215
Other sovereign government obligations		31,341		25,445
Corporate and other debt ($5,809 at March 31, 2010 related to consolidated variable interest entities, generally not available to the Company)		90,192		90,454
Corporate equities		67,591		57,968
Derivative and other contracts		47,906		49,081
Investments ($1,102 at March 31, 2010 related to consolidated variable interest entities, generally not available to the Company)		9,482		9,286
Physical commodities		4,898		5,329

Total financial instruments owned, at fair value		320,684		299,778
Securities available for sale		18,637		—
Securities received as collateral, at fair value		16,891		13,656
Federal funds sold and securities purchased under agreements to resell		138,633		143,208
Securities borrowed		181,055		167,501
Receivables:
Customers		25,949		27,594
Brokers, dealers and clearing organizations		6,575		5,719
Fees, interest and other		9,768		11,164
Loans		7,484		7,259
Other investments		3,901		3,752
Premises, equipment and software costs (net of accumulated depreciation of $3,915 at March 31, 2010 and $3,734 at December 31, 2009) ($388 at March 31, 2010 related to consolidated variable interest entities, generally not available to the Company)		6,047		7,067
Goodwill		7,169		7,162
Intangible assets (net of accumulated amortization of $365 at March 31, 2010 and $275 at December 31, 2009) (includes $175 and $137 at fair value at March 31, 2010 and December 31, 2009, respectively)		4,998		5,054
Other assets ($398 at March 31, 2010 related to consolidated variable interest entities, generally not available to the Company)		14,083		16,845

Total assets	$	819,719	$	771,462

See Notes to Condensed Consolidated Financial Statements.


		1

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION—(CONTINUED)

(dollars in millions, except share data)

(unaudited)


	March 31, 2010			December 31, 2009
Liabilities and Equity
Commercial paper and other short-term borrowings (includes $1,520 and $791 at fair value at March 31, 2010 and December 31, 2009, respectively)	$	3,323		$	2,378
Deposits (includes $4,789 and $4,967 at fair value at March 31, 2010 and December 31, 2009, respectively)		63,926			62,215
Financial instruments sold, not yet purchased, at fair value:
U.S. government and agency securities		26,220			20,503
Other sovereign government obligations		22,754			18,244
Corporate and other debt		9,643			7,826
Corporate equities		29,409			22,601
Derivative and other contracts		37,777			38,209
Physical commodities		39			—

Total financial instruments sold, not yet purchased, at fair value		125,842			107,383
Obligation to return securities received as collateral, at fair value		16,891			13,656
Securities sold under agreements to repurchase		174,591			159,401
Securities loaned		31,372			26,246
Other secured financings, at fair value ($4,883 at March 31, 2010 related to consolidated variable interest entities and are non-recourse to the Company)		9,560			8,102

Payables:
Customers		121,025			117,058
Brokers, dealers and clearing organizations		12,121			5,423
Interest		2,729			2,597
Other liabilities and accrued expenses		13,957			20,849
Long-term borrowings (includes $38,373 and $37,610 at fair value at March 31, 2010 and December 31, 2009, respectively)		189,203			193,374

		764,540			718,682

Commitments and contingencies
Equity
Morgan Stanley shareholders’ equity:
Preferred stock		9,597			9,597
Common stock, $0.01 par value;
Shares authorized: 3,500,000,000 at March 31, 2010 and December 31, 2009;
Shares issued: 1,487,850,163 at March 31, 2010 and December 31, 2009;
Shares outstanding: 1,398,469,576 at March 31, 2010 and 1,360,595,214 at December 31, 2009		15			15
Paid-in capital		6,750			8,619
Retained earnings		36,539			35,056
Employee stock trust		3,772			4,064
Accumulated other comprehensive loss		(559	)		(560	)
Common stock held in treasury, at cost, $0.01 par value; 89,380,587 shares at March 31, 2010 and 127,254,949 shares at December 31, 2009		(4,078	)		(6,039	)
Common stock issued to employee trust		(3,772	)		(4,064	)

Total Morgan Stanley shareholders’ equity		48,264			46,688
Non-controlling interests		6,915			6,092

Total equity		55,179			52,780

Total liabilities and equity	$	819,719		$	771,462

See Notes to Condensed Consolidated Financial Statements.


