10-K 1 d328282d10k.htm 10-K 10-K
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

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

For the year ended December 31, 2016

Commission File Number 1-11758

 

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(Exact name of Registrant as specified in its charter)

 

 

 

Delaware

(State or other jurisdiction of incorporation or organization)

 

1585 Broadway

New York, NY 10036

(Address of principal executive

offices, including zip code)

 

36-3145972

(I.R.S. Employer Identification No.)

    

(212) 761-4000

(Registrant’s telephone number,

including area code)

 

 

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

 

Title of each class   

Name of exchange on

which registered

Common Stock, $0.01 par value

  

New York Stock Exchange

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

  

New York Stock Exchange

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

  

New York Stock Exchange

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

  

New York Stock Exchange

Depositary Shares, each representing 1/1,000th interest in a share of 6.625% Non-Cumulative Preferred Stock, Series G, $0.01 par value

  

New York Stock Exchange

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

  

New York Stock Exchange

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

  

New York Stock Exchange

Global Medium-Term Notes, Series A, Fixed Rate Step-Up Senior Notes Due 2026 of Morgan Stanley Finance LLC (and Registrant’s guarantee with respect thereto)

  

New York Stock Exchange

Market Vectors ETNs due March 31, 2020 (2 issuances); Market Vectors ETNs due April 30, 2020 (2 issuances)

  

NYSE Arca, Inc.

Morgan Stanley Cushing® MLP High Income Index ETNs due March 21, 2031

  

NYSE Arca, Inc.

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

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

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

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

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  ☒

 

Accelerated Filer  ☐

Non-Accelerated Filer  ☐

 

Smaller reporting company  ☐

(Do not check if a smaller reporting company)

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

As of June 30, 2016, the aggregate market value of the common stock of Registrant held by non-affiliates of Registrant was approximately $47,247,843,093. This calculation does not reflect a determination that persons are affiliates for any other purposes.

As of January 31, 2017, there were 1,866,164,899 shares of Registrant’s common stock, $0.01 par value, outstanding.

Documents Incorporated by Reference: Portions of Registrant’s definitive proxy statement for its 2017 annual meeting of shareholders are incorporated by reference in Part III of this Form 10-K.


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ANNUAL REPORT ON FORM 10-K

for the year ended December 31, 2016

 

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Part I

 

Item 1.     Business

  1

Overview

  1

Business Segments

  1

Competition

  1

Supervision and Regulation

  2

Executive Officers of Morgan Stanley

  10

Item 1A. Risk Factors

  12

Item 1B.  Unresolved Staff Comments

  22

Item 2.     Properties

  22

Item 3.     Legal Proceedings

  23

Item 4.     Mine Safety Disclosures

  28

Part II

 

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

  29

Item 6.     Selected Financial Data

  31

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

  32

Introduction

  32

Executive Summary

  33

Business Segments

  37

Supplemental Financial Information and Disclosures

  52

Accounting Development Updates

  53

Critical Accounting Policies

  54

Liquidity and Capital Resources

  58

Item 7A.  Quantitative and Qualitative Disclosures about Market Risk

  75

Item 8.     Financial Statements and Supplementary Data

  94

Report of Independent Registered Public Accounting Firm

  94

Consolidated Income Statements

  95

Consolidated Comprehensive Income Statements

  96

Consolidated Balance Sheets

  97

Consolidated Statements of Changes in Total Equity

  98

Consolidated Cash Flow Statements

  99

Notes to Consolidated Financial Statements

  100

  1. Introduction and Basis of Presentation

  100

  2. Significant Accounting Policies

  101

  3. Fair Values

  112

   4. Derivative Instruments and Hedging Activities

  129

  5. Investment Securities

  136

  6. Collateralized Transactions

  140

  7. Loans and Allowance for Credit Losses

  143

  8. Equity Method Investments

  147

  9. Goodwill and Intangible Assets

  148

 

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10. Deposits

  149

11. Borrowings and Other Secured Financings

  149

12. Commitments, Guarantees and Contingencies

  152

13. Variable Interest Entities and Securitization Activities

  160

14. Regulatory Requirements

  166

15. Total Equity

  168

16. Earnings per Common Share

  173

17. Interest Income and Interest Expense

  173

18. Deferred Compensation Plans

  173

19. Employee Benefit Plans

  176

20. Income Taxes

  182

21. Segment and Geographic Information

  185

22. Parent Company

  187

23. Quarterly Results (Unaudited)

  190

24. Subsequent Events

  190

Financial Data Supplement (Unaudited)

  191

Item 9.     Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

  195

Item 9A.  Controls and Procedures

  195

Item 9B.  Other Information

  197

Part III

 

Item 10.  Directors, Executive Officers and Corporate Governance

  197

Item 11.  Executive Compensation

  197

Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

  197

Item 13.  Certain Relationships and Related Transactions, and Director Independence

  197

Item 14.  Principal Accountant Fees and Services

  197

Part IV

 

Item 15.  Exhibits and Financial Statement Schedules

  198

Item 16. Form 10-K Summary

  198

Signatures

  S-1

Exhibit Index

  E-1

 

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Forward-Looking Statements

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

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

 

   

the effect of economic and political conditions and geopolitical events, including the United Kingdom’s (the “U.K.”) anticipated withdrawal from the European Union (the “E.U.”);

   

sovereign risk;

   

