Edgar Filing: MORGAN STANLEY

Quarterly Report for the period ended June 30, 2009

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 June 30, 2009

¨ 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 July 31, 2009, there were 1,359,166,836 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 June 30, 2009


Table of Contents		Page
Part I—Financial Information
Item 1.	Financial Statements (unaudited)	1
	Condensed Consolidated Statements of Financial Condition—June 30, 2009, December 31, 2008 and November 30, 2008	1
	Condensed Consolidated Statements of Income—Three and Six Months Ended June 30, 2009 and 2008	3
	Condensed Consolidated Statements of Comprehensive Income—Three and Six Months Ended June 30, 2009 and 2008	4
	Condensed Consolidated Statements of Cash Flows—Six Months Ended June 30, 2009 and 2008	5
	Condensed Consolidated Statements of Changes in Total Equity—For the Six Months Ended June 30, 2009	6
	Condensed Consolidated Statement of Changes in Total Equity—For the Six Months Ended June 30, 2008	7
	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	17
	Note 3. Fair Value Disclosures	21
	Note 4. Collateralized Transactions	38
	Note 5. Securitization Activities and Variable Interest Entities	40
	Note 6. Goodwill and Net Intangible Assets	48
	Note 7. Long-Term Borrowings	50
	Note 8. Derivative Instruments and Hedging Activities	50
	Note 9. Commitments, Guarantees and Contingencies	59
	Note 10. Regulatory Requirements	64
	Note 11. Total Equity	67
	Note 12. Earnings per Common Share	70
	Note 13. Interest and Dividends and Interest Expense	71
	Note 14. Other Revenues	72
	Note 15. Employee Benefit Plans	72
	Note 16. Income Taxes	72
	Note 17. Segment and Geographic Information	73
	Note 18. Joint Venture	76
	Note 19. Discontinued Operations	77
	Note 20. Subsequent Events	77
	Report of Independent Registered Public Accounting Firm	78
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	79
	Introduction	79
	Executive Summary	81
	Certain Factors Affecting Results of Operations and Earnings Per Common Share	88
	Equity Capital-Related Transactions	91
	Business Segments	91
	Other Matters	102
	Critical Accounting Policies	106
	Liquidity and Capital Resources	111
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	124
Item 4.	Controls and Procedures	137
	Financial Data Supplement (Unaudited)	138


		i


				Page


Part II—Other Information
Item 1.	Legal Proceedings	139
Item 1A.	Risk Factors	140
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	141
Item 4.	Submission of Matters to a Vote of Security Holders	142
Item 5.	Other Information	143
Item 6.	Exhibits	143


		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 our Audit Committee; Internal Audit Subcommittee; Compensation, Management Development and Succession Committee; and Nominating and Governance 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.

Morgan Stanley’s Code of Ethics and Business Conduct applies to all directors, officers and employees, including its Chief Executive Officer, its Chief Financial Officer and its Controller and Principal Accounting Officer. 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, Inc. 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)


	June 30, 2009		December 31, 2008		November 30, 2008
Assets
Cash and due from banks	$	9,184	$	13,354	$	11,276
Interest bearing deposits with banks		25,822		65,316		67,378
Cash deposited with clearing organizations or segregated under federal and other regulations or requirements		21,643		24,039		25,446
Financial instruments owned, at fair value (approximately $78 billion, $73 billion and $62 billion were pledged to various parties at June 30, 2009, December 31, 2008 and November 30, 2008, respectively):
U.S. government and agency securities		63,717		28,012		20,251
Other sovereign government obligations		26,768		21,084		20,071
Corporate and other debt		87,802		87,294		88,484
Corporate equities		42,582		42,321		37,174
Derivative and other contracts		58,372		89,418		99,766
Investments		8,825		10,385		10,598
Physical commodities		3,343		2,126		2,204

Total financial instruments owned, at fair value		291,409		280,640		278,548
Securities received as collateral, at fair value		9,872		5,231		5,217
Federal funds sold and securities purchased under agreements to resell		121,799		122,709		106,419
Securities borrowed		107,853		88,052		85,785
Receivables:
Customers		28,410		29,265		31,294
Brokers, dealers and clearing organizations		5,098		6,250		7,259
Other loans		5,814		6,547		6,528
Fees, interest and other		11,348		7,258		7,034
Other investments		3,796		3,709		3,309
Premises, equipment and software costs (net of accumulated depreciation of $4,108, $3,073 and $3,003 at June 30, 2009, December 31, 2008 and November 30, 2008, respectively)		6,548		5,095		5,057
Goodwill		6,836		2,256		2,243
Intangible assets (net of accumulated amortization of $272, $208 and $200 at June 30, 2009, December 31, 2008 and November 30, 2008, respectively) (includes $173, $184 and $220 at fair value at June 30, 2009, December 31, 2008 and November 30, 2008, respectively)		5,553		906		947
Other assets		15,972		16,137		15,295

Total assets	$	676,957	$	676,764	$	659,035

See Notes to Condensed Consolidated Financial Statements.


		1

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION—(Continued)

(dollars in millions, except share data)

(unaudited)


	June 30, 2009			December 31, 2008			November 30, 2008
Liabilities and Equity
Commercial paper and other short-term borrowings (includes $1,062, $1,246 and $1,412 at fair value at June 30, 2009, December 31, 2008 and November 30, 2008, respectively)	$	3,030		$	10,102		$	10,483
Deposits (includes $9,171, $9,993 and $6,008 at fair value at June 30, 2009, December 31, 2008 and November 30, 2008, respectively)		62,382			51,355			42,755
Financial instruments sold, not yet purchased, at fair value:
U.S. government and agency securities		21,072			11,902			10,156
Other sovereign government obligations		17,244			9,511			9,360
Corporate and other debt		7,150			9,927			9,361
Corporate equities		21,649			16,840			16,547
Derivative and other contracts		43,435			68,554			73,521
Physical commodities		11			33			—

Total financial instruments sold, not yet purchased, at fair value		110,561			116,767			118,945
Obligation to return securities received as collateral, at fair value		9,872			5,231			5,217
Securities sold under agreements to repurchase		91,935			92,213			102,401
Securities loaned		18,002			14,580			14,821
Other secured financings, at fair value		10,148			12,539			12,527
Payables:
Customers		105,731			123,617			115,225
Brokers, dealers and clearing organizations		5,407			1,585			3,141
Interest and dividends		2,674			3,305			2,584
Other liabilities and accrued expenses		18,960			16,179			15,963
Long-term borrowings (includes $35,309, $30,766 and $28,830 at fair value at June 30, 2009, December 31, 2008 and November 30, 2008, respectively)		186,792			179,835			163,437

		625,494			627,308			607,499

Commitments and contingencies
Equity
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 June 30, 2009, December 31, 2008 and November 30, 2008;
Shares issued: 1,487,850,163 at June 30, 2009, 1,211,701,552 at December 31, 2008 and November 30, 2008;
Shares outstanding: 1,359,204,010 at June 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		9,214			459			1,619
Retained earnings		34,245			36,154			38,096
Employee stock trust		4,163			4,312			3,901
Accumulated other comprehensive loss		(342	)		(420	)		(125	)
Common stock held in treasury, at cost, $0.01 par value; 128,646,153 shares at June 30, 2009, 137,203,987 shares at December 31, 2008 and 164,103,158 shares at November 30, 2008		(6,143	)		(6,620	)		(7,926	)
Common stock issued to employee trust		(4,163	)		(4,312	)		(3,901	)

Total Morgan Stanley shareholders’ equity		46,586			48,753			50,831
Non-controlling interests		4,877			703			705

Total equity		51,463			49,456			51,536

Total liabilities and equity	$	676,957		$	676,764		$	659,035

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 June 30,						Six Months Ended June 30,
	2009			2008			2009			2008
	(unaudited)						(unaudited)
Revenues:
Investment banking	$	1,281		$	1,288		$	2,167		$	2,259
Principal transactions:
Trading		1,971			2,094			3,062			4,888
Investments		(115	)		(308	)		(1,387	)		(824	)
Commissions		975			1,116			1,747			2,381
Asset management, distribution and administration fees		1,282			1,473			2,266			2,946
Other		505			315			836			1,224

Total non-interest revenues		5,899			5,978			8,691			12,874
Interest and dividends		1,393			9,196			3,917			21,906
Interest expense		1,881			9,063			4,251			20,851

Net interest		(488	)		133			(334	)		1,055

Net revenues		5,411			6,111			8,357			13,929

Non-interest expenses:
Compensation and benefits		3,875			3,108			5,911			6,911
Occupancy and equipment		376			325			715			614
Brokerage, clearing and exchange fees		290			421			559			891
Information processing and communications		317			300			603			605
Marketing and business development		127			196			244			391
Professional services		405			487			727			852
Other		640			388			1,125			776

Total non-interest expenses		6,030			5,225			9,884			11,040

(Losses) income from continuing operations before income taxes		(619	)		886			(1,527	)		2,889
(Benefit from) provision for income taxes		(333	)		192			(1,037	)		785

(Loss) income from continuing operations		(286	)		694			(490	)		2,104
Discontinued operations:
Gain from discontinued operations (including gain on disposal of $499 million in the three and six months ended June 30, 2009)		515			761			537			797
Provision for income taxes		196			296			204			310

Gain on discontinued operations		319			465			333			487

Net income (loss)	$	33		$	1,159		$	(157	)	$	2,591
Net (loss) income applicable to non-controlling interests	$	(116	)	$	16		$	(129	)	$	35

Net income (loss) applicable to Morgan Stanley	$	149		$	1,143		$	(28	)	$	2,556

(Losses) earnings applicable to Morgan Stanley common shareholders	$	(1,256	)	$	1,062		$	(1,834	)	$	2,374

Amounts applicable to Morgan Stanley:
(Losses) income from continuing operations	$	(159	)	$	689		$	(345	)	$	2,084
Net gain from discontinued operations after tax		308			454			317			472

Net income (loss) applicable to Morgan Stanley	$	149		$	1,143		$	(28	)	$	2,556

(Losses) earnings per basic common share:
(Loss) income from continuing operations	$	(1.37	)	$	0.61		$	(2.00	)	$	1.86
Gain on discontinued operations		0.27			0.41			0.29			0.43

(Loss) earnings per basic common share	$	(1.10	)	$	1.02		$	(1.71	)	$	2.29

(Losses) earnings per diluted common share:
(Loss) income from continuing operations	$	(1.37	)	$	0.61		$	(2.00	)	$	1.85
Gain on discontinued operations		0.27			0.41			0.29			0.43

(Losses) earnings per diluted common share	$	(1.10	)	$	1.02		$	(1.71	)	$	2.28

Average common shares outstanding:
Basic		1,138,444,490			1,041,178,821			1,075,092,850			1,037,760,625

Diluted		1,138,444,490			1,044,720,912			1,075,092,850			1,041,873,895

See Notes to Condensed Consolidated Financial Statements.


