Edgar Filing: MORGAN STANLEY

Form 10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2011

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

EXCHANGE ACT OF 1934

Commission File Number 1-11758

LOGO

(Exact Name of Registrant as specified in its charter)

Delaware

(State or other jurisdiction of incorporation or organization)

1585 Broadway

New York, NY 10036

(Address of principal executive
offices, including zip code)

36-3145972

(I.R.S. Employer Identification No.)

(212) 761-4000

(Registrant’s telephone number,
including area code)

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

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

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


Large Accelerated Filer x		Accelerated Filer ¨
Non-Accelerated Filer ¨		Smaller reporting company ¨
(Do not check if a smaller reporting company)

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

As of April 30, 2011, there were 1,544,658,124 shares of the Registrant’s Common Stock, par value $0.01 per share, outstanding.

LOGO

QUARTERLY REPORT ON FORM 10-Q

For the quarter ended March 31, 2011


Table of Contents		Page
Part I—Financial Information
Item 1.	Financial Statements (unaudited)		1
	Condensed Consolidated Statements of Financial Condition—March 31, 2011 and December 31, 2010		1
	Condensed Consolidated Statements of Income—Three Months Ended March 31, 2011 and 2010		3
	Condensed Consolidated Statements of Comprehensive Income—Three Months Ended March 31, 2011 and 2010		4
	Condensed Consolidated Statements of Cash Flows—Three Months Ended March 31, 2011 and 2010		5
	Condensed Consolidated Statements of Changes in Total Equity—Three Months Ended March 31, 2011 and 2010		6
	Notes to Condensed Consolidated Financial Statements (unaudited)		8
	Note 1. Introduction and Basis of Presentation		8
	Note 2. Significant Accounting Policies		10
	Note 3. Fair Value Disclosures		11
	Note 4. Securities Available for Sale		30
	Note 5. Collateralized Transactions		32
	Note 6. Variable Interest Entities and Securitization Activities		34
	Note 7. Financing Receivables		42
	Note 8. Goodwill and Net Intangible Assets		44
	Note 9. Long-Term Borrowings and Other Secured Financings		45
	Note 10. Derivative Instruments and Hedging Activities		46
	Note 11. Commitments, Guarantees and Contingencies		54
	Note 12. Regulatory Requirements		60
	Note 13. Total Equity		63
	Note 14. Earnings per Common Share		63
	Note 15. Interest Income and Interest Expense		65
	Note 16. Employee Benefit Plans		65
	Note 17. Income Taxes		66
	Note 18. Segment and Geographic Information		67
	Note 19. Equity Method Investments		69
	Note 20. Discontinued Operations		70
	Note 21. Subsequent Events		71
	Report of Independent Registered Public Accounting Firm		72
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		73
	Introduction		73
	Executive Summary		74
	Business Segments		82
	Accounting Developments		93
	Other Matters		94
	Critical Accounting Policies		97
	Liquidity and Capital Resources		102
Item 3.	Quantitative and Qualitative Disclosures about Market Risk		115


		i


Table of Contents		Page
Item 4.	Controls and Procedures		127
Financial Data Supplement (Unaudited)			128

Part II—Other Information
Item 1.	Legal Proceedings		131
Item 1A.	Risk Factors		133
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		134
Item 6.	Exhibits		134


		ii

AVAILABLE INFORMATION

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

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

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

•

Amended and Restated Certificate of Incorporation;

•

Amended and Restated Bylaws;

•

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

•

Corporate Governance Policies;

•

Policy Regarding Communication with the Board of Directors;

•

Policy Regarding Director Candidates Recommended by Shareholders;

•

Policy Regarding Corporate Political Contributions;

•

Policy Regarding Shareholder Rights Plan;

•

Code of Ethics and Business Conduct;

•

Code of Conduct; and

•

Integrity Hotline information.

Morgan Stanley’s Code of Ethics and Business Conduct applies to all directors, officers and employees, including its Chief Executive Officer, Chief Financial Officer and Deputy Chief Financial 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 LLC (“NYSE”) on its internet site. You can request a copy of these documents, excluding exhibits, at no cost, by contacting Investor Relations, 1585 Broadway, New York, NY 10036 (212-761-4000). The information on Morgan Stanley’s internet site is not incorporated by reference into this report.


		iii

Part I—Financial Information.

Item 1.

Financial Statements.

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(dollars in millions, except share data)

(unaudited)


	March 31, 2011		December 31, 2010
Assets
Cash and due from banks ($310 and $297 at March 31, 2011 and December 31, 2010, respectively, related to consolidated variable interest entities generally not available to the Company)	$	8,120	$	7,341
Interest bearing deposits with banks		44,488		40,274
Cash deposited with clearing organizations or segregated under federal and other regulations or requirements		21,932		19,180
Financial instruments owned, at fair value (approximately $132 billion and $130 billion were pledged to various parties at March 31, 2011 and December 31, 2010, respectively):
U.S. government and agency securities		46,626		48,446
Other sovereign government obligations		38,878		33,908
Corporate and other debt ($4,316 and $3,816 at March 31, 2011 and December 31, 2010, respectively related to consolidated variable interest entities, generally not available to the Company)		88,459		88,154
Corporate equities ($655 and $625 at March 31, 2011 and December 31, 2010, respectively related to consolidated variable interest entities, generally not available to the Company)		67,042		68,416
Derivative and other contracts		49,913		51,292
Investments ($1,881 and $1,873 at March 31, 2011 and December 31, 2010, respectively related to consolidated variable interest entities, generally not available to the Company)		9,068		9,752
Physical commodities		8,126		6,778

Total financial instruments owned, at fair value		308,112		306,746
Securities available for sale, at fair value		27,733		29,649
Securities received as collateral, at fair value		13,161		16,537
Federal funds sold and securities purchased under agreements to resell		162,923		148,253
Securities borrowed		142,937		138,730
Receivables:
Customers		43,959		35,258
Brokers, dealers and clearing organizations		6,131		9,102
Fees, interest and other		8,840		9,790
Loans (net of allowances of $45 and $82 at March 31, 2011 and December 31, 2010, respectively)		11,882		10,576
Other investments		4,719		5,412
Premises, equipment and software costs (net of accumulated depreciation of $4,259 and $4,476 at March 31, 2011 and December 31, 2010, respectively) ($352 and $321 at March 31, 2011 and December 31, 2010, respectively related to consolidated variable entities, generally not available to the Company)		6,366		6,154
Goodwill		6,743		6,739
Intangible assets (net of accumulated amortization of $692 and $605 at March 31, 2011 and December 31, 2010, respectively) (includes $144 and $157 at fair value at March 31, 2011 and December 31, 2010, respectively)		4,581		4,667
Other assets ($232 and $118 at March 31, 2011 and December 31, 2010, respectively, related to consolidated variable interest entities generally not available to the Company)		13,558		13,290

Total assets	$	836,185	$	807,698

See Notes to Condensed Consolidated Financial Statements.