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

   

the impact of current, pending and future legislation (including with respect to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”)) or changes thereto, regulation (including capital, leverage, funding, liquidity and tax requirements), policies (including fiscal and monetary policies established by central banks and financial regulators, and changes to global trade policies), and other legal and regulatory actions in the United States of America (“U.S.”) and worldwide;

   

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

   

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

   

investor, consumer and business sentiment and confidence in the financial markets;

   

the performance and results of our acquisitions, divestitures, joint ventures, strategic alliances or other strategic arrangements;

   

our reputation and the general perception of the financial services industry;

   

inflation, natural disasters, pandemics and acts of war or terrorism;

   

the actions and initiatives of current and potential competitors as well as governments, central banks, regulators and self-regulatory organizations;

   

the effectiveness of our risk management policies;

   

technological changes instituted by us, our competitors or counterparties and technological risks, including cybersecurity, business continuity and related operational risks;

   

our ability to provide innovative products and services and execute our strategic objectives; and

   

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

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

 

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Available Information

We file annual, quarterly and current reports, proxy statements and other information with the U.S. 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. Our electronic SEC filings are available to the public at the SEC’s internet site, www.sec.gov.

Our internet site is www.morganstanley.com. You can access our Investor Relations webpage at www.morganstanley.com/about-us-ir. We make available free of charge, on or through our Investor Relations webpage, 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. We also make available, through our Investor Relations webpage, via a link to the SEC’s internet site, statements of beneficial ownership of our equity securities filed by our directors, officers, 10% or greater shareholders and others under Section 16 of the Exchange Act.

You can access information about our corporate governance at www.morganstanley.com/about-us-governance. Our Corporate Governance webpage includes:

 

   

Amended and Restated Certificate of Incorporation;

   

Amended and Restated Bylaws;

   

Charters for our Audit Committee, Compensation, Management Development and Succession Committee, Nominating and Governance Committee, Operations and Technology 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 Activities;

   

Policy Regarding Shareholder Rights Plan;

   

Equity Ownership Commitment;

   

Code of Ethics and Business Conduct;

   

Code of Conduct;

   

Integrity Hotline information; and

   

Environmental and Social Policies.

Our Code of Ethics and Business Conduct applies to all directors, officers and employees, including our Chief Executive Officer, Chief Financial Officer and Deputy Chief Financial Officer. We 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 our 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 our internet site is not incorporated by reference into this report.

 

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Part I

Item  1. Business

Overview

We are a global financial services firm that, through our subsidiaries and affiliates, advises, and originates, trades, manages and distributes capital for, governments, institutions and individuals. We were originally incorporated under the laws of the State of Delaware in 1981, and our predecessor companies date back to 1924. We are a financial holding company (“FHC”) regulated by the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHC Act”). We conduct our business from our headquarters in and around New York City, our regional offices and branches throughout the U.S. and our principal offices in London, Tokyo, Hong Kong and other world financial centers. As of December 31, 2016, we had 55,311 employees worldwide. Unless the context otherwise requires, the terms “Morgan Stanley,” the “Firm,” “us,” “we,” and “our” mean Morgan Stanley (the “Parent Company”) together with its consolidated subsidiaries.

Financial information concerning us, our business segments and geographic regions for each of the 12 months ended December 31, 2016, December 31, 2015 and December 31, 2014 is included in the consolidated financial statements and the notes thereto in “Financial Statements and Supplementary Data” in Part II, Item 8.

Business Segments

We are a global financial services firm that maintains significant market positions in each of our business segments—Institutional Securities, Wealth Management and Investment Management. Through our subsidiaries and affiliates, we provide a wide variety of products and services to a large and diversified group of clients and customers, including corporations, governments, financial institutions and individuals. Additional information related to our business segments, respective clients, and products and services provided is included under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7.

Competition

All aspects of our businesses are highly competitive, and we expect them to remain so. We compete in the U.S. and globally for clients, market share and human talent. Operating within the financial services industry on a global basis presents, among other things, technological, risk management, regulatory and other infrastructure challenges that

require effective resource allocation in order for us to remain competitive. Our competitive position depends on our reputation and the quality and consistency of our long-term investment performance. Our ability to sustain or improve our competitive position also depends substantially on our ability to continue to attract and retain highly qualified employees while managing compensation and other costs. We compete with commercial banks, brokerage firms, insurance companies, electronic trading and clearing platforms, financial data repositories, sponsors of mutual funds, hedge funds and private equity funds, energy companies and other companies offering financial or ancillary services in the U.S., globally and through the internet. In addition, restrictive laws and regulations applicable to certain U.S. financial services institutions, such as Morgan Stanley, which may prohibit us from engaging in certain transactions and impose more stringent capital and liquidity requirements, can put us at a competitive disadvantage to competitors in certain businesses not subject to these same requirements. See also “—Supervision and Regulation” below and “Risk Factors” in Part I, Item 1A.

Institutional Securities and Wealth Management

Our competitive position for our Institutional Securities and Wealth Management business segments depends on innovation, execution capability and relative pricing. We compete directly in the U.S. and globally with other securities and financial services firms and broker-dealers and with others on a regional or product basis. Additionally, there is increased competition driven by established firms as well as the emergence of new firms and business models (including innovative uses of technology) competing for the same clients and assets or offering similar products and services.