		2

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

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

(unaudited)


	Three Months Ended March 31,
	2010			2009
Revenues:
Investment banking	$	1,060		$	873
Principal transactions:
Trading		3,751			1,355
Investments		369			(1,150	)
Commissions		1,261			770
Asset management, distribution and administration fees		1,963			866
Other		293			247

Total non-interest revenues		8,697			2,961

Interest income		1,748			2,245
Interest expense		1,367			2,309

Net interest		381			(64	)

Net revenues		9,078			2,897

Non-interest expenses:
Compensation and benefits		4,418			1,978
Occupancy and equipment		392			337
Brokerage, clearing and exchange fees		348			248
Information processing and communications		395			282
Marketing and business development		134			110
Professional services		395			303
Other		480			269

Total non-interest expenses		6,562			3,527

Income (loss) from continuing operations before income taxes		2,516			(630	)
Provision for (benefit from) income taxes		436			(595	)

Income (loss) from continuing operations		2,080			(35	)

Discontinued operations:
Loss from discontinued operations		(100	)		(255	)
Benefit from income taxes		(31	)		(100	)

Net loss from discontinued operations		(69	)		(155	)

Net income (loss)	$	2,011		$	(190	)
Net income (loss) applicable to non-controlling interests		235			(13	)

Net income (loss) applicable to Morgan Stanley	$	1,776		$	(177	)

Earnings (loss) applicable to Morgan Stanley common shareholders	$	1,411		$	(578	)

Amounts applicable to Morgan Stanley:
Income (loss) from continuing operations	$	1,845		$	(17	)
Net loss from discontinued operations		(69	)		(160	)

Net income (loss) applicable to Morgan Stanley	$	1,776		$	(177	)

Earnings (loss) per basic common share:
Income (loss) from continuing operations	$	1.12		$	(0.41	)
Net loss from discontinued operations		(0.05	)		(0.16	)

Earnings (loss) per basic common share	$	1.07		$	(0.57	)

Earnings (loss) diluted common share:
Income (loss) from continuing operations	$	1.03		$	(0.41	)
Net loss from discontinued operations		(0.04	)		(0.16	)

Earnings (loss) per diluted common share	$	0.99		$	(0.57	)

Average common shares outstanding:
Basic		1,314,608,020			1,011,741,210

Diluted		1,626,207,327			1,011,741,210

See Notes to Condensed Consolidated Financial Statements.


		3

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(dollars in millions)


	Three Months Ended March 31,
	2010			2009
	(unaudited)
Net income (loss)	$	2,011		$	(190	)
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments(1)		14			(59	)
Amortization of cash flow hedges(2)		3			3
Net unrealized gains (losses) on Securities available for sale(3)		(20	)		—
Pension and postretirement related adjustments(4)		4			5

Comprehensive income (loss)	$	2,012		$	(241	)
Net income (loss) applicable to non-controlling interests		235			(13	)
Other comprehensive (loss) income applicable to non-controlling interests		(12	)		—

Comprehensive income (loss) applicable to Morgan Stanley	$	1,789		$	(228	)

(1)	Amounts are net of provision for income taxes of $89 million and $31 million for the quarters ended March 31, 2010 and 2009, respectively.

(2)	Amounts are net of provision for income taxes of $2 million for the quarters ended March 31, 2010 and 2009, respectively.

(3)	Amount is net of benefit from income taxes of $14 million for the quarter ended March 31, 2010.

(4)	Amounts are net of provision for income taxes of $2 million and $3 million for quarters ended March 31, 2010 and 2009, respectively.

See Notes to Condensed Consolidated Financial Statements.