		1

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION—(Continued)

(dollars in millions, except share data)

(unaudited)


	March 31, 2011			December 31, 2010
Liabilities and Equity
Deposits (includes $2,848 and $3,027 at fair value at March 31, 2011 and December 31, 2010, respectively)	$	63,495		$	63,812
Commercial paper and other short-term borrowings (includes $1,657 and $1,799 at fair value at March 31, 2011 and December 31, 2010, respectively)		3,302			3,256
Financial instruments sold, not yet purchased, at fair value:
U.S. government and agency securities		31,488			27,948
Other sovereign government obligations		23,133			22,250
Corporate and other debt		10,443			10,918
Corporate equities		26,621			19,838
Derivative and other contracts		44,585			47,802

Total financial instruments sold, not yet purchased, at fair value		136,270			128,756
Obligation to return securities received as collateral, at fair value		18,069			21,163
Securities sold under agreements to repurchase (includes $890 and $849 at fair value at March 31, 2011 and December 31, 2010, respectively)		156,891			147,598
Securities loaned		36,084			29,094
Other secured financings (includes $8,052 and $8,490 at fair value at March 31, 2011 and December 31, 2010, respectively) ($2,812 and $2,656 at March 31, 2011 and December 31, 2010, respectively, related to consolidated variable interest entities and are non-recourse to the Company)		12,958			10,453
Payables:
Customers		121,574			123,249
Brokers, dealers and clearing organizations		8,278			3,363
Interest and dividends		2,659			2,572
Other liabilities and accrued expenses ($177 and $117 at March 31, 2011 and December 31, 2010, respectively, related to consolidated variable interest entities and are non-recourse to the Company)		13,961			16,518
Long-term borrowings (includes $43,575 and $42,709 at fair value at March 31, 2011 and December 31, 2010, respectively)		196,136			192,457

		769,677			742,291

Commitments and contingent liabilities (see Note 11)
Equity
Morgan Stanley shareholders’ equity:
Preferred stock		9,597			9,597
Common stock, $0.01 par value;
Shares authorized: 3,500,000,000 at March 31, 2011 and December 31, 2010;
Shares issued: 1,603,913,074 at March 31, 2011 and December 31, 2010;
Shares outstanding: 1,545,064,012 at March 31, 2011 and 1,512,022,095 at December 31, 2010		16			16
Paid-in capital		12,185			13,521
Retained earnings		39,269			38,603
Employee stock trust		3,468			3,465
Accumulated other comprehensive loss		(426	)		(467	)
Common stock held in treasury at cost, $0.01 par value; 58,849,062 shares at March 31, 2011 and 91,890,979 shares at December 31, 2010		(2,455	)		(4,059	)
Common stock issued to employee trust		(3,468	)		(3,465	)

Total Morgan Stanley shareholders’ equity		58,186			57,211
Noncontrolling interests		8,322			8,196

Total equity		66,508			65,407

Total liabilities and equity	$	836,185		$	807,698

See Notes to Condensed Consolidated Financial Statements.


		2

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

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

(unaudited)


	Three Months Ended March 31,
	2011			2010
Revenues:
Investment banking	$	1,214		$	1,060
Principal transactions:
Trading		2,977			3,758
Investments		329			369
Commissions		1,449			1,260
Asset management, distribution and administration fees		2,109			1,963
Other		(444	)		294

Total non-interest revenues		7,634			8,704

Interest income		1,854			1,736
Interest expense		1,853			1,368

Net interest		1			368

Net revenues		7,635			9,072

Non-interest expenses:
Compensation and benefits		4,333			4,416
Occupancy and equipment		402			390
Brokerage, clearing and exchange fees		405			348
Information processing and communications		445			395
Marketing and business development		147			134
Professional services		428			395
Other		603			479

Total non-interest expenses		6,763			6,557

Income from continuing operations before income taxes		872			2,515
Provision for (benefit from) income taxes		(256	)		436

Income from continuing operations		1,128			2,079

Discontinued operations:
Loss from discontinued operations		—			(99	)
Benefit from income taxes		(2	)		(31	)

Net gain (loss) from discontinued operations		2			(68	)

Net income	$	1,130		$	2,011
Net income applicable to noncontrolling interests		162			235

Net income applicable to Morgan Stanley	$	968		$	1,776

Earnings applicable to Morgan Stanley common shareholders	$	736		$	1,411

Amounts applicable to Morgan Stanley:
Income from continuing operations	$	966		$	1,844
Net gain (loss) from discontinued operations		2			(68	)

Net income applicable to Morgan Stanley	$	968		$	1,776

Earnings (loss) per basic common share:
Income from continuing operations	$	0.50		$	1.12
Net gain (loss) from discontinued operations		0.01			(0.05	)

Earnings per basic common share	$	0.51		$	1.07

Earnings per diluted common share:
Income from continuing operations	$	0.50		$	1.03
Loss from discontinued operations		—			(0.04	)

Earnings per diluted common share	$	0.50		$	0.99

Average common shares outstanding:
Basic		1,456,015,979			1,314,608,020

Diluted		1,472,307,592			1,626,207,327

See Notes to Condensed Consolidated Financial Statements.


		3

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(dollars in millions)

(unaudited)


	Three Months Ended March 31,
	2011			2010
Net income	$	1,130		$	2,011
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments(1)		37			2
Amortization of cash flow hedges(2)		1			3
Net unrealized loss on Securities available for sale(3)		(36	)		(20	)
Pension, postretirement and other related adjustments(4)		5			4

Comprehensive income	$	1,137		$	2,000
Net income applicable to noncontrolling interests		162			235
Other comprehensive loss applicable to noncontrolling interests		(34	)		(12	)

Comprehensive income applicable to Morgan Stanley	$	1,009		$	1,777

(1)	Amounts are net of provision for (benefit from) income taxes of $(68) million and $89 million for the quarters ended March 31, 2011 and 2010, respectively.

(2)	Amounts are net of provision for income taxes of $2 million for both quarters ended March 31, 2011 and 2010.

(3)	Amounts are net of benefit from income taxes of $24 million and $14 million for the quarters ended March 31, 2011 and 2010, respectively.

(4)	Amounts are net of provision for (benefit from) income taxes of $(4) million and $2 million for the quarters ended March 31, 2011 and 2010, respectively.

See Notes to Condensed Consolidated Financial Statements.


		4

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in millions)

(unaudited)


	Three Months Ended March 31,
	2011			2010
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	1,130		$	2,011
Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities:
(Gain) loss on equity method investees		660			(66	)
Compensation payable in common stock and options		340			370
Depreciation and amortization		379			154
Loss on business dispositions		—			932
Gain on sale of securities available for sale		(12	)		—
Loss on repurchase of long-term debt		23			—
Insurance reimbursement		—			(31	)
Impairment charges and other-than-temporary impairment charges		3			10
Changes in assets and liabilities:
Cash deposited with clearing organizations or segregated under federal and other regulations or requirements		(2,752	)		1,345
Financial instruments owned, net of financial instruments sold, not yet purchased		7,568			(5,073	)
Securities borrowed		(4,207	)		(13,554	)
Securities loaned		6,990			5,126
Receivables, loans and other assets		(7,417	)		4,618
Payables and other liabilities		1,350			5,494
Federal funds sold and securities purchased under agreements to resell		(14,670	)		4,575
Securities sold under agreements to repurchase		9,293			15,190

Net cash provided by (used for) operating activities		(1,322	)		21,101

CASH FLOWS FROM INVESTING ACTIVITIES
Net proceeds from (payments for):
Premises, equipment and software costs		(409	)		(138	)
Purchases of securities available for sale		(3,357	)		(18,674	)
Sales and redemptions of securities available for sale		6,311			—

Net cash provided by (used for) investing activities		2,545			(18,812	)

CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from (payments for):
Commercial paper and other short-term borrowings		46			945
Dividends related to noncontrolling interests		(7	)		(7	)
Derivatives financing activities		89			(39	)
Other secured financings		2,312			1,458
Deposits		(317	)		1,711
Net proceeds from:
Excess tax benefits associated with stock-based awards		29			2
Public offerings and other issuances of common stock		—			1
Issuance of long-term borrowings		14,285			7,755
Payments for:
Long-term borrowings		(13,046	)		(9,693	)
Repurchases of common stock for employee tax withholding		(273	)		(262	)
Cash dividends		(302	)		(293	)

Net cash provided by financing activities		2,816			1,578

Effect of exchange rate changes on cash and cash equivalents		644			(380	)

Effect of cash and cash equivalents related to variable interest entities		310			—

Net increase in cash and cash equivalents		4,993			3,487
Cash and cash equivalents, at beginning of period		47,615			31,991

Cash and cash equivalents, at end of period	$	52,608		$	35,478

Cash and cash equivalents include:
Cash and due from banks	$	8,120		$	5,979
Interest bearing deposits with banks		44,488			29,499

Cash and cash equivalents, at end of period	$	52,608		$	35,478

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

Cash payments for interest were $1,697 million and $1,178 million for the quarters ended March 31, 2011 and 2010, respectively.