Our ability to access capital at competitive rates (which is generally impacted by our credit ratings), to commit and to deploy capital efficiently, particularly in our capital-intensive underwriting and sales, trading, financing and market-making activities, also affects our competitive position. Corporate clients may request that we provide loans or lending commitments in connection with certain investment banking activities and such requests are expected to continue.

It is possible that competition may become even more intense as we continue to compete with financial institutions that may be larger, or better capitalized, or may have a stronger local presence and longer operating history in certain geographies or products. Many of these firms have the ability to offer a wide range of products and services that may enhance their competitive position and could result in pricing pressure on our businesses. In addition, our business is subject to extensive regulation in the U.S. and abroad, while certain of our competitors may be subject to less stringent legal and regulatory regimes than us, thereby putting us at a competitive disadvantage.

 

 

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We continue to experience intense price competition in some of our businesses. In particular, the ability to execute securities trades electronically on exchanges and through other automated trading markets has increased the pressure on trading commissions and comparable fees. The trend toward direct access to automated, electronic markets will likely increase as additional trading moves to more automated platforms. It is also possible that we will experience competitive pressures in these and other areas in the future as some of our competitors seek to obtain market share by reducing prices (in the form of commissions or pricing).

Investment Management

Our ability to compete successfully in the asset management industry is affected by several factors, including our reputation, investment objectives, quality of investment professionals, performance of investment strategies or product offerings relative to peers and appropriate benchmark indices, advertising and sales promotion efforts, fee levels, the effectiveness of and access to distribution channels and investment pipelines, and the types and quality of products offered. Our investment products, including alternative investment products, may compete with investments offered by other investment managers with passive investment products or who may be subject to less stringent legal and regulatory regimes than us.

Supervision and Regulation

As a major financial services firm, we are subject to extensive regulation by U.S. federal and state regulatory agencies and securities exchanges and by regulators and exchanges in each of the major markets where we conduct our business. Moreover, in response to the 2007-2008 financial crisis, legislators and regulators, both in the U.S. and worldwide, have adopted, continue to propose or are in the process of implementing a wide range of reforms that have resulted or that may in the future result in major changes to the way we are regulated and conduct our business. These reforms include the Dodd-Frank Act; risk-based capital, leverage and liquidity standards adopted or being developed by the Basel Committee on Banking Supervision (the “Basel Committee”), including Basel III, and the national implementation of those standards; capital planning and stress testing requirements; and new resolution regimes that are being developed in the U.S. and other jurisdictions. While certain portions of these reforms are effective, others are still subject to final rulemaking or transition periods.

We continue to monitor the changing political, tax and regulatory environment; it is likely that there will be further material changes in the way major financial institutions are regulated in both the U.S. and other markets in which we operate,

although it remains difficult to predict the exact impact these changes will have on our business, financial condition, results of operations and cash flows for a particular future period.

Financial Holding Company

Consolidated Supervision.    We have operated as a bank holding company and FHC under the BHC Act since September 2008. As a bank holding company, we are subject to comprehensive consolidated supervision, regulation and examination by the Federal Reserve. Under existing regulation, the Federal Reserve has heightened authority to examine, prescribe regulations and take action with respect to all of our subsidiaries. In particular, we are, or will become, subject to (among other things): significantly revised and expanded regulation and supervision; more intensive scrutiny of our businesses and plans for expansion of those businesses; new activities limitations; a systemic risk regime that imposes heightened capital and liquidity requirements; restrictions on activities and investments imposed by a section of the BHC Act added by the Dodd-Frank Act referred to as the “Volcker Rule”; and comprehensive derivatives regulation. In addition, the Consumer Financial Protection Bureau has primary rulemaking, enforcement and examination authority over us and our subsidiaries with respect to federal consumer protection laws, to the extent applicable.

Scope of Permitted Activities.    The BHC Act limits the activities of bank holding companies and financial holding companies and grants the Federal Reserve authority to limit our ability to conduct activities. We must obtain the Federal Reserve’s approval before engaging in certain banking and other financial activities both in the U.S. and internationally. Since becoming a bank holding company, we have disposed of certain nonconforming assets and conformed certain activities to the requirements of the BHC Act.

The BHC Act grandfathers “activities related to the trading, sale or investment in commodities and underlying physical properties,” provided that we were engaged in “any of such activities as of September 30, 1997 in the United States” and provided that certain other conditions that are within our reasonable control are satisfied. We currently engage in our commodities activities pursuant to the BHC Act grandfather exemption as well as other authorities under the BHC Act.

Activities Restrictions under the Volcker Rule.    The Volcker Rule prohibits “banking entities,” including the Firm and its affiliates, from engaging in certain “proprietary trading” activities, as defined in the Volcker Rule, subject to exemptions for underwriting, market-making-related activities, risk-mitigating hedging and certain other activities. The Volcker Rule also prohibits certain investments and relationships by banking entities with “covered funds,” with a number of

 

 

December 2016 Form 10-K   2  


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exemptions and exclusions. Banking entities were required to bring all of their activities and investments into conformance with the Volcker Rule by July 21, 2015, subject to certain extensions. For more information about the conformance periods applicable to certain covered funds, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Regulatory Developments.” In addition, the Volcker Rule requires banking entities to have comprehensive compliance programs reasonably designed to ensure and monitor compliance with the Volcker Rule.

The Volcker Rule also requires that deductions be made from a bank holding company’s Tier 1 capital for certain permissible investments in covered funds. Beginning with the three months ended September 30, 2015, the required deductions are reflected in our relevant regulatory capital tiers and ratios. Given its complexity, the full impact of the Volcker Rule is still uncertain and will ultimately depend on the interpretation and implementation by the five regulatory agencies responsible for its oversight.