		3

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(dollars in millions)


	Three Months Ended June 30,						Six Months Ended June 30,
	2009			2008			2009			2008
	(unaudited)						(unaudited)
Net income (loss)	$	33		$	1,159		$	(157	)	$	2,591
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments(1)		118			(92	)		58			(50	)
Net change in cash flow hedges(2)		5			6			8			9
Amortization of net loss related to pension and postretirement benefits(3)		5			5			12			10
Amortization of prior service credit related to pension and postretirement benefits(4)		(1	)		(1	)		(3	)		(2	)

Comprehensive income (loss)	$	160		$	1,077		$	(82	)	$	2,558
Net income (loss) applicable to non-controlling interests		(116	)		16			(129	)		35
Other comprehensive income (loss) applicable to non-controlling interests		(3	)		(5	)		(3	)		(5	)

Comprehensive income applicable to Morgan Stanley	$	279		$	1,066		$	50		$	2,528

(1)

Amounts are net of provision for (benefit from) income taxes of $(241) million and $(5) million for the quarters ended June 30, 2009 and June 30, 2008, respectively. Amounts are net of provision for (benefit from) income taxes of $(211) million and $(166) million for the six month periods ended June 30, 2009 and June 30, 2008, respectively.

(2)

Amounts are net of provision for (benefit from) income taxes of $2 million and $4 million for the quarters ended June 30, 2009 and June 30, 2008, respectively. Amounts are net of provision for (benefit from) income taxes of $4 million and $6 million for the six month periods ended June 30, 2009 and June 30, 2008, respectively.

(3)	Amounts are net of provision for income taxes of $5 million and $3 million for the quarters ended June 30, 2009 and June 30, 2008, respectively. Amounts are net of provision for income taxes of $9 million and $6 million for the six month periods ended June 30, 2009 and June 30, 2008, respectively.

(4)	Amounts are net of provision for (benefit from) income taxes of $(1) million for the quarter ended June 30, 2008. Amounts are net of provision for (benefit from) income taxes of $(1) million and $(2) million for the six month periods ended June 30, 2009 and June 30, 2008, respectively.

See Notes to Condensed Consolidated Financial Statements.


		4

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in millions)


	Six Months Ended June 30,
	2009			2008
	(unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)	$	(157	)	$	2,591
Adjustments to reconcile net income (loss) to net cash (used for) provided by operating activities:
Compensation payable in common stock and options		627			1,279
Depreciation and amortization		363			238
(Gain) on business dispositions		(480	)		(1,500	)
Impairment charges		408			—
Changes in assets and liabilities:
Cash deposited with clearing organizations or segregated under federal and other regulations or requirements		2,396			(6,357	)
Financial instruments owned, net of financial instruments sold, not yet purchased		(16,344	)		52,926
Securities borrowed		(19,801	)		(31,718	)
Securities loaned		3,422			(61,770	)
Receivables and other assets		(2,462	)		13,496
Payables and other liabilities		(10,073	)		82,799
Federal funds sold and securities purchased under agreements to resell		910			(3,095	)
Securities sold under agreements to repurchase		(278	)		(13,668	)

Net cash (used for) provided by operating activities		(41,469	)		35,221

CASH FLOWS FROM INVESTING ACTIVITIES
Net (payments for) proceeds from:
Premises, equipment and software costs		(1,879	)		(973	)
Business acquisitions, net of cash acquired		(1,860	)		(174	)
Business dispositions		565			1,523

Net cash (used for) provided by investing activities		(3,174	)		376

CASH FLOWS FROM FINANCING ACTIVITIES
Net (payments for) proceeds from:
Short-term borrowings		(7,072	)		(10,206	)
Derivatives financing activities		(71	)		146
Other secured financings		(2,391	)		2,529
Deposits		11,027			3,394
Excess tax benefits associated with stock-based awards		11			63
Net proceeds from:
Morgan Stanley public offerings of common stock		6,212			—
Issuance of common stock		29			264
Issuance of long-term borrowings		28,805			26,685
Payments for:
Repayments of long-term borrowings		(24,675	)		(20,783	)
Redemption of Series D Preferred Stock		(10,000	)		—
Repurchases of common stock for employee tax withholding		(19	)		(64	)
Cash dividends		(1,078	)		(626	)

Net cash (used for) provided by financing activities		778			1,402

Effect of exchange rate changes on cash and cash equivalents		201			1,105

Net (decrease) increase in cash and cash equivalents		(43,664	)		38,104
Cash and cash equivalents, at beginning of period		78,670			24,659

Cash and cash equivalents, at end of period	$	35,006		$	62,763

Cash and cash equivalents include:
Cash and due from banks	$	9,184		$	7,317
Interest bearing deposits with banks		25,822			55,446

Cash and cash equivalents, at end of period	$	35,006		$	62,763

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

Cash payments for interest were $4,631 million and $20,303 million for the six month periods ended June 30, 2009 and June 30, 2008, respectively.

Cash payments for income taxes were $181 million and $475 million for the six month periods ended June 30, 2009 and June 30, 2008, respectively.

See Notes to Condensed Consolidated Financial Statements.


		5

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN TOTAL EQUITY

For the Six Months Ended June 30, 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 income (loss)		—			—		—			(28	)		—			—			—			—			(129	)		(157	)
Dividends		—			—		—			(747	)		—			—			—			—			(11	)		(758	)
Issuance of common stock		—			—		(176	)		—			—			—			217			—			—			41
Repurchases of common stock		—			—		—			—			—			—			(19	)		—			—			(19	)
Morgan Stanley public offerings of common stock		—			3		6,209			—			—			—			—			—			—			6,212
Preferred stock extinguished and exchanged for common stock		(503	)		—		705			(202	)		—			—			—			—			—			—
Repurchase of Series D preferred stock		(9,068	)		—		—			(932	)		—			—			—			—			—			(10,000	)
Gain on MSSB transaction		—			—		1,711			—			—			—			—			—			—			1,711
Compensation payable in common stock and options		—			—		333			—			(149	)		—			279			149			—			612
Net excess tax benefits (shortfall) associated with stock-based awards		—			—		(27	)		—			—			—			—			—			—			(27	)
Net change in cash flow hedges		—			—		—			—			—			8			—			—			—			8
Pension and other postretirement adjustments.		—			—		—			—			—			9			—			—			—			9
Foreign currency translation adjustments		—			—		—			—			—			61			—			—			(3	)		58
Increases in non-controlling interests related to MSSB transaction		—			—		—			—			—			—			—			—			4,533			4,533
Decreases in non-controlling interests related to disposition of a subsidiary		—			—		—			—			—			—			—			—			(229	)		(229	)
Other increases in non-controlling interests		—			—		—			—			—			—			—			—			13			13

BALANCE AT JUNE 30, 2009	$	9,597		$	15	$	9,214		$	34,245		$	4,163		$	(342	)	$	(6,143	)	$	(4,163	)	$	4,877		$	51,463

See Notes to Condensed Consolidated Financial Statements.


		6

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN TOTAL EQUITY

For the Six Months Ended June 30, 2008

(dollars in millions)

(unaudited)


	Preferred Stock		Common Stock		Other Morgan Stanley Common Equity			Non- controlling Interest			Total Equity
BALANCE AT DECEMBER 31, 2007	$	1,100	$	12	$	30,665		$	1,571		$	33,348
Net income		—		—		2,556			35			2,591
Dividends		—		—		(622	)		(33	)		(655	)
Issuance of common stock		—		—		264			—			264
Repurchases of common stock		—		—		(64	)		—			(64	)
Net excess tax benefits associated with stock-based awards		—		—		(12	)		—			(12	)
Compensation payable in common stock and options		—		—		1,446			—			1,446
Employee tax withholdings and other		—		—		(4	)		—			(4	)
Net change in cash flow hedges		—		—		9			—			9
Pension and other postretirement adjustments		—		—		8			—			8
Foreign currency translation adjustments		—		—		(45	)		(5	)		(50	)
Other		—		—		(60	)		—			(60	)
Increases in non-controlling interests related to sales of subsidiary’s shares by Morgan Stanley		—		—		—			66			66
Decreases in non-controlling interests related to disposition of a subsidiary		—		—		—			(514	)		(514	)
Other net increases in non-controlling interests		—		—		—			7			7

BALANCE AT JUNE 30, 2008	$	1,100	$	12	$	34,141		$	1,127		$	36,380

See Notes to Condensed Consolidated Financial Statements.


		7

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

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”), 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.

See Note 19 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.