Cash payments for income taxes were $250 million and $169 million for the quarters ended March 31, 2011 and 2010, respectively.

See Notes to Condensed Consolidated Financial Statements.


		5

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN TOTAL EQUITY

Three Months Ended March 31, 2011

(dollars in millions)

(unaudited)


	Preferred Stock		Common Stock		Paid-in Capital			Retained Earnings			Employee Stock Trust		Accumulated Other Comprehensive Income (Loss)			Common Stock Held in Treasury at Cost			Common Stock Issued to Employee Trust			Non- controlling Interests			Total Equity
BALANCE AT DECEMBER 31, 2010	$	9,597	$	16	$	13,521		$	38,603		$	3,465	$	(467	)	$	(4,059	)	$	(3,465	)	$	8,196		$	65,407
Net income		—		—		—			968			—		—			—			—			162			1,130
Dividends		—		—		—			(302	)		—		—			—			—			—			(302	)
Shares issued under employee plans and related tax effects		—		—		(1,336	)		—			3		—			1,877			(3	)		—			541
Repurchases of common stock		—		—		—			—			—		—			(273	)		—			—			(273	)
Net change in cash flow hedges		—		—		—			—			—		1			—			—			—			1
Pension, postretirement and other related adjustments		—		—		—			—			—		5			—			—			—			5
Foreign currency translation adjustments		—		—		—			—			—		71			—			—			(34	)		37
Change in net unrealized losses on securities available for sale		—		—		—			—			—		(36	)		—			—			—			(36	)
Decrease in noncontrolling interests related to dividends of noncontrolling interests		—		—		—			—			—		—			—			—			(7	)		(7	)
Other increases in noncontrolling interests		—		—		—			—			—		—			—			—			5			5

BALANCE AT MARCH 31, 2011	$	9,597	$	16	$	12,185		$	39,269		$	3,468	$	(426	)	$	(2,455	)	$	(3,468	)	$	8,322		$	66,508

See Notes to Condensed Consolidated Financial Statements.


		6

MORGAN STANLEY

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

Three Months Ended March 31, 2010

(dollars in millions)

(unaudited)


	Preferred Stock		Common Stock		Paid-in Capital			Retained Earnings			Employee Stock Trust			Accumulated Other Comprehensive Income (Loss)			Common Stock Held in Treasury at Cost			Common Stock Issued to Employee Trust			Non- controlling Interests			Total Equity
BALANCE AT DECEMBER 31, 2009	$	9,597	$	15	$	8,619		$	35,056		$	4,064		$	(560	)	$	(6,039	)	$	(4,064	)	$	6,092		$	52,780
Net income		—		—		—			1,776			—			—			—			—			235			2,011
Dividends		—		—		—			(293	)		—			—			—			—			—			(293	)
Shares issued under employee plans and related tax effects		—		—		(1,869	)		—			(292	)		—			2,223			292			—			354
Repurchases of common stock		—		—		—			—			—			—			(262	)		—			—			(262	)
Net change in cash flow hedges		—		—		—			—			—			3			—			—			—			3
Pension and postretirement adjustments		—		—		—			—			—			4			—			—			—			4
Foreign currency translation adjustments		—		—		—			—			—			14			—			—			(12	)		2
Change in net unrealized losses on securities available for sale		—		—		—			—			—			(20	)		—			—			—			(20	)
Increase in noncontrolling interests related to the consolidation of certain real estate partnerships sponsored by the Company		—		—		—			—			—			—			—			—			468			468
Decrease in noncontrolling interests related to dividends of noncontrolling interests		—		—		—			—			—			—			—			—			(7	)		(7	)
Other increases in noncontrolling interests		—		—		—			—			—			—			—			—			139			139

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

See Notes to Condensed Consolidated Financial Statements.


		7

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.	Introduction and Basis of Presentation.

The Company. Morgan Stanley, a financial holding company, is a global financial services firm that maintains significant market positions in each of its business segments—Institutional Securities, Global Wealth Management Group and Asset Management. Unless the context otherwise requires, the terms “Morgan Stanley” and the “Company” mean Morgan Stanley and its consolidated subsidiaries.

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

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

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

Asset Management provides a broad array of investment strategies that span the risk/return spectrum across geographies, asset classes and public and private markets to a diverse group of clients across the institutional and intermediary channels as well as high net worth clients (see “Discontinued Operations—Retail Asset Management Business” herein).

Discontinued Operations.

Retail Asset Management Business. On June 1, 2010, the Company completed the sale of substantially all of its retail asset management business (“Retail Asset Management”), including Van Kampen Investments, Inc., to Invesco Ltd. (“Invesco”). The Company received $800 million in cash and approximately 30.9 million shares of Invesco stock upon the sale. The results of Retail Asset Management are reported as discontinued operations within the Asset Management business segment for all periods presented through the date of sale.

The Company recorded the 30.9 million shares as securities available for sale. In the fourth quarter of 2010, the Company sold its investment in Invesco.

Revel Entertainment Group, LLC. On March 31, 2010, the Board of Directors authorized a plan of disposal by sale for Revel Entertainment Group, LLC (“Revel”), a development stage enterprise and subsidiary of the Company that was primarily associated with a development property in Atlantic City, New Jersey. On February 17, 2011, the Company completed the sale of Revel to a group of investors led by Revel’s chief executive officer. The Company did not retain any stake or ongoing involvement. The sale price approximated the carrying value of Revel and, accordingly, the Company did not recognize any pre-tax gain or loss on the sale. Total assets of Revel included in the Company’s condensed consolidated statement of financial condition at December 31, 2010 approximated $28 million. The results of Revel are reported as discontinued operations within the Institutional Securities business segment for all periods presented through the date of sale. The quarter ended March 31, 2010 included losses of approximately $932 million in connection with such planned disposition. See Note 17 for additional information about an income tax benefit related to Revel.

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


		8

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Other. In the third quarter of 2010, the Company completed a disposal of a real estate property within the Asset Management business segment. The results of operations are reported as discontinued operations for all periods presented through the date of disposal.

Discover. On June 30, 2007, the Company completed the spin-off of its business segment Discover Financial Services (“DFS”) to its shareholders. On February 11, 2010, DFS paid the Company $775 million in complete satisfaction of its obligations to the Company regarding the sharing of proceeds from a lawsuit against Visa and MasterCard. The payment was recorded as a gain in discontinued operations for the quarter ended March 31, 2010.

Prior period amounts have been recast for discontinued operations. See Note 20 for additional information on discontinued operations.

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

Material intercompany balances and transactions have been eliminated.

The condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 (the “Form 10-K”). The condensed consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for the fair presentation of the results for the interim period. The results of operations for interim periods are not necessarily indicative of results for the entire year.

Consolidation. The condensed consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries and other entities in which the Company has a controlling financial interest, including certain variable interest entities (“VIE”) (see Note 6). For consolidated subsidiaries that are less than wholly owned, the third-party holdings of equity interests are referred to as noncontrolling interests. The portion of net income attributable to noncontrolling interests for such subsidiaries is presented as Net income (loss) applicable to noncontrolling interests on the condensed consolidated statements of income, and the portion of the shareholders’ equity of such subsidiaries is presented as Noncontrolling interests in the condensed consolidated statements of financial condition and condensed consolidated statements of changes in total equity.

For entities where (1) the total equity investment at risk is sufficient to enable the entity to finance its activities without additional support and (2) the equity holders bear the economic residual risks and returns of the entity and have the power to direct the activities of the entity that most significantly affect its economic performance, the Company consolidates those entities it controls either 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 has the power to make the decisions that most significantly affect the economic performance of the VIE and has the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE, except for certain VIEs that are money market funds, investment companies or are entities qualifying for accounting purposes as investment companies. Generally, the Company consolidates those entities when it absorbs a majority of the expected losses or a majority of the expected residual returns, or both, of the entities.