Capital Standards.    The Federal Reserve establishes capital requirements for large bank holding companies and evaluates our compliance with such requirements. The Office of the Comptroller of the Currency (the “OCC”) establishes similar capital requirements and standards for our U.S. bank subsidiaries, Morgan Stanley Bank, N.A. (“MSBNA”) and Morgan Stanley Private Bank, National Association (“MSPBNA”) (collectively, “U.S. Bank Subsidiaries”).

Regulatory Capital Framework.    The Federal Reserve establishes capital requirements for large bank holding companies, including well-capitalized standards, and evaluates our compliance with such capital requirements. The OCC establishes similar capital requirements and standards for our U.S. Bank Subsidiaries. The regulatory capital requirements are largely based on the Basel III capital standards established by the Basel Committee and also implement certain provisions of the Dodd-Frank Act. After completion of certain transitional arrangements in the regulatory capital framework, we will be subject to various risk-based capital requirements, measured against our Common Equity Tier 1 capital, Tier 1 capital and Total capital bases, leverage-based capital requirements, including the Supplementary Leverage Ratio, and additional capital buffers above generally applicable minimum standards for bank holding companies.

The Basel Committee is in the process of considering revisions to various provisions of the capital framework that, if adopted by the U.S. banking agencies, could result in substantial changes to our regulatory capital framework.

Regulated Subsidiaries.    In addition, many of our regulated subsidiaries are, or are expected to be in the future, subject to regulatory capital requirements, including regulated subsidiaries registered as “swap dealers” with the U.S. Commodity Futures Trading Commission (the “CFTC”) or “security-based swap dealers” with the SEC (collectively, “Swaps Entities”) or registered as broker-dealers or futures commission merchants. Specific regulatory capital requirements vary by regulated subsidiary, and in many cases these standards are not yet established or are subject to ongoing rulemakings that could substantially modify requirements.

Commodities-Related Capital Requirements.    In September 2016, the Federal Reserve issued a proposed rulemaking that would increase risk-based capital requirements for certain commodities-related activities and commodities-related merchant banking investments of U.S. FHCs, including the Firm; impose new limitations on the physical commodity trading activities of certain U.S. FHCs; and enhance reporting requirements with respect to U.S. FHCs’ commodities-related activities and investments. If adopted in its current form, the proposed rulemaking would result in increases in our risk-weighted assets (“RWAs”) with respect to certain commodities-related investments and physical commodity holdings. However, we expect that the proposed rule, if finalized in its proposed form, would not have a material impact on our aggregate RWAs or risk-based capital ratios.

For more information about the specific capital requirements applicable to us and our U.S. Bank Subsidiaries, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Regulatory Requirements” in Part II, Item 7.

Capital Planning, Stress Tests and Capital Distributions.    Pursuant to the Dodd-Frank Act, the Federal Reserve has adopted capital planning and stress test requirements for large bank holding companies, including Morgan Stanley. The Dodd-Frank Act also requires each of our U.S. Bank Subsidiaries to conduct an annual stress test. For more information about the capital planning and stress test requirements, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Regulatory Requirements” in Part II, Item 7.

In addition to capital planning requirements, the OCC, the Federal Reserve and the Federal Deposit Insurance Corporation (“FDIC”) have the authority to prohibit or to limit the payment of dividends by the banking organizations they supervise, including the Firm and its U.S. Bank Subsidiaries, if, in the banking regulator’s opinion, payment of a dividend would constitute an unsafe or unsound practice in light of the financial condition of the banking organization. All of these

 

 

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policies and other requirements could affect our ability to pay dividends and/or repurchase stock, or require us to provide capital assistance to our U.S. Bank Subsidiaries under circumstances which we would not otherwise decide to do so.

Liquidity Standards.    In addition to capital regulations, the U.S. banking agencies and the Basel Committee have adopted, or are in the process of considering, liquidity standards. The Basel Committee has developed two standards intended for use in liquidity risk supervision, the Liquidity Coverage Ratio (“LCR”) and the Net Stable Funding Ratio (“NSFR”). The Firm and its U.S. Bank Subsidiaries are subject to the LCR requirements issued by the U.S. banking regulators (“U.S. LCR”) and would be subject to the NSFR requirements proposed by the U.S. banking regulators (“U.S. NSFR”).

In addition to the U.S. LCR and U.S. NSFR, we and many of our regulated subsidiaries, including those registered as Swaps Entities with the CFTC or SEC, are, or are expected to be in the future, subject to other liquidity standards, including liquidity stress-testing and associated liquidity reserve requirements.

For more information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Regulatory Liquidity Framework” in Part II, Item 7.

Systemic Risk Regime.    The Dodd-Frank Act established a systemic risk regime to which bank holding companies with $50 billion or more in consolidated assets, such as Morgan Stanley, are subject. Under rules issued by the Federal Reserve to implement certain requirements of the Dodd-Frank Act’s enhanced prudential standards, such bank holding companies must conduct internal liquidity stress tests, maintain unencumbered highly liquid assets to meet projected net cash outflows for 30 days over the range of liquidity stress scenarios used in internal stress tests, and comply with various liquidity risk management requirements. Institutions also must comply with a range of risk management and corporate governance requirements.