		4

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in millions)


	Three Months Ended March 31,
	2010			2009
	(unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)	$	2,011		$	(190	)
Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities:
Compensation payable in common stock and options		370			204
Depreciation and amortization		154			155
Loss on business dispositions		932			19
Gain on repurchase of long-term debt		—			(233	)
Impairment charges and other-than-temporary impairment charges		10			278
Changes in assets and liabilities:
Cash deposited with clearing organizations or segregated under federal and other regulations or requirements		1,345			945
Financial instruments owned, net of financial instruments sold, not yet purchased		(5,073	)		1,711
Securities borrowed		(13,554	)		(4,537	)
Securities loaned		5,126			4,526
Receivables, loans and other assets		4,521			2,771
Payables and other liabilities		5,487			(17,767	)
Federal funds sold and securities purchased under agreements to resell		4,575			2,169
Securities sold under agreements to repurchase		15,190			(22,572	)

Net cash provided by (used for) operating activities		21,094			(32,521	)

CASH FLOWS FROM INVESTING ACTIVITIES
Net (payments for) proceeds from:
Premises, equipment and software costs		(138	)		(1,127	)
Business dispositions, net of cash disposed		—			(8	)
Purchases of securities available for sale		(18,674	)		—

Net cash used for investing activities		(18,812	)		(1,135	)

CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from (payments for):
Short-term borrowings		945			(6,691	)
Derivatives financing activities		(39	)		(53	)
Other secured financings		1,458			(2,024	)
Deposits		1,711			8,567
Excess tax benefits associated with stock-based awards		2			10
Net proceeds from:
Issuance of common stock		1			19
Issuance of long-term borrowings		7,755			19,433
Payments for:
Long-term borrowings		(9,693	)		(14,414	)
Repurchases of common stock for employee tax withholding		(262	)		(14	)
Cash dividends		(293	)		(645	)

Net cash provided by financing activities		1,585			4,188

Effect of exchange rate changes on cash and cash equivalents		(380	)		(661	)

Net increase (decrease) in cash and cash equivalents		3,487			(30,129	)
Cash and cash equivalents, at beginning of period		31,991			78,670

Cash and cash equivalents, at end of period	$	35,478		$	48,541

Cash and cash equivalents include:
Cash and due from banks	$	5,979		$	8,019
Interest bearing deposits with banks		29,499			40,522

Cash and cash equivalents, at end of period	$	35,478		$	48,541

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

Cash payments for interest were $1,178 million and $2,856 million for the quarters ended March 31, 2010 and 2009, respectively.

Cash payments for income taxes were $169 million and $97 million for the quarters ended March 31, 2010 and 2009, respectively.

See Notes to Condensed Consolidated Financial Statements.


		5

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN TOTAL EQUITY

Three Months Ended March 31, 2010

(dollars in millions)

(unaudited)


	Preferred Stock		Common Stock		Paid-in Capital			Retained Earnings			Employee Stock Trust			Accumulated Other Comprehensive Income (Loss)			Common Stock Held in Treasury at Cost			Common Stock Issued to Employee Trust			Non- controlling Interests			Total Equity
BALANCE AT DECEMBER 31, 2009	$	9,597	$	15	$	8,619		$	35,056		$	4,064		$	(560	)	$	(6,039	)	$	(4,064	)	$	6,092		$	52,780
Net income		—		—		—			1,776			—			—			—			—			235			2,011
Dividends		—		—		—			(293	)		—			—			—			—			—			(293	)
Shares issued under employee plans and related tax effects		—		—		(1,869	)		—			(292	)		—			2,223			292			—			354
Repurchases of common stock		—		—		—			—			—			—			(262	)		—			—			(262	)
Net change in cash flow hedges		—		—		—			—			—			3			—			—			—			3
Pension and postretirement adjustments		—		—		—			—			—			4			—			—			—			4
Foreign currency translation adjustments		—		—		—			—			—			14			—			—			(12	)		2
Change in net unrealized gains (losses) on securities available for sale		—		—		—			—			—			(20	)		—			—			—			(20	)
Increases for issuances of shares by a subsidiary of the Company		—		—		—			—			—			—			—			—			51			51
Increases for the sale of a subsidiary’s shares by the Company		—		—		—			—			—			—			—			—			25			25
Increase in non-controlling interests related to the consolidation of certain real estate partnerships sponsored by the Company		—		—		—			—			—			—			—			—			468			468
Decrease in non-controlling interests related to dividends of non-controlling interests		—		—		—			—			—			—			—			—			(7	)		(7	)
Other increases in non-controlling interests		—		—		—			—			—			—			—			—			63			63

BALANCE AT MARCH 31, 2010	$	9,597	$	15	$	6,750		$	36,539		$	3,772		$	(559	)	$	(4,078	)	$	(3,772	)	$	6,915		$	55,179

See Notes to Condensed Consolidated Financial Statements.