		9

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

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

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

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

Income Statement Presentation. The Company, through its subsidiaries and affiliates, provides a wide variety of products and services to a large and diversified group of clients and customers, including corporations, governments, financial institutions and individuals. In connection with the delivery of the various products and services to clients, the Company manages its revenues and related expenses in the aggregate. As such, when assessing the performance of its businesses, primarily in its Institutional Securities business segment, the Company considers its principal trading, investment banking, commissions and interest income, along with the associated interest expense, as one integrated activity.

2.	Significant Accounting Policies.

For a detailed discussion about the Company’s significant accounting policies, see Note 2 to the consolidated financial statements for the year ended December 31, 2010 included in the Form 10-K.

During the quarter ended March 31, 2011, other than the following, no other updates were made to the Company’s significant accounting policies.

Financial Instruments and Fair Value.

Fair value for many cash instruments and OTC derivative 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, creditworthinness of the counterparty, creditworthiness of the Company, 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, model uncertainty and concentration risk. Adjustments for liquidity risk adjust model derived mid-market levels of Level 2 and Level 3 financial instruments for the bid-mid or mid-ask spread required to properly reflect the exit price of a risk position. Bid-mid and mid-ask spreads are marked to levels observed in trade activity, broker quotes or other external third-party data. Where these spreads are unobservable for the particular position in question, spreads are derived from observable levels of similar positions. The Company applies credit-related valuation adjustments to its short-term and long-term borrowings (primarily structured notes) for which the fair value option was elected and to OTC derivatives. The Company considers the impact of changes in its own credit spreads based upon observations of the Company’s secondary bond market spreads when measuring the fair value for short-term and long-term borrowings. For OTC derivatives, the impact of changes in both the Company’s and the counterparty’s credit standing is considered when measuring fair


		10

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

value. In determining the expected exposure, the Company simulates the distribution of the future exposure to a counterparty, then applies market-based default probabilities to the future exposure, leveraging external third-party credit default swap (“CDS”) spread data. Where CDS spread data are unavailable for a specific counterparty, bond market spreads, CDS spread data based on the counterparty’s credit rating or CDS spread data that reference a comparable counterparty may be utilized. The Company also considers collateral held and legally enforceable master netting agreements that mitigate the Company’s exposure to each counterparty. Adjustments for model uncertainty are taken for positions whose underlying models are reliant on significant inputs that are neither directly nor indirectly observable, hence requiring reliance on established theoretical concepts in their derivation. These adjustments are derived by making assessments of the possible degree of variability using statistical approaches and market-based information where possible. The Company generally subjects all valuations and models to a review process initially and on a periodic basis thereafter. The Company may apply a concentration adjustment to certain of its OTC derivatives portfolios to reflect the additional cost of closing out a particularly large risk position. Where possible, these adjustments are based on observable market information but in many instances significant judgment is required to estimate the costs of closing out concentrated risk positions due to the lack of liquidity in the marketplace.

Accounting Developments.

Goodwill Impairment Test.

In December 2010, the Financial Accounting Standards Board (the “FASB”) issued accounting guidance that modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity shall consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors are consistent with the existing guidance. This guidance became effective for the Company on January 1, 2011. The adoption of this accounting guidance did not have a material impact on the Company’s condensed consolidated financial statements.

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 composed of three main categories consisting of agency-issued debt, agency mortgage pass-through pool securities and collateralized mortgage obligations. 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. The fair value of agency mortgage


		11

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

pass-through pool securities is model-driven based on spreads of the comparable To-be-announced (“TBA”) security. Collateralized mortgage obligations are valued using indices, quoted market prices and trade data for identical or comparable securities. Actively traded non-callable agency-issued debt securities are generally categorized in Level 1 of the fair value hierarchy. Callable agency-issued debt securities, agency mortgage pass-through pool securities and collateralized mortgage obligations 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 Level 1 or Level 2 of the fair value hierarchy.

Corporate and Other Debt.

•

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

•

Residential Mortgage-Backed Securities (“RMBS”), Commercial Mortgage-Backed Securities (“CMBS”) and other Asset-Backed Securities (“ABS”). RMBS, CMBS and other ABS may be valued based on price or spread data obtained from observed transactions or independent external parties such as vendors or brokers. When position-specific external price data are not observable, the fair value determination may require benchmarking to similar instruments and/or analyzing expected credit losses, default and recovery rates. In evaluating the fair value of each security, the Company considers security collateral-specific attributes, including payment priority, credit enhancement levels, type of collateral, delinquency rates and loss severity. In addition, for RMBS borrowers, Fair Isaac Corporation (“FICO”) scores and the level of documentation for the loan are also considered. Market standard models, such as Intex, Trepp or others, may be deployed to model the specific collateral composition and cash flow structure of each transaction. Key inputs to these models are market spreads, forecasted credit losses, default and prepayment rates for each asset category. Valuation levels of RMBS and CMBS indices are also used as an additional data point for benchmarking purposes or to price outright index positions.

RMBS, CMBS and other ABS are generally categorized in Level 2 of the fair value hierarchy. If external prices or significant spread inputs are unobservable or if the comparability assessment involves significant subjectivity related to property type differences, cash flows, performance and other inputs, then RMBS, CMBS and other ABS are categorized in Level 3 of the fair value hierarchy.

•

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


		12

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

•

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

•

Corporate Loans and Lending Commitments. The fair value of corporate loans is determined using recently executed transactions, market price quotations (where observable), implied yields from comparable debt, and market observable credit default swap spread levels obtained from independent external parties such as vendors and brokers adjusted for any basis difference between cash and derivative instruments, along with proprietary valuation models and default recovery analysis where such transactions and quotations are unobservable. The fair value of contingent corporate lending commitments is determined by using executed transactions on comparable loans and the anticipated market price based on pricing indications from syndicate banks and customers. The valuation of loans and lending commitments also takes into account fee income that is considered an attribute of the contract. Corporate loans and lending commitments are categorized in Level 2 of the fair value hierarchy except in instances where prices or significant spread inputs are unobservable, in which case they are categorized in Level 3 of the fair value hierarchy.

•

Mortgage Loans. Mortgage loans are valued using observable prices based on transactional data for identical or comparable instruments, when available. 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 or a methodology that utilizes the capital structure and credit spreads of recent comparable securitization transactions. Mortgage loans valued based on observable transactional data for identical or comparable instruments are categorized in Level 2 of the fair value hierarchy. Where observable prices are not available, due to the subjectivity involved in the comparability assessment related to mortgage loan vintage, geographical concentration, prepayment speed and projected loss assumptions, mortgage loans are categorized 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.

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


		13

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

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; otherwise, they are categorized in Level 2 or Level 3 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 formulas, 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 in Level 2 of the fair value hierarchy.

Other derivative products, including complex products that have become illiquid, require more judgment in the implementation of the valuation technique applied due to the complexity of the valuation assumptions and the reduced observability of inputs. This includes derivative interests in certain mortgage-related CDO securities, certain types of ABS credit default swaps, basket credit default swaps and CDO-squared positions (a CDO-squared position is a special purpose vehicle that issues interests, or tranches, that are backed by tranches issued by other CDOs) where direct trading activity or quotes are unobservable. These instruments involve significant unobservable inputs and are categorized in Level 3 of the fair value hierarchy.

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

For basket credit default swaps and CDO-squared positions, the correlation input between reference credits is unobservable for each specific swap or position 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; otherwise, these instruments are categorized in Level 2 of the fair value hierarchy.


		14

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

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 price curves, implied volatility of the underlying commodities and, in some cases, the implied correlation between these inputs. The fair value of these products is determined 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 10.

Investments.

•

The Company’s investments include investments in private equity funds, real estate funds, hedge funds and direct investments in equity securities. Direct investments are presented in the fair value hierarchy table as Principal investments and Other. Initially, the transaction price is generally considered by the Company as the exit price and is the Company’s best estimate of fair value.