In March 2016, the Federal Reserve re-proposed rules that would establish single-counterparty credit limits for large banking organizations (“covered companies”), with more stringent limits for the largest covered companies. U.S. global systemically important banks (“G-SIBs”), including the Firm, would be subject to a limit of 15% of Tier 1 capital for credit exposures to any “major counterparty” (defined as other U.S. G-SIBs, foreign G-SIBs and nonbank systemically important financial institutions supervised by the Federal Reserve) and to a limit of 25% of Tier 1 capital for credit exposures to any other unaffiliated counterparty. We continue to evaluate the potential impact of the proposed rules.

In addition, the Federal Reserve has proposed rules that would create a new early remediation framework to address financial distress or material management weaknesses. The Federal Reserve also has the ability to establish additional prudential standards, including those regarding contingent capital, enhanced public disclosures and limits on short-term debt, including off-balance sheet exposures. For example, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Regulatory Requirements—Total Loss-Absorbing Capacity and Long-Term Debt Requirement” in Part II, Item 7.

Under the systemic risk regime, if the Federal Reserve or the Financial Stability Oversight Council determines that a bank holding company with $50 billion or more in consolidated assets poses a “grave threat” to U.S. financial stability, the institution may be, among other things, restricted in its ability to merge or offer financial products and required to terminate activities and dispose of assets.

See also “—Capital Standards” and “—Liquidity Standards” herein and “—Resolution and Recovery Planning” below.

Resolution and Recovery Planning.    Pursuant to the Dodd-Frank Act, we are required to submit to the Federal Reserve and the FDIC an annual resolution plan that describes our strategy for a rapid and orderly resolution under the U.S. Bankruptcy Code in the event of our material financial distress or failure. Our preferred resolution strategy, which is set out in our 2015 resolution plan, is a single point of entry (“SPOE”) strategy. An SPOE strategy generally contemplates the provision of additional capital and liquidity by the Parent Company to certain of its subsidiaries so that such subsidiaries have the resources necessary to implement the resolution strategy after the Parent Company has filed for bankruptcy.

Further, we are required to submit an annual recovery plan to the Federal Reserve that outlines the steps that management could take over time to generate or conserve financial resources in times of prolonged financial stress.

Certain of our domestic and foreign subsidiaries are also subject to resolution and recovery planning requirements in the jurisdictions in which they operate. For example, MSBNA must submit to the FDIC an annual resolution plan that describes MSBNA’s strategy for a rapid and orderly resolution in the event of material financial distress or failure of MSBNA. In September 2016, the OCC issued final guidelines that establish enforceable standards for recovery planning by national banks and certain other institutions with total consolidated assets of $50 billion or more, calculated on a rolling four-quarter average basis, including MSBNA. The guidelines were effective on January 1, 2017, and MSBNA must be in compliance by January 1, 2018.

 

 

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In addition, under the Dodd-Frank Act, certain financial companies, including bank holding companies such as the Firm and certain of its covered subsidiaries, can be subjected to a resolution proceeding under the orderly liquidation authority in Title II of the Dodd-Frank Act with the FDIC being appointed as receiver, provided that certain procedures are met, including certain extraordinary financial distress and systemic risk determinations by the U.S. Treasury Secretary in consultation with the U.S. President. The orderly liquidation authority rulemaking is proceeding in stages, with some regulations now finalized and others not yet proposed. If we were subject to the orderly liquidation authority, the FDIC would have considerable powers, including: the power to remove directors and officers responsible for our failure and to appoint new directors and officers; the power to assign our assets and liabilities to a third party or bridge financial company without the need for creditor consent or prior court review; the ability to differentiate among our creditors, including by treating certain creditors within the same class better than others, subject to a minimum recovery right on the part of disfavored creditors to receive at least what they would have received in bankruptcy liquidation; and broad powers to administer the claims process to determine distributions from the assets of the receivership. The FDIC has been developing an SPOE strategy that could be used to implement the orderly liquidation authority.

Regulators have taken and proposed various actions to facilitate an SPOE strategy under the U.S. Bankruptcy Code, the orderly liquidation authority or other resolution regimes. For more information about our resolution plan-related submissions and associated regulatory actions, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Regulatory Requirements—Total Loss-Absorbing Capacity, Long-Term Debt and Clean Holding Company Requirements” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Regulatory Developments—Resolution and Recovery Planning” in Part II, Item 7.

Cyber Risk Management.    As a general matter, the financial services industry faces increased regulatory focus regarding cyber risk management practices. In October 2016, the federal banking regulators issued an advance notice of proposed rulemaking regarding enhanced cyber risk management standards, which would apply to a wide range of large financial institutions and their third-party service providers, including the Firm. The proposed standards would expand existing cybersecurity regulations and guidance to focus on cyber risk governance and management; management of internal and external dependencies; and incident response, cyber resilience and situational awareness. In addition, the proposal contemplates more stringent standards for institutions with systems that are critical to the financial sector.

U.S. Bank Subsidiaries

U.S. Bank Subsidiaries.    MSBNA, primarily a wholesale commercial bank, offers commercial lending and certain retail securities-based lending services in addition to deposit products, and also conducts certain foreign exchange activities.

MSPBNA offers certain mortgage and other secured lending products, including retail securities-based lending products, primarily for customers of our affiliate retail broker-dealer, Morgan Stanley Smith Barney LLC (“MSSB LLC”). MSPBNA also offers certain deposit products and prime brokerage custody services.