		6

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN TOTAL EQUITY—(Continued)

Three Months Ended March 31, 2009

(dollars in millions)

(unaudited)


	Preferred Stock		Common Stock		Paid-in Capital			Retained Earnings			Employee Stock Trust			Accumulated Other Comprehensive Income (Loss)			Common Stock Held in Treasury at Cost			Common Stock Issued to Employee Trust			Non- controlling Interest			Total Equity
BALANCE AT DECEMBER 31, 2008	$	19,168	$	12	$	459		$	36,154		$	4,312		$	(420	)	$	(6,620	)	$	(4,312	)	$	703		$	49,456
Net loss		—		—		—			(177	)		—			—			—			—			(13	)		(190	)
Dividends		—		—		—			(360	)		—			—			—			—			(5	)		(365	)
Shares issued under employee plans and related tax effects		—		—		(30	)		—			(145	)		—			401			145			—			371
Repurchases of common stock		—		—		—			—			—			—			(14	)		—			—			(14	)
Preferred stock accretion		40		—					(40	)		—			—			—			—			—			—
Net change in cash flow hedges		—		—		—			—			—			3			—			—			—			3
Pension and postretirement adjustments		—		—		—			—			—			5			—			—			—			5
Foreign currency translation adjustments		—		—		—			—			—			(59	)		—			—			—			(59	)

BALANCE AT MARCH 31, 2009	$	19,208	$	12	$	429		$	35,577		$	4,167		$	(471	)	$	(6,233	)	$	(4,167	)	$	685		$	49,207

See Notes to Condensed Consolidated Financial Statements.


		7

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.	Basis of Presentation and Summary of Significant Accounting Policies.

The Company. Morgan Stanley (or the “Company”), 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.

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 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.

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.

Revel Entertainment Group, LLC. On March 31, 2010, the Board of Directors authorized a plan of disposal by sale for 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. Total assets of Revel included in the Company’s condensed consolidated statement of financial condition at March 31, 2010 approximated $240 million. The results of Revel are reported as discontinued operations for all periods presented and were formerly included within the Institutional Securities business segment. The quarter ended March 31, 2010 includes a loss of approximately $932 million in connection with such planned disposition.

Retail Asset Management Business. On October 19, 2009, as part of a restructuring of its Asset Management business segment, the Company entered into a definitive agreement to sell substantially all of its retail asset management business (“Retail Asset Management”), including Van Kampen Investments, Inc. (“Van Kampen”), to Invesco Ltd. (“Invesco”). This transaction allows the Company’s Asset Management business segment to focus on its institutional client base, including corporations, pension plans, large intermediaries, foundations and endowments, sovereign wealth funds and central banks, among others.

Under the terms of the definitive agreement, Invesco will purchase substantially all of Retail Asset Management, operating under both the Morgan Stanley and Van Kampen brands, in a stock and cash transaction. The Company will receive a 9.4% minority interest in Invesco. The transaction, which has been approved by the Boards of Directors of both companies, is expected to close in mid-2010, subject to customary regulatory, client and fund shareholder approvals. Total assets of Retail Asset Management included in the Company’s condensed consolidated statement of financial condition at March 31, 2010 approximated $950 million. The results of Retail Asset Management are reported as discontinued operations for all periods presented.

MSCI Inc. 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 through the date of sale and were formerly included within the Institutional Securities business segment.