After initial recognition, in determining the fair value of internally and externally managed funds, the Company considers the net asset value of the fund provided by the fund manager to be the best estimate of fair value. For non-exchange-traded investments either held directly or held within internally managed funds, fair value after initial recognition is based on an assessment of each underlying investment, considering rounds of financing and third-party transactions, discounted cash flow analyses and market-based information, including comparable company transactions, trading multiples and changes in market outlook, among other factors. Exchange-traded direct equity investments are generally valued based on quoted prices from the exchange.

Exchange-traded direct equity investments that are actively traded are categorized in Level 1 of the fair value hierarchy. Non-exchange-traded direct equity investments and investments in private equity and real estate funds are generally categorized in Level 3 of the fair value hierarchy. Investments in hedge funds that are redeemable at the measurement date or in the near future are categorized in Level 2 of the fair value hierarchy; otherwise, they are categorized in Level 3 of the fair value hierarchy.

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.

Securities Available for Sale.

•

Securities available for sale are composed of U.S. government and agency securities, including U.S. Treasury securities, agency-issued debt, agency mortgage pass-through securities and collateralized mortgage obligations. Actively traded U.S. Treasury securities and non-callable agency-issued debt securities are generally categorized in Level 1 of the fair value hierarchy. Callable agency-issued debt securities, agency mortgage pass-through securities and collateralized mortgage obligations are generally categorized in Level 2 of the fair value hierarchy. For further information on securities available for sale, see Note 4.


		15

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

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

•

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

Deposits.

•

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

Securities Sold under Agreements to Repurchase.

•

In 2010, the fair value option was elected for certain securities sold under agreements to repurchase. The fair value of a repurchase agreement is computed using a standard cash flow discounting methodology. The inputs to the valuation include contractual cash flows and collateral funding spreads, which are estimated using various benchmarks, interest rate yield curves and option volatilities. In instances where the unobservable inputs are deemed significant, repurchase agreements are categorized in Level 3 of the fair value hierarchy; otherwise, they are categorized in Level 2 of the fair value hierarchy.

The following fair value hierarchy tables present information about the Company’s assets and liabilities measured at fair value on a recurring basis at March 31, 2011 and December 31, 2010.


		16

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Assets and Liabilities Measured at Fair Value on a Recurring Basis at March 31, 2011


	Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Counterparty and Cash Collateral Netting			Balance at March 31, 2011
	(dollars in millions)
Assets
Financial instruments owned:
U.S. government and agency securities:
U.S. Treasury securities	$	15,174		$	21		$	—		$	—		$	15,195
U.S. agency securities		4,253			27,121			57			—			31,431

Total U.S. government and agency securities		19,427			27,142			57			—			46,626
Other sovereign government obligations		30,494			8,258			126			—			38,878
Corporate and other debt:
State and municipal securities		—			3,370			4			—			3,374
Residential mortgage-backed securities		—			3,572			361			—			3,933
Commercial mortgage-backed securities		—			2,782			132			—			2,914
Asset-backed securities		—			2,355			—			—			2,355
Corporate bonds		—			40,454			1,366			—			41,820
Collateralized debt obligations		—			1,961			1,593			—			3,554
Loans and lending commitments		—			16,757			11,218			—			27,975
Other debt		—			2,369			165			—			2,534

Total corporate and other debt		—			73,620			14,839			—			88,459
Corporate equities(1)		64,037			2,503			502			—			67,042
Derivative and other contracts:
Interest rate contracts		1,578			534,820			5,767			—			542,165
Credit contracts		—			85,999			13,012			—			99,011
Foreign exchange contracts		—			58,336			389			—			58,725
Equity contracts		1,577			38,555			1,043			—			41,175
Commodity contracts		6,829			57,540			1,056			—			65,425
Other		—			119			143			—			262
Netting(2)		(8,337	)		(677,036	)		(11,186	)		(60,291	)		(756,850	)

Total derivative and other contracts		1,647			98,333			10,224			(60,291	)		49,913
Investments:
Private equity funds		—			—			2,006			—			2,006
Real estate funds		—			6			1,251			—			1,257
Hedge funds		—			666			871			—			1,537
Principal investments		269			193			3,057			—			3,519
Other		191			160			398			—			749

Total investments		460			1,025			7,583			—			9,068
Physical commodities		—			8,126			—			—			8,126

Total financial instruments owned		116,065			219,007			33,331			(60,291	)		308,112
Securities available for sale:
U.S. government and agency securities		15,157			12,576			—			—			27,733
Securities received as collateral		13,007			154			—			—			13,161
Intangible assets(3)		—			—			144			—			144
Liabilities
Deposits	$	—		$	2,848		$	—		$	—		$	2,848
Commercial paper and other short-term borrowings		—			1,653			4			—			1,657
Financial instruments sold, not yet purchased:
U.S. government and agency securities:
U.S. Treasury securities		29,260			4			—			—			29,264
U.S. agency securities		2,147			77			—			—			2,224

Total U.S. government and agency securities		31,407			81			—			—			31,488


		17

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)


	Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Counterparty and Cash Collateral Netting			Balance at March 31, 2011
	(dollars in millions)
Other sovereign government obligations		19,784			3,349			—			—			23,133
Corporate and other debt:
State and municipal securities		—			4			—			—			4
Asset-backed securities		—			7			—			—			7
Corporate bonds		—			9,421			150			—			9,571
Collateralized debt obligations		—			—			2			—			2
Unfunded lending commitments		—			435			171			—			606
Other debt		—			73			180			—			253

Total corporate and other debt		—			9,940			503			—			10,443
Corporate equities(1)		25,713			899			9			—			26,621
Derivative and other contracts:
Interest rate contracts		1,366			508,086			5,825			—			515,277
Credit contracts		—			80,208			6,933			—			87,141
Foreign exchange contracts		—			60,507			343			—			60,850
Equity contracts		1,663			43,003			1,688			—			46,354
Commodity contracts		7,477			59,024			726			—			67,227
Other		—			581			651			—			1,232
Netting(2)		(8,337	)		(677,036	)		(11,186	)		(36,937	)		(733,496	)

Total derivative and other contracts		2,169			74,373			4,980			(36,937	)		44,585

Total financial instruments sold, not yet purchased		79,073			88,642			5,492			(36,937	)		136,270
Obligation to return securities received as collateral		17,915			154			—			—			18,069
Securities sold under agreements to repurchase		—			538			352			—			890
Other secured financings		—			7,447			605			—			8,052
Long-term borrowings		21			42,180			1,374			—			43,575

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

(2)

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 10.

(3)	Amount represents mortgage servicing rights (“MSR”) accounted for at fair value. See Note 6 for further information on MSRs.

Transfers Between Level 1 and Level 2 During the Quarter Ended March 31, 2011.

Financial instruments owned—Derivative and other contracts and Financial instruments sold, not yet purchased—Derivative and other contracts. During the quarter ended March 31, 2011, the Company reclassified approximately $0.6 billion of derivative assets and approximately $0.8 billion of derivative liabilities from Level 2 to Level 1 as these listed derivatives became actively traded and were valued based on quoted prices from the exchange.