Both MSBNA and MSPBNA are FDIC-insured national banks subject to supervision, regulation and examination by the OCC. They are both subject to the OCC’s risk governance guidelines, which establish heightened standards for a large national bank’s risk governance framework and the oversight of that framework by the bank’s board of directors.

Prompt Corrective Action.    The Federal Deposit Insurance Corporation Improvement Act of 1991 provides a framework for regulation of depository institutions and their affiliates, including parent holding companies, by their federal banking regulators. Among other things, it requires the relevant federal banking regulator to take “prompt corrective action” (“PCA”) with respect to a depository institution if that institution does not meet certain capital adequacy standards. Current PCA regulations generally apply only to insured banks and thrifts such as MSBNA or MSPBNA and not to their parent holding companies. The Federal Reserve is, however, authorized to take appropriate action at the holding company level, subject to certain limitations. Under the systemic risk regime, as described above, we also would become subject to an early remediation protocol in the event of financial distress. In addition, bank holding companies, such as Morgan Stanley, are required to serve as a source of strength to their U.S. bank subsidiaries and commit resources to support these subsidiaries in the event such subsidiaries are in financial distress.

Transactions with Affiliates.    Our U.S. Bank Subsidiaries are subject to Sections 23A and 23B of the Federal Reserve Act, which impose restrictions on “covered transactions” with any affiliates. Covered transactions include any extension of credit to, purchase of assets from, and certain other transactions by insured banks with an affiliate. These restrictions limit the total amount of credit exposure that our U.S. Bank Subsidiaries may have to any one affiliate and to all affiliates. Other provisions set collateral requirements and require all such transactions to be made on market terms. Derivatives, securities borrowing and securities lending transactions between our U.S. Bank Subsidiaries and their affiliates are

 

 

  5   December 2016 Form 10-K


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subject to these restrictions. The Federal Reserve has indicated that it will propose a rulemaking to implement these more recent restrictions.

In addition, the Volcker Rule generally prohibits covered transactions between (i) us or any of our affiliates and (ii) covered funds for which we or any of our affiliates serves as the investment manager, investment adviser, commodity trading advisor or sponsor, or other covered funds organized and offered by us or any of our affiliates pursuant to specific exemptions in the Volcker Rule. See also “—Financial Holding Company—Activities Restriction under the Volcker Rule” above.

FDIC Regulation.    An FDIC-insured depository institution is generally liable for any loss incurred or expected to be incurred by the FDIC in connection with the failure of an insured depository institution under common control by the same bank holding company. As commonly controlled FDIC-insured depository institutions, each of MSBNA and MSPBNA could be responsible for any loss to the FDIC from the failure of the other. In addition, both institutions are exposed to changes in the cost of FDIC insurance. Under the Dodd-Frank Act, some of the restoration of the FDIC’s reserve fund must be paid for exclusively by large depository institutions, including MSBNA.

Institutional Securities and Wealth Management

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

MSSB LLC is also a registered investment adviser with the SEC. MSSB LLC’s relationship with its investment advisory clients is subject to the fiduciary and other obligations imposed on investment advisers under the Investment Advisers Act of 1940, and the rules and regulations promulgated thereunder as well as various state securities laws. These laws and regulations generally grant the SEC and other supervisory bodies broad administrative powers to address non-compliance, including the power to restrict or limit MSSB LLC from carrying on its investment advisory and other asset management activities. Other sanctions that may be imposed include the suspension of individual employees, limitations on engaging in certain activities for specified periods of time or for specified types of clients, the revocation of registrations, other censures and significant fines.

The Firm is subject to various regulations that affect broker-dealer sales practices and customer relationships. For example, under the Dodd-Frank Act, the SEC is authorized to impose a fiduciary duty rule applicable to broker-dealers when providing personalized investment advice about securities to retail customers, although the SEC has not yet acted on this authority.

As a separate matter, in April 2016, the U.S. Department of Labor adopted a conflict of interest rule under the Employee Retirement Income Security Act of 1974 that broadens the circumstances under which a firm and/or financial adviser is considered a fiduciary when providing certain recommendations to retirement investors and requires that such recommendations be in the best interests of clients. Subject to any potential delays, the new fiduciary standard for investment advice has a scheduled applicability date of April 10, 2017, with certain aspects subject to phased-in compliance, and with full compliance required by January 1, 2018. Given the breadth and scale of our platform and continued investment in technology and infrastructure, we believe that we will be able to provide compliant solutions to meet our clients’ investment needs. However, these developments may impact the manner in which affected businesses are conducted, decrease profitability and increase potential litigation or enforcement risk.

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

As registered U.S. broker-dealers, certain of our subsidiaries are subject to the SEC’s net capital rule and the net capital requirements of various exchanges, other regulatory author-

 

 

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ities and self-regulatory organizations. These rules are generally designed to measure the broker-dealer subsidiary’s general financial integrity and/or liquidity and require that at least a minimum amount of net and/or liquid assets be maintained by the subsidiary. See also “—Financial Holding Company—Consolidated Supervision” and “—Financial Holding Company—Liquidity Standards” above. Rules of FINRA and other self-regulatory organizations also impose limitations and requirements on the transfer of member organizations’ assets.