Certain reclassifications have been made to prior-period amounts to conform to the current period’s presentation. 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 fiscal year ended November 30, 2008 (the “Form 10-K”). The condensed consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for the fair statement 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


		8

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

certain variable interest entities (“VIEs”). The Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment of Accounting Research Bulletin No. 51” (“SFAS No. 160”) 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 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


		9

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

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 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.


		10

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

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 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


		11

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

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),


		12

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

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 $10.5 billion and assumed liabilities, in connection with business acquisitions, of $3.2 billion in the six month period ended June 30, 2009. The six month period ended June 30, 2008 included assumed liabilities of $77 million. During the quarter ended June 30, 2008, the Company consolidated real estate limited partnership assets and liabilities of approximately $4.6 billion and $3.8 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.


		13

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

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 adoption of FASB Staff Position Emerging Issues Task Force (“FSP EITF”) 03-6-1 reduced basic EPS by $0.07 and $0.15 for the quarter and six month period ended June 30, 2008, respectively, and reduced diluted EPS by $0.04 and $0.10 for the quarter and six month period ended June 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 EITF reached consensus on Issue No. 06-11, “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards” (“EITF No. 06-11”). EITF No. 06-11 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 EITF No. 06-11 prospectively effective December 1, 2008. The Company previously accounted for this tax benefit as a reduction to its income tax provision. The adoption of EITF No. 06-11 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 FSP Financial Accounting Standards (“FAS”) 140-3, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions” (“FSP FAS No. 140-3”). The objective of FSP FAS No. 140-3 is to provide implementation guidance on accounting for a transfer of a financial asset and repurchase financing. Under the guidance in FSP FAS No. 140-3, 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 under SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities” (“SFAS No. 140”). 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 under SFAS No. 140. The adoption of FSP FAS 140-3 on December 1, 2008 did not have a material impact on the Company’s condensed consolidated financial statements.


		14

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Determination of the Useful Life of Intangible Assets. In April 2008, the FASB issued FSP FAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP FAS 142-3”). FSP FAS 142-3 removes the requirement of SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”) 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. FSP FAS 142-3 replaced 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 FSP FAS 142-3 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 by the EITF on Issue No. 07-5, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF No. 07-5”). EITF No. 07-5 provides guidance for determining whether an equity-linked financial instrument (or embedded feature) is indexed to an entity’s own stock. EITF No. 07-5 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 the exception of share-based payment awards within the scope of SFAS 123(R) “Share-Based Payment”). 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 EITF No. 07-5 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 FSP FAS 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets” (“FSP FAS 132(R)-1”). FSP FAS 132(R)-1 amends SFAS No. 132 (Revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits,” to provide guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan. The disclosures about plan assets required by this FSP will be effective December 31, 2009 for the Company.

Guidance and Disclosures on Fair Value Measurements. In April 2009, the FASB issued FSP FAS 157-4, “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” (“FSP FAS 157-4”) and FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP FAS 107-1” and “APB 28-1”).

FSP FAS 157-4 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 what SFAS No. 157, “Fair Value Measurements” states is 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 FSP FAS 157-4 in the quarter ended June 30, 2009. The adoption did not have a material impact on the Company’s condensed consolidated financial statements.

FSP FAS 107-1 and APB 28-1 amends SFAS No. 107, “Disclosures about Fair Value of Financial Instruments” and APB Opinion No. 28, “Interim Financial Reporting” by requiring an entity to provide qualitative and


		15

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

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 of FSP FAS 107-1 and APB 28-1 in the quarter ended June 30, 2009.

Subsequent Events. In May 2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS No. 165”). The objective of SFAS No. 165 is 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 SFAS No. 165 in the quarter ended June 30, 2009. The adoption of SFAS No. 165 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 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 SFAS No. 140 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 FASB Interpretation No. 46, as revised (“FIN 46R”), “Consolidation of Variable Interest Entities,” 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 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 Codification^TM. In July 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification^TM and the Hierarchy of Generally Accepted Accounting Principles—a replacement of FASB Statement No. 162” (“SFAS No. 168”). SFAS No. 168 establishes the FASB Accounting Standards Codification^TM (“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 existing accounting standard documents are superseded. All other accounting literature not included in the Codification will be considered non-authoritative. The Codification does not change current GAAP. SFAS No. 168 and the Codification are effective for financial statements issued for interim and annual periods ending after September 15, 2009. The Company plans to adopt the Codification in the quarter ended September 30,


		16

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

2009. The Company does not expect the adoption to have a material impact on the Company’s condensed consolidated financial statements. References to authoritative U.S. GAAP literature, however, in the Company’s financial statements, notes thereto and Quarterly Reports on Form 10-Q and Annual Reports on Form 10-K will be updated to reflect new Codification references.

2.	Morgan Stanley Smith Barney Holdings LLC.

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 Morgan Stanley Smith Barney Holdings LLC (“MSSB”), which the Company consolidates. Pursuant to the terms of the 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 appointing four directors to the MSSB board and Citi appointing 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.

Pursuant to the amended contribution agreement, dated as of May 29, 2009, and the Managed Futures Contribution and Interest Purchase Agreement, dated as of July 31, 2009, Citi contributed its managed futures business and certain related proprietary trading positions to MSSB on July 31, 2009, and the Company paid Citi approximately $300 million in connection with this transfer. The Company accounted for this transaction using the acquisition method of accounting. As this acquisition was recently completed, the Company is in the process of valuing the assets acquired and liabilities assumed.

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


		17

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

$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 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 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.


		18

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Amortizable intangible assets include 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.


		19

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

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 had been completed on January 1, 2009 and January 1, 2008 (dollars in millions, except share data).


	Three Months Ended June 30,					Six Months Ended June 30,
	2009			2008		2009			2008
	(unaudited)					(unaudited)
Net revenues	$	6,972		$	8,233	$	11,581		$	18,135
Total non-interest expenses		7,414			7,271		12,817			14,839

(Losses) income from continuing operations before income taxes		(442	)		962		(1,236	)		3,296
(Benefit from) provision for income taxes		(301	)		207		(984	)		864

(Loss) income from continuing operations		(141	)		755		(252	)		2,432
Discontinued operations:
Gain from discontinued operations		515			761		537			797
Provision for income taxes		196			296		204			310

Gain on discontinued operations		319			465		333			487

Net income (loss)	$	178		$	1,220	$	81		$	2,919
Net (loss) income applicable to non-controlling interests	$	(19	)	$	65	$	(4	)	$	122

Net income (loss) applicable to Morgan Stanley	$	197		$	1,155	$	85		$	2,797

Earnings (losses) applicable to Morgan Stanley common shareholders	$	(1,208	)	$	1,074	$	(1,721	)	$	2,601

Amounts applicable to Morgan Stanley:
(Losses) income from continuing operations	$	(111	)	$	701	$	(232	)	$	2,325
Net gain from discontinued operations after tax		308			454		317			472

Net income (loss) applicable to Morgan Stanley	$	197		$	1,155	$	85		$	2,797

(Losses) earnings per basic common share:
(Loss) income from continuing operations	$	(1.33	)	$	0.62	$	(1.90	)	$	2.08
Gain on discontinued operations		0.27			0.41		0.29			0.43

(Loss) earnings per basic common share	$	(1.06	)	$	1.03	$	(1.61	)	$	2.51

(Losses) earnings per diluted common share:
(Loss) income from continuing operations	$	(1.33	)	$	0.62	$	(1.90	)	$	2.07
Gain on discontinued operations		0.27			0.41		0.29			0.43

(Losses) earnings per diluted common share	$	(1.06	)	$	1.03	$	(1.61	)	$	2.50

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 MSSB been completed, 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 six month periods ended June 30, 2009 and June 30, 2008, were pro forma adjustments to reflect the results of operations of Smith Barney as well as the impact of amortizing certain purchase accounting adjustments such as 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.


		20

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

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 certain To-be-announced (“TBA”) securities and mortgage pass-through pools. TBA securities are generally valued using quoted market prices or are benchmarked thereto. Fair value of mortgage pass-through pools are model driven with respect to spreads of the comparable TBA security. Actively traded non-callable agency issued debt securities and TBA securities are categorized in Level 1 of the fair value hierarchy. Callable agency issued debt securities and mortgage pass-through certificates 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 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


		21

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

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 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 hierarchy.

•

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.

•

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 hierarchy.

•

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.

•

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.


		22

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

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.

In the fair value hierarchy tables below, SLARS are presented within ABS and MARS are presented within state and municipal securities.

Corporate Equities

•

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

•

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 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.