		8

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Crescent. Discontinued operations for the quarter ended March 31, 2009 include operating results related to Crescent Real Estate Equities Limited Partnership (“Crescent”), a former real estate subsidiary of the Company. The Company completed the disposition of Crescent in the fourth quarter of 2009, whereby the Company transferred its ownership interest in Crescent to Crescent’s primary creditor in exchange for full release of liability on the related loans. The results of Crescent were formerly included in the Asset Management business segment.

Discover. On June 30, 2007, the Company completed the spin-off of its business segment Discover Financial Services (“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 the lawsuit against Visa and MasterCard. The payment was recorded as a gain in discontinued operations for the quarter ended March 31, 2010.

See Note 18 for additional information on discontinued operations.

Basis of Financial Information. The condensed consolidated financial statements for the quarters ended March 31, 2010 and 2009 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, tax matters 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 the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 (the “Form 10-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”) (see Note 6). 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 in 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 has the power to make the decisions that most significantly affect the economic performance of the VIE and has the obligation to absorb losses or the right to receive benefits, in either case that could potentially be significant to the VIE, except for certain VIEs that are investment companies or are entities qualifying for accounting purposes as an investment company. For such entities, the Company consolidates those entities when it absorbs a majority of the expected losses or a majority of the expected residual returns, or both, of the entities.


		9

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Notwithstanding the above, under accounting guidance prior to January 1, 2010, certain securitization vehicles, commonly known as qualifying special purpose entities (“QSPEs”), were not consolidated by the Company if they met certain criteria regarding the types of assets and derivatives they could hold and the range of discretion they could exercise in connection with the assets they held. These entities are now subject to the consolidation requirements for VIEs.

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 significant regulated U.S. and international subsidiaries include Morgan Stanley & Co. Incorporated (“MS&Co.”), Morgan Stanley Smith Barney LLC, Morgan Stanley & Co. International plc (“MSIP”), Morgan Stanley Japan Securities Co., Ltd. (“MSJS”), Morgan Stanley Bank, N.A. and Morgan Stanley Investment Advisors Inc.

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 income, along with the associated interest expense, as one integrated activity for each of the Company’s separate businesses.

Effective January 1, 2010, the Company reclassified dividend income associated with trading and investing activities to Principal transactions—Trading or Principal transactions—Investments depending upon the business activity. Previously, these amounts were included in Interest and dividends on the condensed consolidated statements of income. These reclassifications were made in connection with the Company’s conversion to a financial holding company. Prior periods have been adjusted to conform to the current presentation.

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 substantially 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.


		10

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

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.

Principal Transactions. See “Financial Instruments and Fair Value” below for principal transactions revenue recognition discussions.

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 guidance. These financial instruments primarily represent the Company’s trading and investment activities and include both cash and derivative products. In addition, certain debt securities classified as Securities available for sale are measured at fair value in accordance with accounting guidance for certain investments in debt and equity securities. Furthermore, Securities received as collateral and Obligation to return securities received as collateral are measured at fair value as required by other accounting guidance. 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 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 Securities available for sale (see “Securities Available for Sale” section herein and Note 4) and derivatives accounted for as hedges (see “Hedge Accounting” section herein and Note 9). Interest income and expense are recorded within the condensed consolidated statements of income depending on the nature of the instrument and related market conventions. When interest is included as a component of the instruments’ fair value, interest is included within Principal transactions—Trading or Principal transactions—Investments. Otherwise, it is included within Interest income or Interest expense. Dividend income is recorded in Principal transactions—Trading or Principal transactions—Investments depending on the business activity. 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


		11

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

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 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 considers 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