Research.    Both U.S. and non-U.S. regulators continue to focus on research conflicts of interest. Research-related regulations have been implemented in many jurisdictions, including in the U.S. where FINRA has adopted rules that cover both equity and debt. New and revised requirements resulting from these regulations and the global research settlement with U.S. federal and state regulators (to which we are a party) have necessitated the development or enhancement of corresponding policies and procedures.

Regulation of Futures Activities and Certain Commodities Activities.    MS&Co., as a futures commission merchant, and MSSB LLC, as an introducing broker, are subject to net capital requirements of, and certain of their activities are regulated by, the CFTC, the National Futures Association (the “NFA”), CME Group, and various commodity futures exchanges. MS&Co. and MSSB LLC and certain of their affiliates are registered members of the NFA in various capacities. Rules and regulations of the CFTC, NFA and commodity futures exchanges address obligations related to, among other things, customer protections, the segregation of customer funds and the holding of secured amounts, the use by futures commission merchants of customer funds, recordkeeping and reporting obligations of futures commission merchants, and introducing brokers, risk disclosure, risk management and discretionary trading.

Our commodities activities are subject to extensive and evolving energy, commodities, environmental, health and safety, and other governmental laws and regulations in the U.S. and abroad. Intensified scrutiny of certain energy markets by U.S. federal, state and local authorities in the U.S. and abroad and by the public has resulted in increased regulatory and legal enforcement and remedial proceedings involving companies conducting the activities in which we are engaged. See also “—Financial Holding Company—Scope of Permitted Activities” and “—Capital Standards—Commodities-Related Capital Requirements” above.

Derivatives Regulation.    Under the U.S. regulatory regime for “swaps” and “security-based swaps” (collectively, “Swaps”) implemented pursuant to the Dodd-Frank Act, we

are subject to regulations including, among others, public and regulatory reporting, central clearing and mandatory trading on regulated exchanges or execution facilities for certain types of Swaps. While the CFTC has completed the majority of its regulations in this area, most of which are in effect, the SEC has not yet adopted a number of its Swaps regulations. The Dodd-Frank Act also requires the registration of “swap dealers” with the CFTC and “security-based swap dealers” with the SEC. Certain of our subsidiaries have registered with the CFTC as swap dealers and will in the future be required to register with the SEC as security-based swap dealers. Such Swaps Entities are or will be subject to a comprehensive regulatory regime with new obligations for the Swaps activities for which they are registered, including capital requirements, margin requirements for uncleared Swaps and comprehensive business conduct rules. Each of the CFTC and the SEC have proposed rules to impose capital standards on Swaps Entities subject to their respective jurisdictions, which include our subsidiaries, but these rules have not yet been finalized.

The specific parameters of some of these requirements for Swaps have been and continue to be developed through the CFTC, SEC and bank regulator rulemakings. In 2015, the federal banking regulators and the CFTC separately issued final rules establishing uncleared Swap margin requirements for Swaps Entities subject to their respective regulation, including MSBNA, Morgan Stanley Capital Services LLC and Morgan Stanley & Co. International plc (“MSIP”), respectively. These final rules impose variation margin requirements under a phase-in compliance schedule that applied to the largest dealers as of September 1, 2016 and will apply to the remainder of in-scope market participants as of March 1, 2017. Similarly, the final rules phase-in initial margin requirements from September 1, 2016 through September 1, 2020, depending on the level of over-the-counter (“OTC”) derivatives activity of the swap dealer and the relevant counterparty. Margin rules with the same or similar compliance dates have been adopted or are in the process of being finalized by regulators outside the U.S. and certain of our subsidiaries may be subject to such rules.

Although the full impact of global derivatives regulation on us remains unclear, we have already faced, and are expected to continue to face, increased costs and regulatory oversight due to the registration and regulatory requirements indicated above. Complying with the Swaps rules also has required, and is expected to in the future require, us to change our Swaps businesses and has required, and may in the future require, extensive systems and personnel changes. Compliance with Swaps-related regulatory capital requirements may require us to devote more capital to our Swaps business.

 

 

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Non-U.S. Regulation.    Our Institutional Securities businesses also are regulated extensively by non-U.S. regulators, including governments, securities exchanges, commodity exchanges, self-regulatory organizations, central banks and regulatory bodies, especially in those jurisdictions in which we maintain an office. In addition, certain Morgan Stanley subsidiaries are regulated as broker-dealers under the laws of the jurisdictions in which they operate. Subsidiaries engaged in banking and trust activities outside the U.S. are regulated by various government agencies in the particular jurisdiction where they are chartered, incorporated and/or conduct their business activity. For instance, the Prudential Regulation Authority (“PRA”), the Financial Conduct Authority (“FCA”) and several securities and futures exchanges in the U.K., including the London Stock Exchange and ICE Futures Europe, regulate our activities in the U.K.; the Bundesanstalt für Finanzdienstleistungsaufsicht (the Federal Financial Supervisory Authority) and the Deutsche Börse AG regulate our activities in the Federal Republic of Germany; the Financial Services Agency, the Bank of Japan, the Japanese Securities Dealers Association and several Japanese securities and futures exchanges, regulate our activities in Japan; the Securities and Futures Commission of Hong Kong, the Hong Kong Monetary Authority and the Hong Kong Exchanges and Clearing Limited regulate our operations in Hong Kong; and the Monetary Authority of Singapore and the Singapore Exchange Limited regulate our business in Singapore.