		18

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

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


	Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Counterparty and Cash Collateral Netting			Balance at December 31, 2010
	(dollars in millions)
Assets
Financial instruments owned:
U.S. government and agency securities:
U.S. Treasury securities	$	19,226		$	—		$	—		$	—		$	19,226
U.S. agency securities		3,827			25,380			13			—			29,220

Total U.S. government and agency securities		23,053			25,380			13			—			48,446
Other sovereign government obligations		25,334			8,501			73			—			33,908
Corporate and other debt:
State and municipal securities		—			3,229			110			—			3,339
Residential mortgage-backed securities		—			3,690			319			—			4,009
Commercial mortgage-backed securities		—			2,692			188			—			2,880
Asset-backed securities		—			2,322			13			—			2,335
Corporate bonds		—			39,569			1,368			—			40,937
Collateralized debt obligations		—			2,305			1,659			—			3,964
Loans and lending commitments		—			15,308			11,666			—			26,974
Other debt		—			3,523			193			—			3,716

Total corporate and other debt		—			72,638			15,516			—			88,154
Corporate equities(1)		65,009			2,923			484			—			68,416
Derivative and other contracts:
Interest rate contracts		3,985			616,016			966			—			620,967
Credit contracts		—			95,818			14,316			—			110,134
Foreign exchange contracts		1			61,556			431			—			61,988
Equity contracts		2,176			36,612			1,058			—			39,846
Commodity contracts		5,464			57,528			1,160			—			64,152
Other		—			108			135			—			243
Netting(2)		(8,551	)		(761,939	)		(7,168	)		(68,380	)		(846,038	)

Total derivative and other contracts		3,075			105,699			10,898			(68,380	)		51,292
Investments:
Private equity funds		—			—			1,986			—			1,986
Real estate funds		—			8			1,176			—			1,184
Hedge funds		—			736			901			—			1,637
Principal investments		286			486			3,131			—			3,903
Other(3)		403			79			560			—			1,042

Total investments		689			1,309			7,754			—			9,752
Physical commodities		—			6,778			—			—			6,778

Total financial instruments owned		117,160			223,228			34,738			(68,380	)		306,746
Securities available for sale:
U.S. government and agency securities		20,792			8,857			—			—			29,649
Securities received as collateral		15,646			890			1			—			16,537
Intangible assets(4)		—			—			157			—			157
Liabilities
Deposits	$	—		$	3,011		$	16		$	—		$	3,027
Commercial paper and other short-term borrowings		—			1,797			2			—			1,799
Financial instruments sold, not yet purchased:
U.S. government and agency securities:
U.S. Treasury securities		25,225			—			—			—			25,225
U.S. agency securities		2,656			67			—			—			2,723

Total U.S. government and agency securities		27,881			67			—			—			27,948


		19

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)


	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, 2010
	(dollars in millions)
Other sovereign government obligations		19,708			2,542			—			—			22,250
Corporate and other debt:
State and municipal securities		—			11			—			—			11
Asset-backed securities		—			12			—			—			12
Corporate bonds		—			9,100			44			—			9,144
Collateralized debt obligations		—			2			—			—			2
Unfunded lending commitments		—			464			263			—			727
Other debt		—			828			194			—			1,022

Total corporate and other debt		—			10,417			501			—			10,918
Corporate equities(1)		19,696			127			15			—			19,838
Derivative and other contracts:
Interest rate contracts		3,883			591,378			542			—			595,803
Credit contracts		—			87,904			7,722			—			95,626
Foreign exchange contracts		2			64,301			385			—			64,688
Equity contracts		2,098			42,242			1,820			—			46,160
Commodity contracts		5,871			58,885			972			—			65,728
Other		—			520			1,048			—			1,568
Netting(2)		(8,551	)		(761,939	)		(7,168	)		(44,113	)		(821,771	)

Total derivative and other contracts		3,303			83,291			5,321			(44,113	)		47,802

Total financial instruments sold, not yet purchased		70,588			96,444			5,837			(44,113	)		128,756
Obligation to return securities received as collateral		20,272			890			1			—			21,163
Securities sold under agreements to repurchase		—			498			351			—			849
Other secured financings		—			7,474			1,016			—			8,490
Long-term borrowings		—			41,393			1,316			—			42,709

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

(2)

(3)

In June 2010, the Company voluntarily contributed $25 million to certain other investments in funds that it manages in connection with upcoming rule changes regarding net asset value disclosures for money market funds. Based on current liquidity and fund performance, the Company does not expect to provide additional voluntary support to non-consolidated funds that it manages.

(4)	Amount represents MSRs accounted for at fair value. See Note 6 for further information on MSRs.

Transfers Between Level 1 and Level 2 during the Quarter Ended March 31, 2010.

Financial instruments owned—Derivative and other contracts and Financial instruments sold, not yet purchased—Derivative and other contracts. During the quarter ended March 31, 2010, the Company reclassified approximately $1.3 billion of derivative assets and approximately $1.5 billion of derivative liabilities from Level 2 to Level 1 as these listed derivatives became actively traded and were valued based on quoted prices from the exchange.

Financial instruments owned—Corporate equities. During the quarter ended March 31, 2010, the Company reclassified approximately $1.0 billion of certain Corporate equities from Level 2 to Level 1 as transactions in these securities occurred with sufficient frequency and volume to constitute an active market.

The following tables present additional information about Level 3 assets and liabilities measured at fair value on a recurring basis for the quarters ended March 31, 2011 and 2010, respectively. Level 3 instruments may be hedged with instruments classified in Level 1 and Level 2. As a result, the realized and unrealized gains (losses) for assets and liabilities within the Level 3 category presented in the tables below do not reflect the related


		20

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

realized and unrealized gains (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 (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.

For assets and liabilities that were transferred into Level 3 during the period, gains (losses) are presented as if the assets or liabilities had been transferred into Level 3 at the beginning of the period; similarly, for assets and liabilities that were transferred out of Level 3 during the period, gains (losses) are presented as if the assets or liabilities had been transferred out at the beginning of the period.


		21

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Three Months Ended March 31, 2011


	Beginning Balance at December 31, 2010			Total Realized and Unrealized Gains (Losses)(1)			Purchases			Sales			Issuances			Settlements			Net Transfers			Ending Balance at March 31, 2011			Unrealized Gains (Losses) for Level 3 Assets/ Liabilities Outstanding at March 31, 2011(2)
	(dollars in millions)
Assets
Financial instruments owned:
U.S. agency securities	$	13		$	—		$	103		$	(52	)	$	—		$	—		$	(7	)	$	57		$	—
Other sovereign government obligations		73			—			59			—			—			—			(6	)		126			—
Corporate and other debt:
State and municipal securities		110			(1	)		4			(96	)		—			—			(13	)		4			—
Residential mortgage-backed securities		319			(58	)		198			(183	)		—			(1	)		86			361			(21	)
Commercial mortgage-backed securities		188			16			9			(30	)		—			—			(51	)		132			10
Asset-backed securities		13			—			12			(19	)		—			—			(6	)		—			—
Corporate bonds		1,368			33			255			(215	)		—			—			(75	)		1,366			55
Collateralized debt obligations		1,659			254			355			(595	)		—			(36	)		(44	)		1,593			93
Loans and lending commitments		11,666			386			1,023			(643	)		—			(1,024	)		(190	)		11,218			382
Other debt		193			(6	)		1			(22	)		—			—			(1	)		165			(16	)

Total corporate and other debt		15,516			624			1,857			(1,803	)		—			(1,061	)		(294	)		14,839			503
Corporate equities		484			(53	)		101			(98	)		—			—			68			502			(18	)
Net derivatives and other contracts(3):
Interest rate contracts		424			169			1			—			(663	)		(114	)		125			(58	)		100
Credit contracts		6,594			(673	)		128			—			(152	)		71			111			6,079			(245	)
Foreign exchange contracts		46			(124	)		—			—			—			127			(3	)		46			(100	)
Equity contracts		(762	)		75			65			(12	)		(85	)		15			59			(645	)		75
Commodity contracts		188			(9	)		161			—			(132	)		85			37			330			(4	)
Other		(913	)		209			—			—			(5	)		205			(4	)		(508	)		203

Total net derivative and other contracts		5,577			(353	)		355			(12	)		(1,037	)		389			325			5,244			29
Investments:
Private equity funds		1,986			107			32			(190	)		—			—			71			2,006			95
Real estate funds		1,176			64			14			(3	)		—			—			—			1,251			102
Hedge funds		901			(9	)		135			(189	)		—			—			33			871			(9	)
Principal investments		3,131			66			202			(301	)		—			—			(41	)		3,057			(85	)
Other		560			8			1			(14	)		—			—			(157	)		398			3

Total investments		7,754			236			384			(697	)		—			—			(94	)		7,583			106
Securities received as collateral		1			—			—			(1	)		—			—			—			—			—
Intangible assets		157			(15	)		3			(1	)		—			—			—			144			(14	)