		12

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

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. Adjustments for liquidity risk adjust model derived mid-market levels of Level 2 and Level 3 financial instruments for the bid-mid or mid-ask spread required to properly reflect the exit price of a risk position. Bid-mid and mid-ask spreads are marked to levels observed in trade activity, broker quotes or other external third-party data. Where these spreads are unobservable for the particular position in question, spreads are derived from observable levels of similar positions. The Company applies credit-related valuation adjustments to its short-term and long-term borrowings (including structured notes and junior subordinated debentures) for which the fair value option was elected and to OTC derivatives. The Company considers the impact of changes in its own credit spreads based upon observations of the Company’s secondary bond market spreads when measuring fair value for short-term and long-term borrowings. 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 simulates the distribution of the future exposure to a counterparty, then applies market-based default probabilities to the future exposure, leveraging external third-party credit default swap (“CDS”) spread data. Where CDS spread data is unavailable for a specific counterparty, bond market spreads, CDS spread data based on the counterparty’s credit rating or CDS spread data that references a comparable counterparty may be utilized. The Company also considers collateral held and legally enforceable master netting agreements that mitigate the Company’s exposure to each counterparty. Adjustments for model uncertainty are taken for positions whose underlying models are reliant on significant inputs that are neither directly nor indirectly observable, hence requiring reliance on established theoretical concepts in their derivation. These adjustments are derived by making assessments of the possible degree of variability using statistical approaches and market-based information where possible. 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 losses or gains for any adjustments 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.


		13

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

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 9.

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.

Repurchase and Securities Lending Transactions

Securities borrowed or purchased under agreements to resell and securities loaned or sold under agreements to repurchase are generally treated as collateralized financings. Securities purchased under agreements to resell (“reverse repurchase agreements”) and Securities sold under agreements to repurchase (“repurchase agreements”) are carried on the condensed consolidated statements of financial condition at the amounts at which the securities will be subsequently sold or repurchased, plus accrued interest. Securities borrowed and securities loaned are recorded at the amount of cash collateral advanced or received. Where appropriate, transactions with the same counterparty are reported on a net basis.

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 6). 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 eligibility requirements. Diluted EPS reflects the assumed conversion of all dilutive securities.


		14

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Effective October 13, 2008, as a result of an adjustment to Equity Units sold to a wholly owned subsidiary of China Investment Corporation Ltd. (“CIC”), the Company calculates EPS in accordance with the 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 13). 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.

Under current 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. Share-based payment awards that pay dividend equivalents subject to vesting are not deemed participating securities and are included in diluted shares outstanding (if dilutive) under the treasury stock method.

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 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.

Employee Loans.

At March 31, 2010 and December 31, 2009, the Company had $5.8 billion and $3.5 billion, respectively, of loans outstanding primarily to certain MSSB employees that are included in Receivables—Fees, interest and other on the condensed consolidated statement of financial condition. These loans are full-recourse, require periodic payments and have repayment terms ranging from 4 to 12 years.

Securities Available for Sale.

In the first quarter of 2010, the Company established a portfolio of debt securities that are classified as securities available for sale (“AFS”). AFS securities are reported at fair value in the condensed consolidated statement of financial condition with unrealized gains and losses reported in Accumulated other comprehensive income (loss), (net of tax). Interest income, including amortization of premiums and accretion of discounts, is included in


		15

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

interest income in the condensed consolidated statement of income. Realized gains and losses on AFS securities sale are reported in earnings (see Note 4). The Company utilizes the “first-in, first-out” method as the basis for determining the cost of AFS securities.

Other-than-temporary impairment. The Company evaluates and accounts for impairment of securities in accordance with accounting guidance for investments in debt and equity securities. AFS securities in unrealized loss positions, resulting from the current fair value of a security being less than amortized cost, are analyzed as part of the Company’s ongoing assessment of other-than-temporary impairment (“OTTI”). OTTI is recognized in earnings if the Company has the intent to sell the security, or if it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis as of the reporting date. For those securities the Company does not expect to sell or expect to be required to sell, the Company must evaluate whether it expects to recover the entire amortized cost basis of the security. In the event of a credit loss, only the amount of impairment associated with the credit loss is recognized in income. Unrealized losses relating to factors other than credit are recorded in Accumulated other comprehensive income (loss), net of tax.

Accounting Developments.

Transfers of Financial Assets and Extinguishments of Liabilities and Consolidation of Variable Interest Entities. In June 2009, the Financial Accounting Standards Board (the “FASB”) issued accounting guidance which changed the way entities account for securitizations and special-purpose entities. The accounting guidance amended the accounting for transfers of financial assets and requires 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 eliminated the concept of a QSPE and changed the requirements for derecognizing financial assets.