		23

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

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

•

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 nonpublic 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

•

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

•

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

•

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


		24

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

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 June 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 June 30, 2009


	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 June 30, 2009
	(dollars in millions)
Assets
Financial instruments owned:
U.S. Treasury securities	$	14,035	$	347	$	—	$	—		$	14,382
U.S. agency securities		24,016		25,291		28		—			49,335

Total U.S. government and agency securities		38,051		25,638		28		—			63,717

Other sovereign government obligations		21,577		5,188		3		—			26,768
State and municipal securities		—		2,856		1,705		—			4,561
Residential mortgage-backed securities		—		2,682		820		—			3,502
Commercial mortgage-backed securities		—		1,439		1,506		—			2,945
Asset-backed securities		—		2,558		1,827		—			4,385
Corporate bonds		—		30,020		2,449		—			32,469
Collateralized debt obligations		—		1,368		508		—			1,876
Loans and lending commitments		—		13,065		19,436		—			32,501
Other debt		—		4,074		1,489		—			5,563

Total corporate and other debt(1)		—		58,062		29,740		—			87,802
Corporate equities(2)		37,582		3,899		1,101		—			42,582
Derivative and other contracts(3)		3,599		112,886		19,779		(77,892	)		58,372
Investments		438		215		8,172		—			8,825
Physical commodities		—		3,343		—		—			3,343

Total financial instruments owned		101,247		209,231		58,823		(77,892	)		291,409
Securities received as collateral		9,327		528		17		—			9,872
Intangible assets(4)		—		—		173		—			173

Liabilities
Commercial paper and other short-term borrowings	$	—	$	1,062	$	—	$	—		$	1,062
Deposits		—		9,171		—		—			9,171
Financial instruments sold, not yet purchased:
U.S. Treasury securities		18,877		416		—		—			19,293
U.S. agency securities		1,379		400		—		—			1,779

Total U.S. government and agency securities		20,256		816		—		—			21,072
Other sovereign government obligations		15,805		1,439		—		—			17,244
State and municipal securities		—		6		—		—			6
Commercial mortgage-backed securities		—		—		4		—			4
Asset-backed securities		—		—		4		—			4
Corporate bonds		16		3,281		132		—			3,429
Collateralized debt obligations		—		2		—		—			2
Unfunded lending commitments		—		1,170		303		—			1,473
Other debt		—		2,146		86		—			2,232

Total corporate and other debt		16		6,605		529		—			7,150
Corporate equities(2)		19,610		2,017		22		—			21,649
Derivative and other contracts(3)		6,297		70,896		7,173		(40,931	)		43,435
Physical commodities		—		11		—		—			11

Total financial instruments sold, not yet purchased		61,984		81,784		7,724		(40,931	)		110,561
Obligation to return securities received as collateral		9,327		528		17		—			9,872
Other secured financings(1)		19		5,666		4,463		—			10,148
Long-term borrowings		—		29,409		5,900		—			35,309


		25

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(1)

Approximately $6.6 billion of assets is included in Corporate and other debt and approximately $5.3 billion of related liabilities is included in Other secured financings related to consolidated VIEs or non-consolidated VIEs (in the cases where the assets were transferred by the Company to the VIE and the transfers were accounted for as secured financings). The Company cannot unilaterally remove the assets from the VIEs as these assets are not generally available to the Company. The related liabilities issued by these VIEs are non-recourse to the Company. Approximately $6.1 billion of these assets and approximately $4.1 billion of these liabilities are included in Level 3 of the fair value hierarchy. See Note 5 for additional information on consolidated and non-consolidated VIEs, including retained interests in these entities that the Company holds.

(2)	The Company holds or sells short for trading purposes, equity securities issued by entities in diverse industries and size.

(3)

For positions with the same counterparty that cross over the levels of the fair value hierarchy, both counterparty netting and cash collateral netting are included in the column titled “Counterparty and Cash Collateral Netting.” For contracts with the same counterparty, counterparty netting among positions classified within the same level is included within that level. For further information on derivative instruments and hedging activities, see Note 8.

(4)	Amount represents mortgage servicing rights (“MSRs”) accounted for at fair value. See Note 5 for further information on MSRs.

Assets and Liabilities Measured at Fair Value on a Recurring Basis as of December 31, 2008


	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 December 31, 2008
	(dollars in millions)
Assets
Financial instruments owned:
U.S. government and agency securities	$	10,150	$	17,735	$	127	$	—		$	28,012
Other sovereign government obligations		16,118		4,965		1		—			21,084
Corporate and other debt(1)		99		52,277		34,918		—			87,294
Corporate equities		37,807		3,538		976		—			42,321
Derivative and other contracts(2)		1,069		156,224		37,711		(105,586	)		89,418
Investments		417		270		9,698		—			10,385
Physical commodities		—		2,126		—		—			2,126

Total financial instruments owned		65,660		237,135		83,431		(105,586	)		280,640
Securities received as collateral		4,623		578		30		—			5,231
Intangible assets(3)		—		—		184		—			184

Liabilities
Commercial paper and other short-term borrowings	$	—	$	1,246	$	—	$	—		$	1,246
Deposits		—		9,993		—		—			9,993
Financial instruments sold, not yet purchased:
U.S. government and agency securities		11,133		769		—		—			11,902
Other sovereign government obligations		7,303		2,208		—		—			9,511
Corporate and other debt		17		6,102		3,808		—			9,927
Corporate equities		15,064		1,749		27		—			16,840
Derivative and other contracts(2)		3,886		118,432		14,329		(68,093	)		68,554
Physical commodities		—		33		—		—			33

Total financial instruments sold, not yet purchased		37,403		129,293		18,164		(68,093	)		116,767
Obligation to return securities received as collateral		4,623		578		30		—			5,231
Other secured financings(1)		—		6,391		6,148		—			12,539
Long-term borrowings		—		25,293		5,473		—			30,766


		26

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(1)

Approximately $8.9 billion of assets is included in Corporate and other debt and approximately $7.9 billion of related liabilities is included in Other secured financings related to consolidated VIEs or non-consolidated VIEs (in the cases where the assets were transferred by the Company to the VIE and the transfers were accounted for as secured financings). The Company cannot unilaterally remove the assets from the VIEs; these assets are not generally available to the Company. The related liabilities issued by these VIEs are non-recourse to the Company. Approximately $8.1 billion of these assets and approximately $5.9 billion of these liabilities are included in Level 3 of the fair value hierarchy. See Note 5 for additional information on consolidated and non-consolidated VIEs, including retained interests in these entities that the Company holds.

(2)

(3)	Amount represents MSRs accounted for at fair value. See Note 5 for further information on MSRs.

Assets and Liabilities Measured at Fair Value on a Recurring Basis as of November 30, 2008


	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 November 30, 2008
	(dollars in millions)
Assets
Financial instruments owned:
U.S. government and agency securities	$	5,930	$	14,115	$	206	$	—		$	20,251
Other sovereign government obligations		9,148		10,920		3		—			20,071
Corporate and other debt(1)		47		53,977		34,460		—			88,484
Corporate equities		32,519		3,748		907		—			37,174
Derivative and other contracts(2)		2,478		150,033		40,852		(93,597	)		99,766
Investments		536		330		9,732		—			10,598
Physical commodities		2		2,202		—		—			2,204

Total financial instruments owned		50,660		235,325		86,160		(93,597	)		278,548
Securities received as collateral		4,402		800		15		—			5,217
Intangible assets(3)		—		—		220		—			220

Liabilities
Commercial paper and other short-term borrowings	$	—	$	1,412	$	—	$	—		$	1,412
Deposits		—		6,008		—		—			6,008
Financial instruments sold, not yet purchased:
U.S. government and agency securities		9,474		682		—		—			10,156
Other sovereign government obligations		5,140		4,220		—		—			9,360
Corporate and other debt		18		5,400		3,943		—			9,361
Corporate equities		16,418		108		21		—			16,547
Derivative and other contracts(2)		5,509		115,621		13,228		(60,837	)		73,521

Total financial instruments sold, not yet purchased		36,559		126,031		17,192		(60,837	)		118,945
Obligation to return securities received as collateral		4,402		800		15		—			5,217
Other secured financings(1)		—		6,780		5,747		—			12,527
Long-term borrowings		—		23,413		5,417		—			28,830

(1)	Approximately $9.0 billion of assets is included in Corporate and other debt and approximately $7.2 billion of related liabilities is included in Other secured financings related to consolidated VIEs or non-consolidated VIEs (in the cases where the assets were


		27

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

transferred by the Company to the VIE and the transfers were accounted for as secured financings). The Company cannot unilaterally remove the assets from the VIEs; these assets are not generally available to the Company. The related liabilities issued by these VIEs are non-recourse to the Company. Approximately $7.7 billion of these assets and approximately $5.0 billion of these liabilities are included in Level 3 of the fair value hierarchy. See Note 5 for additional information on consolidated and non-consolidated VIEs, including retained interests in these entities that the Company holds.

(2)

(3)	Amount represents MSRs accounted for at fair value. See Note 5 for further information on MSRs.

The following tables present additional information about Level 3 assets and liabilities measured at fair value on a recurring basis for the quarters and six month periods ended June 30, 2009 and June 30, 2008. Level 3 instruments may be offset with instruments classified in Level 1 and Level 2. As a result, the realized and unrealized gains or (losses) for assets and liabilities within the Level 3 category presented in the tables below do not reflect the related realized and unrealized gains or (losses) on hedging instruments that have been classified by the Company within the Level 1 and/or Level 2 categories. Additionally, both observable and unobservable inputs may be used to determine the fair value of positions that the Company has classified within the Level 3 category. As a result, the unrealized gains or (losses) during the period for assets and liabilities within the Level 3 category presented in the tables below may include changes in fair value during the period that were attributable to both observable (e.g., changes in market interest rates) and unobservable (e.g., changes in unobservable long-dated volatilities) inputs.

The following tables reflect gains or (losses) for all assets and liabilities categorized as Level 3 for the quarters and six month periods ended June 30, 2009 and June 30, 2008, respectively. For assets and liabilities that were transferred into Level 3 during the period, gains or (losses) are presented as if the assets or liabilities had been transferred into Level 3 as of the beginning of the period; similarly, for assets and liabilities that were transferred out of Level 3 during the period, gains or (losses) are presented as if the assets or liabilities had been transferred out as of the beginning of the period.