Liabilities
Deposits	$	16		$	2		$	—		$	—		$	—		$	(14	)	$	—		$	—		$	—
Commercial paper and other short-term borrowings		2			—			—			—			4			(2	)		—			4			—
Financial instruments sold, not yet purchased:
Corporate and other debt:
Corporate bonds		44			1			(27	)		155			—			—			(21	)		150			8
Collateralized debt obligations		—			1			—			3			—			—			—			2			1
Unfunded lending commitments		263			92			—			—			—			—			—			171			92
Other debt		194			—			—			—			—			—			(14	)		180			—

Total corporate and other debt		501			94			(27	)		158			—			—			(35	)		503			101
Corporate equities		15			(1	)		(8	)		1			—			—			—			9			—
Obligation to return securities received as collateral		1			—			(1	)		—			—			—			—			—			—
Securities sold under agreements to repurchase		351			(2	)		—			—			—			(1	)		—			352			(2	)
Other secured financings		1,016			(12	)		—			—			—			(117	)		(306	)		605			(12	)
Long-term borrowings		1,316			(84	)		—			—			141			(180	)		13			1,374			(83	)


		22

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(1)	Total realized and unrealized gains (losses) are primarily included in Principal transactions—Trading in the condensed consolidated statements of income except for $236 million related to Financial instruments owned—Investments, which is included in Principal transactions—Investments.

(2)	Amounts represent unrealized gains (losses) for the quarter ended March 31, 2011 related to assets and liabilities still outstanding at March 31, 2011.

(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 10.

Financial instruments owned—Corporate and other debt. During the quarter ended March 31, 2011, the Company reclassified approximately $1.6 billion of certain Corporate and other debt, primarily corporate loans, from Level 3 to Level 2. The Company reclassified the corporate loans as external prices and/or spread inputs for these instruments became observable.

The Company also reclassified approximately $1.3 billion of certain Corporate and other debt from Level 2 to Level 3. The reclassifications were primarily related to corporate loans and were generally 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.


		23

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Three Months Ended March 31, 2010


	Beginning Balance at December 31, 2009			Total Realized and Unrealized Gains (Losses)(1)			Purchases, Sales, Other Settlements and Issuances, net			Net Transfers			Ending Balance at March 31, 2010			Unrealized Gains (Losses) for Level 3 Assets/ Liabilities Outstanding at March 31, 2010(2)
	(dollars in millions)
Assets
Financial instruments owned:
U.S. agency securities	$	36		$	—		$	(35	)	$	—		$	1		$	—
Other sovereign government obligations		3			2			76			(1	)		80			1
Corporate and other debt:
State and municipal securities		713			(18	)		(297	)		—			398			1
Residential mortgage-backed securities		818			24			(220	)		3			625			19
Commercial mortgage-backed securities		1,573			109			(860	)		(43	)		779			42
Asset-backed securities		591			1			(440	)		(3	)		149			10
Corporate bonds		1,038			(55	)		128			34			1,145			(48	)
Collateralized debt obligations		1,553			133			(171	)		(3	)		1,512			121
Loans and lending commitments		12,506			155			572			270			13,503			143
Other debt		1,662			252			8			(1	)		1,921			244

Total corporate and other debt		20,454			601			(1,280	)		257			20,032			532
Corporate equities		536			70			(7	)		(63	)		536			56
Net derivative and other contracts:
Interest rate contracts		387			9			7			(19	)		384			1
Credit contracts		8,824			(434	)		96			(534	)		7,952			(352	)
Foreign exchange rate contracts		254			(285	)		201			36			206			(308	)
Equity contracts		(689	)		(96	)		58			26			(701	)		(88	)
Commodity contracts		7			(25	)		108			—			90			83
Other		(437	)		(147	)		4			1			(579	)		(113	)

Total net derivative and other contracts(3)		8,346			(978	)		474			(490	)		7,352			(777	)
Investments		7,613			56			19			(142	)		7,546			50
Securities received as collateral		23			—			(23	)		—			—			—
Intangible assets		137			38			—			—			175			30

Liabilities
Deposits	$	24		$	1		$	—		$	(8	)	$	15		$	1
Commercial paper and other short-term borrowings		—			—			300			—			300			—
Financial instruments sold, not yet purchased:
Corporate and other debt:
Asset-backed securities		4			—			—			—			4			—
Corporate bonds		29			(42	)		(79	)		25			17			(36	)
Collateralized debt obligations		3			—			(3	)		—			—			—
Unfunded lending commitments		252			(32	)		(71	)		—			213			(29	)
Other debt		431			25			(76	)		(13	)		317			24

Total corporate and other debt		719			(49	)		(229	)		12			551			(41	)
Corporate equities		4			(1	)		5			3			13			—
Obligation to return securities received as collateral		23			—			(23	)		—			—			—
Other secured financings		1,532			(104	)		175			—			1,811			(104	)
Long-term borrowings		6,865			5			45			(177	)		6,728			5


		24

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(1)	Total realized and unrealized gains (losses) are primarily included in Principal transactions—Trading in the condensed consolidated statements of income except for $56 million related to Financial instruments owned—Investments, which is included in Principal transactions—Investments.

(2)	Amounts represent unrealized gains (losses) for the quarter ended March 31, 2010 related to assets and liabilities still outstanding at March 31, 2010.

(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 10.

Financial instruments owned—Corporate and other debt. During the quarter ended March 31, 2010, the Company reclassified approximately $0.6 billion of certain Corporate and other debt, primarily corporate loans, from Level 3 to Level 2. The Company reclassified the corporate loans as external prices and/or spread inputs for these instruments became observable.

The Company also reclassified approximately $0.9 billion of certain Corporate and other debt from Level 2 to Level 3. The reclassifications were primarily related to corporate loans and were generally 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 Company reclassified the corporate loans as external prices and/or spread inputs became unobservable.

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 bespoke basket credit default swaps.

Fair Value of Investments that Calculate Net Asset Value.

The Company’s Investments measured at fair value were $9,068 million and $9,752 million at March 31, 2011 and December 31, 2010, respectively. The following table presents information solely about the Company’s investments in private equity funds, real estate funds and hedge funds measured at fair value based on net asset value at March 31, 2011 and December 31, 2010, respectively.


	At March 31, 2011				At December 31, 2010
	Fair Value		Unfunded Commitment		Fair Value		Unfunded Commitment
	(dollars in millions)
Private equity funds	$	1,968	$	1,111	$	1,947	$	1,047
Real estate funds		1,225		552		1,154		500
Hedge funds(1):
Long-short equity hedge funds		877		4		1,046		4
Fixed income/credit-related hedge funds		304		—		305		—
Event-driven hedge funds		196		—		143		—
Multi-strategy hedge funds		161		—		140		—

Total	$	4,731	$	1,667	$	4,735	$	1,551

(1)

Fixed income/credit-related hedge funds, event-driven hedge funds, and multi-strategy hedge funds are redeemable at least on a six-month period basis primarily with a notice period of 90 days or less. At March 31, 2011, approximately 57% of the fair value amount of long-short equity hedge funds is redeemable at least quarterly, 20% is redeemable every six months and 23% of these funds have a redemption frequency of greater than six months. At December 31, 2010, approximately 49% of the fair value amount of long-short equity hedge funds is redeemable at least quarterly, 24% is redeemable every six months and 27% of these funds have a redemption frequency of greater than six months. The notice period for long-short equity hedge funds is primarily greater than 90 days.


		25

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Private Equity Funds. Amount includes several private equity funds that pursue multiple strategies including leveraged buyouts, venture capital, infrastructure growth capital, distressed investments, and mezzanine capital. In addition, the funds may be structured with a focus on specific domestic or foreign geographic regions. These investments are generally not redeemable with the funds. Instead, the nature of the investments in this category is that distributions are received through the liquidation of the underlying assets of the fund. At March 31, 2011, it is estimated that 6% of the fair value of the funds will be liquidated in the next five years, another 36% of the fair value of the funds will be liquidated between five to 10 years and the remaining 58% of the fair value of the funds have a remaining life of greater than 10 years.