The accounting guidance also amended the accounting for consolidation and changed 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. In February 2010, the FASB finalized a deferral of these accounting changes, effective January 1, 2010, for certain interests in investment companies or in entities qualifying for accounting purposes as investment companies (the “Deferral”). The Company will continue to analyze consolidation under other existing authoritative guidance for entities subject to the Deferral. The adoption of the accounting guidance on January 1, 2010 did not have a material impact on the Company’s condensed consolidated statement of financial condition.

2. Morgan Stanley Smith Barney Holdings LLC.

Smith Barney. On May 31, 2009, the Company and Citigroup Inc. (“Citi”) consummated the combination of the Company’s Global Wealth Management Group and the businesses of Citi’s Smith Barney in the U.S., Quilter Holdings Ltd (“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 Morgan Stanley Smith Barney. Pursuant to the terms of the amended contribution agreement, dated at May 29, 2009, certain businesses of Smith Barney and Morgan Stanley will be contributed to MSSB subsequent to May 31, 2009 (the “delayed contribution businesses”). Morgan Stanley and 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.


		16

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

At May 31, 2009, the Company included MSSB in its condensed consolidated financial statements. The results of MSSB are included within the Global Wealth Management Group business segment. See Note 3 to the consolidated financial statements for the year ended December 31, 2009 included in the Form 10-K for further information on Smith Barney.

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. At July 31, 2009, Citi Managed Futures was wholly-owned and consolidated by MSSB, of which the Company owns 51% and Citi owns 49%.

See Note 3 to the consolidated financial statements for the year ended December 31, 2009 included in the Form 10-K for further information on Citi Managed Futures.

Pro forma condensed combined financial information (unaudited).

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 (dollars in millions, except share data).


	Three Months Ended March 31, 2009
	(unaudited)
Net revenues	$	4,560
Total non-interest expenses		5,076

Loss from continuing operations before income taxes		(516	)
Benefit from income taxes		(574	)

Income from continuing operations		58
Discontinued operations:
Loss from discontinued operations		(255	)
Benefit from income taxes		(100	)

Net loss from discontinued operations		(155	)

Net loss		(97	)
Net income applicable to non-controlling interests		15

Net loss applicable to Morgan Stanley	$	(112	)

Loss applicable to Morgan Stanley common shareholders	$	(513	)

Loss per basic common share:
Loss from continuing operations	$	(0.35	)
Loss on discontinued operations		(0.16	)

Loss per basic common share	$	(0.51	)

Loss per diluted common share:
Loss from continuing operations	$	(0.35	)
Loss on discontinued operations		(0.16	)

Loss per diluted common share	$	(0.51	)


		17

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

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, nor is it indicative of the results of operations in future periods. Included in the unaudited pro forma combined financial information for the quarter ended March 31, 2009 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 market conditions, expense efficiencies or other factors.

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. The fair value of mortgage pass-throughs are model driven based on 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.

•

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 price or spread data obtained from observed transactions or independent external parties such as


		18

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

vendors or brokers. When position-specific external price data are not observable, the fair value determination may require benchmarking to similar instruments and/or analyzing expected credit losses, default and recovery rates. In evaluating the fair value of each security, the Company considers security collateral-specific attributes including payment priority, credit enhancement levels, type of collateral, delinquency rates and loss severity among other factors. In addition for RMBS borrowers, FICO scores and the level of documentation for the loan are also considered. Market standard models, such as Intex, Trepp or others, may be deployed to model the specific collateral compositions and cash flow structure of each deal. Key inputs to these models are market spreads, forecasted credit losses, default and prepayments rates for each asset category. Valuation levels of RMBS and CMBS indices are also 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.

•

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 obtained from independent external parties such as vendors and brokers 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 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.

•

Collateralized Debt Obligations (“CDOs”). The Company holds cash CDOs that typically reference a tranche of an underlying synthetic portfolio of single name credit default swaps. The collateral is usually ABS or other corporate bonds. Credit correlation, a primary input used to determine the fair value of a cash CDO, is usually unobservable and derived using a benchmarking technique. The other model inputs such as credit spreads, including collateral spreads, and interest rates are typically observable. CDOs are categorized in Level 2 of the fair value hierarchy when the credit correlation input is insignificant. In instances where the credit correlation input is deemed to be significant, these instruments are categorized in Level 3 of the fair value hierarchy.