		28

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Three Months Ended June 30, 2009


	Beginning Balance at March 31, 2009		Total Realized and Unrealized Gains or (Losses)(1)			Purchases, Sales, Other Settlements and Issuances, net			Net Transfers In and/or (Out) of Level 3			Ending Balance at June 30, 2009		Unrealized Gains or (Losses) for Level 3 Assets/ Liabilities Outstanding at June 30, 2009(2)
	(dollars in millions)
Assets
Financial instruments owned:
U.S. agency securities	$	17	$	(1	)	$	12		$	—		$	28	$	—
Other sovereign government obligations		2		—			—			1			3		—
State and municipal securities		1,887		25			(207	)		—			1,705		(7	)
Residential mortgage-backed securities		988		(16	)		(41	)		(111	)		820		(15	)
Commercial mortgage-backed securities		2,443		(215	)		(680	)		(42	)		1,506		(204	)
Asset-backed securities		4,519		108			(2,961	)		161			1,827		30
Corporate bonds		2,370		(39	)		161			(43	)		2,449		(180	)
Collateralized debt obligations		972		88			(236	)		(316	)		508		49
Loans and lending commitments		17,108		630			48			1,650			19,436		570
Other debt		1,201		256			33			(1	)		1,489		245

Total corporate and other debt		31,488		837			(3,883	)		1,298			29,740		488
Corporate equities		946		366			(302	)		91			1,101		(172	)
Net derivative and other contracts(3)		16,521		(3,510	)		(1,098	)		693			12,606		(3,101	)
Investments		8,834		(166	)		(487	)		(9	)		8,172		(97	)
Securities received as collateral		3		—			14			—			17		—
Intangible assets		159		14			—			—			173		13

Liabilities
Financial instruments sold, not yet purchased:
Commercial mortgage-backed securities	$	4	$	—		$	—		$	—		$	4	$	—
Asset-backed securities		1,636		109			(1,523	)		—			4		108
Corporate bonds		58		(11	)		63			—			132		(9	)
Collateralized debt obligations		16		1			(15	)		—			—		—
Unfunded lending commitments		208		(134	)		(37	)		(2	)		303		(128	)
Other debt		28		(4	)		54			—			86		(1	)

Total corporate and other debt		1,950		(39	)		(1,458	)		(2	)		529		(30	)
Corporate equities		74		(26	)		(83	)		5			22		(12	)
Obligation to return securities received as collateral		3		—			14			—			17		—
Other secured financings		4,264		52			20			231			4,463		52
Long-term borrowings		5,671		(224	)		1			4			5,900		(224	)

(1)	Total realized and unrealized gains or (losses) are primarily included in Principal transactions—trading in the condensed consolidated statements of income except for $(166) million related to Financial instruments owned—investments, which is included in Principal transactions—investments.

(2)	Amounts represent unrealized gains or (losses) for the quarter ended June 30, 2009 related to assets and liabilities still outstanding at June 30, 2009.

(3)	Net derivative and other contracts represent Financial instruments owned—derivative and other contracts net of Financial instruments sold, not yet purchased—derivative and other contracts. For further information on derivative instruments and hedging activities, see Note 8.


		29

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Financial instruments owned—Corporate and other debt. The net gains in Corporate and other debt were primarily driven by corporate loans.

During the quarter ended June 30, 2009, the Company reclassified approximately $1.3 billion of certain Corporate and other debt from Level 2 to Level 3. The reclassifications were primarily related to certain corporate loans. The reclassifications were due to a reduction in market price quotations for these or comparable instruments, or a lack of available broker quotes, such that unobservable inputs had to be utilized for the fair value measurement of these instruments. The key unobservable inputs include assumptions to establish comparability to bonds, loans or swaps with observable price/spread levels.

Financial instruments owned—Net derivative and other contracts. The net losses in Net derivative and other contracts were primarily driven by tightening of credit spreads on underlying reference entities of single name and basket credit default swaps.

During the quarter ended June 30, 2009, the Company reclassified approximately $700 million of certain Derivatives and other contracts from Level 2 to Level 3. These reclassifications of certain Derivatives and other contracts were related to interest rate swaps and bespoke basket default swaps, for which some inputs were unobservable and deemed significant.

Financial instruments owned—Investments. The net losses from investments were primarily related to investments associated with the Company’s real estate products.


		30

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Three Months Ended June 30, 2008


	Beginning Balance at March 31, 2008		Total Realized and Unrealized Gains or (Losses)(1)			Purchases, Sales, Other Settlements and Issuances, net			Net Transfers In and/or (Out) of Level 3			Ending Balance at June 30, 2008		Unrealized Gains or (Losses) for Level 3 Assets/ Liabilities Outstanding at June 30, 2008(2)
	(dollars in millions)
Assets
Financial instruments owned:
U.S. government and agency securities	$	438	$	(37	)	$	(91	)	$	(38	)	$	272	$	(27	)
Other sovereign government obligations		25		(2	)		(18	)		(3	)		2		—
Corporate and other debt		38,241		(1,527	)		(4,113	)		1,438			34,039		(1,809	)
Corporate equities		1,547		(2	)		(98	)		(159	)		1,288		(14	)
Net derivative and other contracts(3)		12,749		(272	)		2,791			885			16,153		(121	)
Investments		11,866		(137	)		609			148			12,486		(189	)
Securities received as collateral		27		—			(25	)		—			2		—
Intangible assets		4		—			—			—			4		—

Liabilities
Financial instruments sold, not yet purchased:
Corporate and other debt	$	908	$	221		$	472		$	50		$	1,209	$	274
Corporate equities		514		(184	)		(405	)		(232	)		61		(182	)
Obligation to return securities received as collateral		27		—			(25	)		—			2		—
Other secured financings		7,241		977			1,684			1,169			9,117		977
Long-term borrowings		5,834		100			(60	)		—			5,674		97

(1)	Total realized and unrealized gains or (losses) are primarily included in Principal transactions—trading in the condensed consolidated statements of income except for $(137) million related to Financial instruments owned—investments, which is included in Principal transactions—investments.

(2)	Amounts represent unrealized gains or (losses) for the quarter ended June 30, 2008 related to assets and liabilities still outstanding at June 30, 2008.

(3)	Net derivative and other contracts represent Financial instruments owned—derivative and other contracts net of Financial instruments sold, not yet purchased—derivative and other contracts. For further information on derivative instruments and hedging activities, see Note 8.

Financial instruments owned—Corporate and other debt. The net losses from Corporate and other debt were primarily driven by certain mortgage-related products.

The sales of Corporate and other debt were primarily related to whole loans and CMBS.

During the quarter ended June 30, 2008, the Company reclassified certain Corporate and other debt from Level 2 to Level 3 because certain significant inputs for the fair value measurement became unobservable. These reclassifications included transfers primarily related to certain mortgage-related products and corporate loans and lending commitments.

Financial instruments owned—Net derivative and other contracts. The Company reclassified certain OTC derivatives from Level 2 to Level 3. The reclassifications primarily related to tranche-indexed credit default swaps. The reclassifications were due to a reduction in the availability of transaction data and broker quotes.


		31

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Six Months Ended June 30, 2009


	Beginning Balance at December 31, 2008		Total Realized and Unrealized Gains or (Losses)(1)			Purchases, Sales, Other Settlements and Issuances, net			Net Transfers In and/or (Out) of Level 3			Ending Balance at June 30, 2009		Unrealized Gains or (Losses) for Level 3 Assets/ Liabilities Outstanding at June 30, 2009(2)
	(dollars in millions)
Assets
Financial instruments owned:
U.S. agency securities	$	127	$	(3	)	$	(73	)	$	(23	)	$	28	$	—
Other sovereign government obligations		1		2			(4	)		4			3		(2	)
State and municipal securities		2,065		3			(289	)		(74	)		1,705		(8	)
Residential mortgage-backed securities		1,251		(93	)		(156	)		(182	)		820		(111	)
Commercial mortgage-backed securities		3,130		(609	)		(1,035	)		20			1,506		(634	)
Asset-backed securities		968		(42	)		505			396			1,827		(85	)
Corporate bonds		3,088		(318	)		(74	)		(247	)		2,449		(508	)
Collateralized debt obligations		982		(21	)		(202	)		(251	)		508		(66	)
Loans and lending commitments		19,701		(1,898	)		533			1,100			19,436		(1,786	)
Other debt		3,733		340			(927	)		(1,657	)		1,489		292

Total corporate and other debt		34,918		(2,638	)		(1,645	)		(895	)		29,740		(2,906	)
Corporate equities		976		332			(365	)		158			1,101		(201	)
Net derivative and other contracts(3)		23,382		(2,346	)		100			(8,530	)		12,606		229
Investments		9,698		(1,484	)		13			(55	)		8,172		(1,372	)
Securities received as collateral		30		—			(13	)		—			17		—
Intangible assets		184		(12	)		1			—			173		13

Liabilities
Financial instruments sold, not yet purchased:
Commercial mortgage-backed securities	$	1	$	1		$	4		$	—		$	4	$	1
Asset-backed securities		4		1			1			—			4		—
Corporate bonds		320		(9	)		(101	)		(96	)		132		(9	)
Unfunded lending commitments		36		(131	)		136			—			303		(131	)
Other debt		3,447		1			(935	)		(2,425	)		86		2

Total corporate and other debt		3,808		(137	)		(895	)		(2,521	)		529		(137	)
Corporate equities		27		(8	)		(5	)		(8	)		22		(8	)
Obligation to return securities received as collateral		30		—			(13	)		—			17		—
Other secured financings		6,148		1,143			(628	)		86			4,463		1,143
Long-term borrowings		5,473		(337	)		83			7			5,900		(354	)

(1)	Total realized and unrealized gains or (losses) are primarily included in Principal transactions—trading in the condensed consolidated statements of income except for $(1,484) million related to Financial instruments owned—investments, which is included in Principal transactions—investments.


		32

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(2)	Amounts represent unrealized gains or (losses) for the quarter ended June 30, 2009 related to assets and liabilities still outstanding at June 30, 2009.

(3)	Net derivative and other contracts represent Financial instruments owned—derivative and other contracts net of Financial instruments sold, not yet purchased—derivative and other contracts. For further information on derivative instruments and hedging activities, see Note 8.