Real Estate Funds. Amount includes several real estate funds that invest in real estate assets such as commercial office buildings, retail properties, multi-family residential properties, developments or hotels. In addition, the funds may be structured with a focus on specific geographic domestic or foreign regions. These investments are generally not redeemable with the funds. Distributions from each fund will be received as the underlying investments of the funds are liquidated. At March 31, 2011, it is estimated that 19% of the fair value of the funds will be liquidated within the next five years, another 33% of the fair value of the funds will be liquidated between five to 10 years and the remaining 48% of the fair value of the funds have a remaining life of greater than 10 years.

Hedge Funds. Investments in hedge funds may be subject to initial period lock-up restrictions or gates. A hedge fund lock-up provision is a provision that provides that, during a certain initial period, an investor may not make a withdrawal from the fund. The purpose of a gate is to restrict the level of redemptions that an investor in a particular hedge fund can demand on any redemption date.

•

Long-short Equity Hedge Funds. Amount includes investments in hedge funds that invest, long or short, in equities. Equity value and growth hedge funds purchase stocks perceived to be undervalued and sell stocks perceived to be overvalued. Investments representing approximately 22% of the fair value of the investments in this category cannot be redeemed currently because the investments include certain initial period lock-up restrictions. The remaining restriction period for 100% of investments subject to lock-up restrictions ranged from one to three years at March 31, 2011. Investments representing approximately 23% of the fair value of the investments in long-short equity hedge funds cannot be redeemed currently because an exit restriction has been imposed by the hedge fund manager. The restriction period for 100% of investments subject to an exit restriction was primarily two years or less at March 31, 2011.

•

Fixed Income/Credit-Related Hedge Funds. Amount includes investments in hedge funds that employ long-short, distressed or relative value strategies in order to benefit from investments in undervalued or overvalued securities that are primarily debt or credit related. At March 31, 2011, investments representing approximately 18% of the fair value of the investments in fixed income/credit-related hedge funds cannot be redeemed currently because the investments include certain initial period lock-up restrictions. The remaining restriction period for these investments was two years or less at March 31, 2011.

•

Event-Driven Hedge Funds. Amount includes investments in hedge funds that invest in event-driven situations such as mergers, hostile takeovers, reorganizations, or leveraged buyouts. This may involve the simultaneous purchase of stock in companies being acquired and the sale of stock in its acquirer, hoping to profit from the spread between the current market price and the ultimate purchase price of the target company. At March 31, 2011, investments representing approximately 37% of the value of the investments in this category cannot be redeemed currently because the investments include certain initial period lock-up restrictions. The remaining restriction period for these investments was two years or less at March 31, 2011.

•

Multi-strategy Hedge Funds. Amount includes investments in hedge funds that pursue multiple strategies to realize short- and long-term gains. Management of the hedge funds has the ability to


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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

overweight or underweight different strategies to best capitalize on current investment opportunities. At March 31, 2011, investments representing approximately 35% of the fair value of the investments in this category cannot be redeemed currently because the investments include certain initial period lock-up restrictions. The remaining restriction period for 72% of investments subject to lock-ups was two years or less at March 31, 2011. The remaining restriction period for the other 28% of investments subject to lock-up restrictions was greater than three years at March 31, 2011. Investments representing approximately 23% of the fair value of investments in multi-strategy hedge funds cannot be redeemed currently because of an exit restriction that has been imposed by the hedge fund manager. The restriction period for 100% of investments subject to an exit restriction was indefinite at March 31, 2011.

Fair Value Option.

The Company elected the fair value option for certain eligible instruments that are risk managed on a fair value basis to mitigate income statement volatility caused by measurement basis differences between the elected instruments and their associated risk management transactions or to eliminate complexities of applying certain accounting models. The following tables present net gains (losses) due to changes in fair value for items measured at fair value pursuant to the fair value option election for the quarters ended March 31, 2011 and 2010, respectively.


	Principal Transactions- Trading			Interest Expense			Gains (Losses) Included in Net Revenues
	(dollars in millions)
Three Months Ended March 31, 2011
Deposits	$	13		$	(30	)	$	(17	)
Commercial paper and other short-term borrowings		(5	)		—			(5	)
Long-term borrowings		(1,266	)		(290	)		(1,556	)
Securities sold under agreements to repurchase		(2	)		—			(2	)

Three Months Ended March 31, 2010
Deposits	$	(25	)	$	(47	)	$	(72	)
Commercial paper and other short-term borrowings		13			—			13
Long-term borrowings		(366	)		(202	)		(568	)

In addition to the amounts in the above table, as discussed in Note 2 to the consolidated financial statements for the year ended December 31, 2010 included in the Form 10-K, 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 guidance.

The following tables present information on the Company’s short-term and long-term borrowings (primarily structured notes), loans and unfunded lending commitments for which the fair value option was elected.

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


	Three Months Ended March 31,
	2011			2010
	(dollars in millions)
Short-term and long-term borrowings(1)	$	(189	)	$	54
Loans(2)		140			316
Unfunded lending commitments(3)		10			(21	)

(1)	The change in the fair value of short-term and long-term borrowings (primarily structured notes) includes an adjustment to reflect the credit quality of the Company based upon observations of the Company’s secondary bond market spreads.

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

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


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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Amount by Which Contractual Principal Amount Exceeds Fair Value


	At March 31, 2011		At December 31, 2010
	(dollars in billions)
Short-term and long-term borrowings(1)	$	1.1	$	0.6
Loans(2)		23.6		24.3
Loans 90 or more days past due and/or on non-accrual status(2)(3)		21.2		21.2

(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 in non-accrual status, which includes all loans 90 or more days past due, was $2.7 billion and $2.2 billion at March 31, 2011 and December 31, 2010, respectively. The aggregate fair value of loans that were 90 or more days past due was $2.0 billion at both March 31, 2011 and December 31, 2010.

The tables above exclude non-recourse debt from consolidated VIEs, liabilities related to failed sales and other liabilities that have specified assets attributable to them.

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 loans, equity method investments, premises and equipment, intangible assets and real estate investments.

The following tables present, by caption on the condensed consolidated statements of financial condition, the fair value hierarchy for those assets measured at fair value on a non-recurring basis for which the Company recognized a non-recurring fair value adjustment for the quarters ended March 31, 2011 and 2010, respectively.

Three Months Ended March 31, 2011.


			Fair Value Measurements Using:
	Carrying Value at March 31, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total Gains (Losses) for the Three Months Ended March 31, 2011(1)
	(dollars in millions)
Loans(2)	$	559	$	—	$	46	$	513	$	16
Other investments(3)		77		—		—		77		(9	)
Intangible assets(4)		—		—		—		—		(3	)

Total	$	636	$	—	$	46	$	590	$	4

(1)	Losses are recorded within Other expenses in the condensed consolidated statement of income except for fair value adjustments related to Loans and losses related to Other investments, which are included in Other revenues.

(2)

Non-recurring change in fair value for loans held for investment was calculated based upon the fair value of the underlying collateral. The fair value of the collateral was determined using internal expected recovery models. The non-recurring change in fair value for mortgage loans held for sale is based upon a valuation model incorporating market observable inputs.

(3)	Losses recorded were determined primarily using discounted cash flow models.

(4)	Losses primarily related to investment management contracts, including contracts associated with FrontPoint, and were determined primarily using discounted cash flow models.


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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

There were no liabilities measured at fair value on a non-recurring basis during the quarter ended March 31, 2011.

Three Months Ended March 31, 2010.


				Fair Value Measurements Using:
		Carrying Value at March 31, 2010		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 March 31, 2010(1)
		(dollars in millions)
Loans(2)		$	634	$	—	$	—	$	634	$	(3	)
Other investments(3)			17		—		—		17		(5	)
Intangible assets(4)			5		—		—		5		(10	)
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