•

Corporate Loans and Lending Commitments. The fair value of corporate loans is estimated using recently executed transactions, market price quotations (where observable), implied yields from comparable debt, and market observable credit default swap spread levels obtained from independent external parties such as vendors and brokers 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


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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.

•

Mortgage Loans. Mortgage loans are valued using prices based on transactional 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.

•

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, level of seniority in the capital structure, 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; otherwise, they are categorized in Level 2.

Derivative and Other Contracts.

•

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.

•

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 formulas, such as the Black-Scholes option-pricing model, and simulation models or a combination thereof. Many pricing models do not entail material subjectivity


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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, including 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 (a CDO-squared is a special purpose vehicle that issues interests, or tranches, that are backed by tranches issued by other CDOs) 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 ABS 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 9.

Investments.

•

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.

After initial recognition, in determining the fair value of internally and externally managed funds, the Company considers the net asset value of the fund provided by the fund manager to be the best estimate


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of fair value. For direct private equity investments and privately held investments within internally managed funds, fair value after initial recognition is based on an assessment of each underlying investment, considering rounds of financing and third-party transactions, discounted cash flow analyses and market-based information, including comparable company transactions, trading multiples and changes in market outlook, among other factors.

Investments in private equity and real estate funds are generally categorized in Level 3 of the fair value hierarchy. Investments in hedge funds that are redeemable at the measurement date or in the near future, are categorized in Level 2 of the fair value hierarchy; otherwise they are categorized in Level 3.

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.

Securities Available for Sale.

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Securities available for sale primarily include U.S. government and agency securities. These securities are valued using quoted prices in active markets and, accordingly, are categorized in Level 1 of the fair value hierarchy (see Note 4).

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

•

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. Independent, external and traded prices for the notes are also considered. 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.

•

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 at March 31, 2010 and December 31, 2009. See Note 1 for a discussion of the Company’s policies regarding this fair value hierarchy.


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Assets and Liabilities Measured at Fair Value on a Recurring Basis at March 31, 2010


	Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Counterparty and Cash Collateral Netting			Balance at March 31, 2010
	(dollars in millions)
Assets
Financial instruments owned:
U.S. government and agency securities:
U.S. Treasury securities	$	27,276		$	—		$	—		$	—		$	27,276
U.S. agency securities		11,105			30,892			1			—			41,998

Total U.S. government and agency securities		38,381			30,892			1			—			69,274
Other sovereign government obligations		25,186			6,075			80			—			31,341
Corporate and other debt:
State and municipal securities		—			4,637			398			—			5,035
Residential mortgage-backed securities		—			3,466			625			—			4,091
Commercial mortgage-backed securities		—			2,247			779			—			3,026
Asset-backed securities		—			2,729			149			—			2,878
Corporate bonds		—			39,677			1,145			—			40,822
Collateralized debt obligations		—			2,081			1,512			—			3,593
Loans and lending commitments		—			14,267			13,503			—			27,770
Other debt		—			1,056			1,921			—			2,977

Total corporate and other debt		—			70,160			20,032			—			90,192
Corporate equities(1)		62,328			4,727			536			—			67,591
Derivatives and other contracts:
Interest rate contracts		1,743			600,743			930			—			603,416
Credit contracts		—			105,339			19,815			—			125,154
Foreign exchange rate contracts		2			49,193			453			—			49,648
Equity contracts		2,725			33,945			587			—			37,257
Commodity contracts		6,778			65,397			1,729			—			73,904
Other		—			93			282			—			375
Netting(2)		(9,769	)		(752,856	)		(9,683	)		(69,540	)		(841,848	)

Total derivatives and other contracts		1,479			101,854			14,113			(69,540	)		47,906
Investments		934			1,002			7,546			—			9,482
Physical commodities		—