Financial instruments owned—Corporate and other debt. The net losses in Corporate and other debt were primarily driven by certain corporate loans and lending commitments and certain commercial mortgage-backed securities.

During the six month period ended June 30, 2009, the Company reclassified approximately $0.9 billion of certain Corporate and other debt from Level 3 to Level 2. The reclassifications were primarily related to certain other debt. Their fair value was highly correlated with similar instruments in an observable market and, due to market deterioration, unobservable inputs were no longer deemed significant. These reclassifications were partly offset by the reclassification of certain corporate loans from Level 2 to Level 3. The reclassifications were due to a reduction in market price quotations for these or comparable instruments, or a lack of available broker quotes, such that unobservable inputs had to be utilized for the fair value measurement of these instruments. The key unobservable inputs include assumptions to establish comparability to bonds, loans or swaps with observable price/spread levels.

During the six month period ended June 30, 2009, the Company reclassified approximately $8.5 billion of certain Derivatives and other contracts from Level 3 to Level 2. These reclassifications of certain Derivatives and other contracts were related to single name mortgage-related credit default swaps and credit default swaps on certain classes of CDOs. The primary reason for the reclassifications is that, due to market deterioration, the values associated with the unobservable inputs, such as correlation, for these derivative contracts were no longer deemed significant to the fair value measurement. In addition, certain corporate tranche-indexed credit default swaps were reclassified due to increased availability of transaction data, broker quotes and/or consensus pricing.

Financial instruments owned—Investments. The net losses from investments were primarily related to investments associated with the Company’s real estate products.

Financial instruments sold, not yet purchased—Corporate and other debt. During the six month period ended June 30, 2009, the Company reclassified approximately $2.5 billion of certain Corporate and other debt from Level 3 to Level 2. These reclassifications primarily related to contracts referencing commercial mortgage-backed securities, subprime CDO and other subprime ABS securities. Their fair value was highly correlated with similar instruments in an observable market and, due to market deterioration, the values associated with the unobservable inputs were no longer deemed significant to the fair value measurement.

Other secured financings. The net gains in Other secured financings were primarily due to net gains on liabilities resulting from securitizations recognized on balance sheet. These net gains were offset by net losses in Financial instruments owned—Corporate and other debt.


		33

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Six Months Ended June 30, 2008


	Beginning Balance at December 31, 2007		Total Realized and Unrealized Gains or (Losses)(1)			Purchases, Sales, Other Settlements and Issuances, net			Net Transfers In and/or (Out) of Level 3			Ending Balance at June 30, 2008		Unrealized Gains or (Losses) for Level 3 Assets/ Liabilities Outstanding at June 30, 2008(2)
	(dollars in millions)
Assets
Financial instruments owned:
U.S. government and agency securities	$	622	$	28		$	(242	)	$	(136	)	$	272	$	(3	)
Other sovereign government obligations		15		(4	)		(18	)		9			2		—
Corporate and other debt		39,707		(5,323	)		(3,108	)		2,763			34,039		(5,417	)
Corporate equities		1,717		(170	)		(370	)		111			1,288		(31	)
Net derivative and other contracts(3)		5,486		7,201			3,790			(324	)		16,153		6,737
Investments		12,758		(374	)		1,369			(1,267	)		12,486		(498	)
Securities received as collateral		71		—			(69	)		—			2		—
Intangible assets		3		1			—			—			4		1

Liabilities
Financial instruments sold, not yet purchased:
Corporate and other debt	$	717	$	5		$	432		$	65		$	1,209	$	(11	)
Corporate equities		175		(301	)		(302	)		(113	)		61		(300	)
Obligation to return securities received as collateral		71		—			(69	)		—			2		—
Other secured financings		6,160		910			3,191			676			9,117		910
Long-term borrowings		5,829		91			(64	)		—			5,674		86

(1)	Total realized and unrealized gains or (losses) are primarily included in Principal transactions—trading in the condensed consolidated statements of income except for $(374) million related to Financial instruments owned—investments, which is included in Principal transactions—investments.

(2)	Amounts represent unrealized gains or (losses) for the quarter ended June 30, 2008 related to assets and liabilities still outstanding at June 30, 2008.

(3)	Net derivative and other contracts represent Financial instruments owned—derivative and other contracts net of Financial instruments sold, not yet purchased—derivative and other contracts. For further information on derivative instruments and hedging activities, see Note 8.

Financial instruments owned—Corporate and other debt. The net losses from Corporate and other debt were primarily driven by certain mortgage-related products and by corporate loans and lending commitments.

The sales from Corporate and other debt were primarily related to whole loans and CMBS.


		34

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

During the six month period ended June 30, 2008, the Company reclassified certain Corporate and other debt from Level 2 to Level 3 because certain significant inputs for the fair value measurement became unobservable. These reclassifications included transfers primarily related to certain mortgage-related products and corporate loans and lending commitments.

Financial instruments owned—Net derivative and other contracts. The net gains from Net derivative contracts were primarily driven by certain basket and single name credit default swaps.

The purchases in Net derivative contracts were primarily driven by certain basket and single name credit default swaps.

Financial instruments owned—Investments. The Company reclassified investments from Level 3 to Level 2 because certain significant inputs for the fair value measurement were identified and, therefore, became observable.

Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis.

Certain assets were measured at fair value on a non-recurring basis and are not included in the tables above. These assets may include certain loans, certain equity method investments, certain premises and equipment, certain intangible assets and certain real estate investments.

The following table presents, by caption on the condensed consolidated statement of financial position, the fair value hierarchy for those assets measured at fair value on a non-recurring basis for which the Company recognized an impairment charge for the quarter and six month period ended June 30, 2009.


	Carrying Value at June 30, 2009		Fair Value Measurements Using:						Total (Losses) for the Three Months Ended June 30, 2009(1)			Total (Losses) for the Six Months Ended June 30, 2009(1)
	Carrying Value at June 30, 2009		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total (Losses) for the Three Months Ended June 30, 2009(1)			Total (Losses) for the Six Months Ended June 30, 2009(1)
	(dollars in millions)
Receivables—Other loans(2)	$	664	$	—	$	—	$	664	$	(84	)	$	(182	)
Other investments(3)		24		—		—		24		(7	)		(51	)
Premises, equipment and software costs(4)		8		—		—		8		—			(5	)
Intangible assets(5)		7		—		—		7		(3	)		(9	)
Other assets(6)		147		—		—		147		(36	)		(161	)

Total	$	850	$	—	$	—	$	850	$	(130	)	$	(408	)

(1)	Impairment losses are recorded within Other expenses in the condensed consolidated statement of income except for impairment losses related to Receivables—Other loans and Other investments, which are included in Other revenues.

(2)

Loans held for investment and held for sale with a carrying amount of $748 million were written down to their fair value of $664 million as of June 30, 2009, resulting in an impairment charge of $84 million in the quarter ended June 30, 2009, calculated based upon the fair value of the collateral. Loans held for investment and held for sale with a carrying amount of $846 million were written down to their fair value of $664 million as of June 30, 2009, resulting in an impairment charge of $182 million in the six month period ended June 30, 2009, calculated based upon the fair value of the collateral. The fair value of the collateral was determined using internal expected recovery models.

(3)

Equity method investments with a carrying amount of $31 million were written down to their fair value of $24 million as of June 30, 2009, resulting in an impairment charge of $7 million in the quarter ended June 30, 2009. Equity method investments with a carrying amount of $75 million were written down to their fair value of $24 million as of June 30, 2009, resulting in an impairment charge of $51 million in the six month period ended June 30, 2009. Impairment losses recorded were determined primarily using discounted cash flow models.


		35

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(4)	Equipment with a carrying value of $13 million was written down to its fair value of $8 million as of June 30, 2009, resulting in an impairment charge of $5 million in the six month period ended June 30, 2009.

(5)

Intangible assets other than goodwill with a carrying amount of $10 million were written down to fair value of $7 million as of June 30, 2009, resulting in an impairment charge of $3 million in the quarter ended June 30, 2009, recorded within the Asset Management business segment. Intangible assets other than goodwill with a carrying amount of $16 million were written down to fair value of $7 million as of June 30, 2009, resulting in an impairment charge of $9 million in the six month period ended June 30, 2009, recorded within the Asset Management business segment (see Note 6).

(6)

Buildings and property with a carrying amount of $183 million were written down to their fair value of $147 millions of June 30, 2009, resulting in an impairment charge of $36 million in the quarter ended June 30, 2009. Buildings and property with a carrying amount of $308 million were written down to their fair value of $147 million, resulting in an impairment charge of $161 million in the six month period ended June 30, 2009. Fair values were generally determined using discounted cash flow models or third-party appraisals and valuations. This charge relates to the Asset Management business segment.

There were no liabilities measured at fair value on a non-recurring basis during the quarter and six month period ended June 30, 2009.

In addition, there were no assets or liabilities measured at fair value on a non-recurring basis for which the Company recognized an impairment charge during the quarter and six month period ended June 30, 2008.

Fair Value Option.

The Company elected the fair value option for certain eligible instruments that are risk managed on a fair value basis. The following tables present net gains or (losses) due to changes in fair value for items measured at fair value pursuant to the fair value option election for the quarters and six month periods ended June 30, 2009 and June 30, 2008.


	Principal Transactions: Trading			Net Interest Revenue			Gains (Losses) Included in Net Revenues
	(dollars in millions)
Three Months Ended June 30, 2009
Commercial paper and other short-term borrowings	$	(126	)	$	—		$	(126	)
Deposits		10			(87	)		(77	)
Long-term borrowings		(3,391	)		(187	)		(3,578	)

Three Months Ended June 30, 2008
Commercial paper and other short-term borrowings	$	270		$	—		$	270
Deposits		1			(5	)		(4	)
Long-term borrowings		576			(215	)		361

Six Months Ended June 30, 2009
Commercial paper and other short-term borrowings	$	(42	)	$	—		$	(42	)
Deposits		(77	)		(179	)		(256	)
Long-term borrowings		(4,796	)		(327	)		(5,123	)

Six Months Ended June 30, 2008
Commercial paper and other short-term borrowings	$	196		$	(4	)	$	192
Deposits		5			(29	)		(24	)
Long-term borrowings		2,680			(383	)		2,297

In addition to the amounts in the above table, as discussed in Note 1, all of the instruments within Financial instruments owned or Financial instruments sold, not yet purchased are measured at fair value, either through the election of the fair value option, or as required by other accounting pronouncements.


		36

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The following table presents information on the Company’s short-term and long-term borrowings (including structured notes and junior subordinated debentures), loans and unfunded lending commitments for which the fair value option was elected:

(Losses) Gains Due to Changes in Instrument Specific Credit Spreads


	Three Months Ended June 30,					Six Months Ended June 30,
	2009		2008			2009		2008
	(dollars in millions)
Short-term and long-term borrowings(1)	$(2,286	)		$ (326	)	$ (3,926	)	$	1,565
Loans(2)	3,718			412		3,644			(1,248	)
Unfunded lending commitments(3)	(144	)		251		(142	)		95

(1)

Gains or (losses) were attributable to widening or (tightening), respectively, of the Company’s credit spreads and were determined based upon observations of the Company’s secondary bond market spreads. The remainder of changes in overall fair value of the short-term and long-term borrowings is attributable to changes in foreign currency exchange rates and interest rates and movements in the reference price or index for structured notes.

(2)	Instrument-specific credit gains or (losses) were determined by excluding the non-credit components of gains and losses, such as those due to changes in interest rates.

(3)	Gains or (losses) were generally determined based on the differential between estimated expected client and contractual yields at each respective period end.

Contractual Principal Amount Over Fair Value


	At June 30, 2009		At December 31, 2008		At November 30, 2008
	(dollars in billions)
Short-term and long-term debt borrowings(1)	$	3.7	$	5.7	$	7.5
Loans(2)		27.2		31.0		30.5
Loans 90 or more days past due(2)(3)		19.6		19.8		19.8

(1)	These amounts do not include structured notes where the repayment of the initial principal amount fluctuates based on changes in the reference price or index.

(2)	The majority of this difference between principal and fair value amounts emanates from the Company’s distressed debt trading business, which purchases distressed debt at amounts well below par.

(3)	The aggregate fair value of loans that were 90 or more days past due as of June 30, 2009, December 31, 2008 and November 30, 2008 was $1.9 billion, $2.0 billion and $2.0 billion, respectively.

Financial Instruments Not Measured at Fair Value.

Some of the Company’s financial instruments are not measured at fair value on a recurring basis but nevertheless are recorded at amounts that approximate fair value due to their liquid or short-term nature. Such financial assets and financial liabilities include: Cash and due from banks, Cash deposited with clearing organizations or segregated under federal and other regulations or requirements, Interest bearing deposits with banks, Federal funds sold and Securities purchased under agreements to resell, Securities borrowed, Securities sold under agreements to repurchase, Securities loaned, Receivables—customers, Receivables—brokers, dealers and clearing organizations, Payables—customers, Payables—brokers, dealers and clearing organizations, certain Commercial paper and other short-term borrowings, and certain Deposits.


		37

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The Company’s long-term borrowings are recorded at historical amounts unless elected under the fair value option or designated as a hedged item in a fair value hedge. For long-term borrowings not measured at fair value, the fair value of the Company’s long-term borrowings was estimated using either quoted market prices or discounted cash flow analyses based on the Company’s current borrowing rates for similar types of borrowing arrangements. At June 30, 2009, the carrying value of the Company’s long-term borrowings was approximately $8.6 billion higher than fair value. At November 30, 2008, the carrying value of the Company’s long-term borrowings was approximately $25.0 billion higher than fair value.

4.	Collateralized Transactions.

Securities purchased under agreements to resell (“reverse repurchase agreements”) and Securities sold under agreements to repurchase (“repurchase agreements”), principally government and agency securities, are carried at the amounts at which the securities subsequently will be resold or reacquired as specified in the respective agreements; such amounts include accrued interest. Reverse repurchase agreements and repurchase agreements are presented on a net-by-counterparty basis, when appropriate. The Company’s policy is generally to take possession of securities purchased under agreements to resell. Securities borrowed and Securities loaned are carried at the amounts of cash collateral advanced and received in connection with the transactions. Other secured financings include the liabilities related to transfers of financial assets that are accounted for as financings rather than sales, consolidated VIEs where the Company is deemed to be the primary beneficiary, and certain equity-referenced securities and loans where in all instances these liabilities are payable solely from the cash flows of the related assets accounted for as Financial instruments owned (see Note 5).

The Company pledges its financial instruments owned to collateralize repurchase agreements and other securities financings. Pledged financial instruments that can be sold or repledged by the secured party are identified as Financial instruments owned (pledged to various parties) in the condensed consolidated statements of financial condition. The carrying value and classification of financial instruments owned by the Company that have been loaned or pledged to counterparties where those counterparties do not have the right to sell or repledge the collateral were as follows:


	At June 30, 2009		At December 31, 2008		At November 30, 2008
	(dollars in millions)
Financial instruments owned:
U.S. government and agency securities	$	12,576	$	9,134	$	7,701
Other sovereign government obligations		6,096		2,570		626
Corporate and other debt		13,809		21,850		33,037
Corporate equities		7,050		4,388		5,726

Total	$	39,531	$	37,942	$	47,090

The Company enters into reverse repurchase agreements, repurchase agreements, securities borrowed and securities loaned transactions to, among other things, acquire securities to cover short positions and settle other securities obligations, to accommodate customers’ needs and to finance the Company’s inventory positions. The Company also engages in securities financing transactions for customers through margin lending. Under these agreements and transactions, the Company either receives or provides collateral, including U.S. government and agency securities, other sovereign government obligations, corporate and other debt, and corporate equities. The Company receives collateral in the form of securities in connection with reverse repurchase agreements,


		38

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

securities borrowed and derivative transactions, and customer margin loans. In many cases, the Company is permitted to sell or repledge these securities held as collateral and use the securities to secure repurchase agreements, to enter into securities lending and derivative transactions or for delivery to counterparties to cover short positions. At June 30, 2009, December 31, 2008 and November 30, 2008, the fair value of financial instruments received as collateral where the Company is permitted to sell or repledge the securities was $331 billion, $290 billion and $294 billion, respectively, and the fair value of the portion that had been sold or repledged was $257 billion, $214 billion and $227 billion, respectively.

The Company additionally receives securities as collateral in connection with certain securities for securities transactions in which the Company is the lender. In instances where the Company is permitted to sell or repledge these securities, the Company reports the fair value of the collateral received and the related obligation to return the collateral in the condensed consolidated statements of financial condition. At June 30, 2009, December 31, 2008 and November 30, 2008, $10 billion, $5 billion and $5 billion, respectively, were reported as Securities received as collateral and an Obligation to return securities received as collateral in the condensed consolidated statements of financial condition. Collateral received in connection with these transactions that was subsequently repledged was approximately $9 billion, $4 billion and $5 billion at June 30, 2009, December 31, 2008 and November 30, 2008, respectively.

The Company manages credit exposure arising from reverse repurchase agreements, repurchase agreements, securities borrowed and securities loaned transactions by, in appropriate circumstances, entering into master netting agreements and collateral arrangements with counterparties that provide the Company, in the event of a customer default, the right to liquidate collateral and the right to offset a counterparty’s rights and obligations. The Company also monitors the fair value of the underlying securities as compared with the related receivable or payable, including accrued interest, and, as necessary, requests additional collateral to ensure such transactions are adequately collateralized. Where deemed appropriate, the Company’s agreements with third parties specify its rights to request additional collateral. Customer receivables generated from margin lending activity are collateralized by customer-owned securities held by the Company. For these transactions, adherence to the Company’s collateral policies significantly limits the Company’s credit exposure in the event of customer default. The Company may request additional margin collateral from customers, if appropriate, and, if necessary, may sell securities that have not been paid for or purchase securities sold but not delivered from customers.

At June 30, 2009, December 31, 2008 and November 30, 2008, cash and securities deposited with clearing organizations or segregated under federal and other regulations or requirements were as follows:


	June 30, 2009		December 31, 2008		November 30, 2008
	(dollars in millions)
Cash	$	21,643	$	24,039	$	25,446
Securities(1)		8,721		38,670		33,642

Total	$	30,364	$	62,709	$	59,088

(1)	Securities deposited with clearing organizations or segregated under federal and other regulations or requirements are sourced from Federal funds sold and securities purchased under agreements to resell and Financial instruments owned in the condensed consolidated statements of financial condition.


		39

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

5.	Securitization Activities and Variable Interest Entities.

Securitization Activities and Qualifying Special Purpose Entities.

Securitization Activities. In a securitization transaction, the Company transfers assets (generally commercial or residential mortgage loans or U.S. agency securities) to a special purpose entity (an “SPE”), sells to investors most of the beneficial interests, such as notes or certificates, issued by the SPE and in many cases retains other beneficial interests. In many securitization transactions involving commercial mortgage loans, the Company transfers a portion of the assets transferred to the SPE with unrelated parties transferring the remaining assets.

The purchase of the transferred assets by the SPE is financed through the sale of these interests. In some of these transactions, primarily involving residential mortgage loans in the U.S. and Europe and commercial mortgage loans in Europe, the Company serves as servicer for some or all of the transferred loans. In many securitizations, particularly involving residential mortgage loans, the Company also enters into derivative transactions, primarily interest rate swaps or interest rate caps, with the SPE.

In most of these transactions, the SPE meets the criteria to be a QSPE under the accounting guidance for the transfer and servicing of financial assets. The Company does not consolidate QSPEs if they meet certain criteria regarding the types of assets and derivatives they may hold, the activities in which they may engage and the range of discretion they may exercise in connection with the assets they hold. The determination of whether an SPE meets the criteria to be a QSPE requires considerable judgment, particularly in evaluating whether the permitted activities of the SPE are significantly limited and in determining whether derivatives held by the SPE are passive and not excessive.

The primary risk retained by the Company in connection with these transactions generally is limited to the beneficial interests issued by the SPE that are owned by the Company, with the risk highest on the most subordinate class of beneficial interests. Where the QSPE criteria are met, these beneficial interests generally are included in Financial instruments owned—Corporate and other debt and are measured at fair value. The Company does not provide additional support in these transactions through contractual facilities, such as liquidity facilities, guarantees, or similar derivatives.

Although not obligated, the Company generally makes a market in the securities issued by SPEs in these transactions. In these market-making transactions, the Company offers to buy these securities from, and sell these securities to, investors. Securities purchased through these market-making activities are not considered to be retained interests, although these beneficial interests generally are included in Financial instruments owned—Corporate and other debt securities and are measured at fair value.

The Company enters into derivatives, generally interest rate swaps and interest rate caps with a senior payment priority in many securitization transactions. The risks associated with these and similar derivatives with SPEs are essentially the same as similar derivatives with non-SPE counterparties and are managed as part of the Company’s overall exposure.

See Note 8 for further information on derivative instruments and hedging activities.


		40

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

QSPEs. The following tables present information as of June 30, 2009 and December 31, 2008 regarding QSPEs to which the Company acting as principal, has transferred assets and received sales treatment, and QSPEs sponsored by the Company to which the Company has not transferred assets (dollars in millions):


	At June 30, 2009
	Residential Mortgage Loans		Commercial Mortgage Loans		U.S. Agency Collateralized Mortgage Obligations		Other
QSPE assets (unpaid principal balance)(1)	$	59,741	$	111,280	$	25,917	$	3,843
Retained interests (fair value):
Investment grade	$	196	$	214	$	155	$	—
Non-investment grade		68		234		—		—

Total retained interests (fair value)	$	264	$	448	$	155	$	—

Interests purchased in the secondary market (fair value):
Investment grade	$	148	$	351	$	2	$	75
Non-investment grade		88		56		—		16

Total interests purchased in the secondary market (fair value)	$	236	$	407	$	2	$	91

Derivatives (fair value)	$	299	$	325	$	—	$	1,338
Assets serviced (unpaid principal balance)		20,097		8,585		—		—

(1)	Amount includes $57.6 billion of assets transferred to the QSPEs by unrelated transferors.


	At December 31, 2008
	Residential Mortgage Loans		Commercial Mortgage Loans		U.S. Agency Collateralized Mortgage Obligations		Other
QSPE assets (unpaid principal balance)(1)	$	65,344	$	112,557	$	28,380	$	2,684
Retained interests (fair value):
Investment grade	$	500	$	482	$	102	$	—
Non-investment grade		33		100		—		—

Total retained interests (fair value)	$	533	$	582	$	102	$	—

Interests purchased in the secondary market (fair value):
Investment grade	$	42	$	156	$	8	$	23
Non-investment grade		49		14		—		12

Total interests purchased in the secondary market (fair value)	$	91	$	170	$	8	$	35

Derivatives (fair value)	$	488	$	515	$	—	$	1,156
Assets serviced (unpaid principal balance)		23,211		8,196		—		—

(1)	Amount includes $57.8 billion of assets transferred to the QSPEs by unrelated transferors.

Transferred assets are carried at fair value prior to securitization, and any changes in fair value are recognized in the condensed consolidated statements of income. The Company may act as underwriter of the beneficial interests issued by securitization vehicles. Underwriting net revenues are recognized in connection with these transactions. The Company may retain interests in the securitized financial assets as one or more tranches of the


		41

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

securitization. These retained interests are included in the condensed consolidated statements of financial condition at fair value. Any changes in the fair value of such retained interests are recognized in the condensed consolidated statements of income. Net gains at the time of securitization were not material during the six month period ended June 30, 2009 and the one month period ended December 31, 2008.

During the six month periods ended June 30, 2009 and June 30, 2008, the Company received proceeds from new securitization transactions of $2.0 billion and $5.0 billion, respectively. During the six month periods ended June 30, 2009 and June 30, 2008, the Company received proceeds from cash flows from retained interests in securitization transactions of $1.3 billion and $1.4 billion, respectively.

The Company provides representations and warranties that certain assets transferred in securitization transactions conform to specific guidelines (see Note 9).

Mortgage Servicing Rights. The Company may retain servicing rights to certain mortgage loans that are sold through its securitization activities. These transactions create an asset referred to as MSRs, which totaled approximately $173 million and $184 million as of June 30, 2009 and December 31, 2008, respectively, and are included within Intangible assets and carried at fair value in the condensed consolidated statements of financial condition.

SPE Mortgage Servicing Activities. The Company services residential mortgage loans in the U.S. and Europe and commercial mortgage loans in Europe owned by SPEs, including SPEs sponsored by the Company and SPEs not sponsored by the Company. Most of these SPEs meet the requirements for QSPEs. The Company generally holds retained interests in Company-sponsored QSPEs. In some cases, as part of its market making activities, the Company may own some beneficial interests issued by both Company-sponsored and non-Company sponsored SPEs.

The Company provides no credit support as part of its servicing activities. The Company is required to make servicing advances to the extent that it believes that such advances will be reimbursed. Reimbursement of servicing advances is a senior obligation of the SPE, senior to the most senior beneficial interests outstanding. Outstanding advances are included in Other assets and are recorded at cost. Advances as of June 30, 2009 and December 31, 2008 totaled approximately $2.3 billion and $2.4 billion, respectively, net of reserves of approximately $14 million and $10 million, respectively.

The following table presents information about the Company’s mortgage servicing activities for SPEs to which the Company transferred loans as of June 30, 2009 and December 31, 2008 (dollars in millions):


	At June 30, 2009
	Residential Mortgage QSPEs			Residential Mortgage Failed Sales			Commercial Mortgage QSPEs		Commercial Mortgage Consolidated SPEs
Assets serviced (unpaid principal balance)	$	20,097		$	819		$	8,585	$	2,363
Amounts past due 90 days or greater (unpaid principal balance)(1)	$	7,480		$	343		$	2	$	4
Percentage of amounts past due 90 days or greater(1)		37.2	%		41.8	%		—		0.2	%
Credit losses	$	1,083		$	21		$	—	$	—

(1)	Includes loans that are at least 90 days contractually delinquent, loans for which the borrower has filed for bankruptcy, loans in foreclosure and real estate owned.


		42

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)


	At December 31, 2008
	Residential Mortgage QSPEs			Residential Mortgage Failed Sales			Commercial Mortgage QSPEs		Commercial Mortgage Consolidated SPEs
Assets serviced (unpaid principal balance)	$	23,211		$	890		$	8,196	$	2,349
Amounts past due 90 days or greater (unpaid principal balance)(1)	$	7,586		$	308		$	—	$	—
Percentage of amounts past due 90 days or greater(1)		32.7	%		34.6	%		—		—
Credit losses	$	181		$	11		$	—	$	—

(1)	Includes loans that are at least 90 days contractually delinquent, loans for which the borrower has filed for bankruptcy, loans in foreclosure and real estate owned.

The Company also serviced residential and commercial mortgage loans for SPEs sponsored by unrelated parties with unpaid principal balances totaling $23 billion and $25 billion as of June 30, 2009 and December 31, 2008, respectively.

Variable Interest Entities. Accounting guidance for consolidation of VIEs applies to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. QSPEs currently are not subject to consolidation. The primary beneficiary of a VIE is the party that absorbs a majority of the entity’s expected losses, receives a majority of its expected residual returns or both, as a result of holding variable interests. The Company consolidates entities of which it is the primary beneficiary.

The Company is involved with various entities in the normal course of business that may be deemed to be VIEs. The Company’s variable interests in VIEs include debt and equity interests, commitments, guarantees and derivative instruments. The Company’s involvement with VIEs arises primarily from:

•

Interests purchased in connection with market making and retained interests held as a result of securitization activities.

•

Guarantees issued and residual interests retained in connection with municipal bond securitizations.

•

Loans and investments made to VIEs that hold debt, equity, real estate or other assets.

•

Derivatives entered into with VIEs.

•

Structuring of credit-linked notes (“CLNs”) or other asset-repackaged notes designed to meet the investment objectives of clients.

•

Other structured transactions designed to provide tax-efficient yields to the Company or its clients.

The Company determines whether it is the primary beneficiary of a VIE upon its initial involvement with the VIE. This determination is based upon an analysis of the design of the VIE, including the VIE’s structure and activities and the variable interests owned by the Company.

The Company reassesses whether it is the primary beneficiary of a VIE upon the occurrence of certain reconsideration events. If the Company’s initial assessment results in a determination that it is not the primary beneficiary of a VIE, then the Company reassesses this determination upon the occurrence of:

•

Changes to the VIE’s governing documents or contractual arrangements in a manner that reallocates the obligation to absorb the expected losses or the right to receive the expected residual returns of the VIE between the current primary beneficiary and the other variable interest holders, including the Company.

•

Acquisition by the Company of additional variable interests in the VIE.


		43

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

If the Company’s initial assessment results in a determination that it is the primary beneficiary, then the Company reassesses this determination upon the occurrence of:

•