Our largest non-U.S. entity, MSIP, is subject to extensive regulation and supervision by the PRA, which has broad legal authority to establish prudential and other standards applicable to MSIP that seek to ensure its safety and soundness and to minimize adverse effects on the stability of the U.K. financial system. MSIP is also regulated and supervised by the FCA with respect to business conduct matters.

Non-U.S. policymakers and regulators, including the European Commission and European Supervisory Authorities (among others, the European Banking Authority and the European Securities and Markets Authority), continue to propose and adopt numerous reforms, including those that may further impact the structure of banks, and to formulate regulatory standards and measures that will be of relevance and importance to our European operations. In November 2016, the European Commission published proposals that would require certain large, non-E.U. financial groups with two or more institutions established in the E.U., to establish a single E.U. intermediate holding company (“IHC”). The proposals would require E.U. banks and broker-dealers to be held below the E.U. IHC; until more specific regulations are proposed, it remains unclear which other E.U. entities would need to be held beneath the E.U. IHC. The E.U. IHC would be subject to: direct supervision and authorization by the European Central Bank or the relevant national E.U. regu-

lator; the E.U. bank recovery and resolution regime under the E.U. Bank Recovery and Resolution Directive (“BRRD”); and capital, liquidity, leverage and other prudential standards on a consolidated basis. The proposals will now be considered by the European Parliament and the Council of the E.U. The final form of the proposals, as well as the date of their adoption, is not yet certain.

Regulators in the U.K., E.U. and other major jurisdictions have also finalized or are in the process of proposing or finalizing risk-based capital, leverage capital, liquidity, market-based reforms and other regulatory standards applicable to certain of our subsidiaries that operate in those jurisdictions. For instance, European Market Infrastructure Regulation introduces new requirements regarding the central clearing and reporting of derivatives, as well as margin requirements for uncleared derivatives. The Markets in Financial Instrument Regulation and a revision of the Markets in Financial Instruments Directive (together, “MiFID II”), which is now scheduled to take effect on January 3, 2018, will also introduce comprehensive and new trading and market infrastructure reforms in the E.U., including new trading venues, enhancements to pre- and post-trading transparency, and additional investor protection requirements, among others. Although the full impact of these changes remains unclear, complying with MiFID II is expected to require extensive changes to our operations, including systems and controls.

Regulators in the U.K., E.U. and other major jurisdictions have also finalized or are in the process of proposing or finalizing recovery and resolution planning frameworks and related regulatory requirements that will apply to certain of our subsidiaries that operate in those jurisdictions. For instance, the BRRD has established a recovery and resolution framework for E.U. credit institutions and investment firms, including MSIP. E.U. Member States were required to apply provisions implementing the BRRD as of January 1, 2015, subject to certain exemptions. In addition, certain jurisdictions, including the U.K. and other E.U. jurisdictions, have implemented, or are in the process of implementing, changes to resolution regimes to provide resolution authorities with the ability to recapitalize a failing entity organized in such jurisdiction by writing down certain unsecured liabilities or converting certain unsecured liabilities into equity.

Investment Management

Many of the subsidiaries engaged in our asset management activities are registered as investment advisers with the SEC. Many aspects of our asset management activities are subject to federal and state laws and regulations primarily intended to benefit the investor or client. These laws and regulations generally grant supervisory agencies and bodies broad administrative powers, including the power to limit or restrict us

 

 

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from carrying on our asset management activities in the event that we fail to comply with such laws and regulations. Sanctions that may be imposed for such failure include the suspension of individual employees, limitations on our engaging in various asset management activities for specified periods of time or specified types of clients, the revocation of registrations, other censures and significant fines. In order to facilitate our asset management business, we own a registered U.S. broker-dealer, Morgan Stanley Distribution, Inc., which acts as distributor to the Morgan Stanley mutual funds and as placement agent to certain private investment funds managed by our Investment Management business segment. In addition, certain of our affiliates are registered as commodity trading advisors and/or commodity pool operators, or are operating under certain exemptions from such registration pursuant to CFTC rules and other guidance, and have certain responsibilities with respect to each pool they advise. Violations of the rules of the CFTC, the NFA or the commodity exchanges could result in remedial actions, including fines, registration restrictions or terminations, trading prohibitions or revocations of commodity exchange memberships. See also “—Institutional Securities and Wealth Management—Broker-Dealer and Investment Adviser Regulation,” “—Institutional Securities and Wealth Management—Regulation of Futures Activities and Certain Commodities Activities,” “—Institutional Securities and Wealth Management—Derivatives Regulation” and “—Institutional Securities and Wealth Management—Non-U.S. Regulation” above for a discussion of other regulations that impact our Investment Management business, including, among other things, the Department of Labor’s conflict of interest rule and MiFID II.

As a result of the passage of the Dodd-Frank Act, our asset management activities are subject to certain additional laws and regulations, including, but not limited to, additional reporting and recordkeeping requirements (including with respect to clients that are private funds) and restrictions on sponsoring or investing in, or maintaining certain other relationships with, “covered funds,” as defined in the Volcker Rule, subject to certain limited exemptions. Many of these requirements may increase the expenses associated with our asset management activities and/or reduce the investment returns we are able to generate for our asset management clients. See also “—Financial Holding Company—Activities Restrictions under the Volcker Rule” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Regulatory Developments.”

Our Investment Management business is also regulated outside the U.S. For example, the FCA is the primary regulator of our business in the U.K.; the Financial Services Agency regulates our business in Japan; the Securities and Futures Commission of Hong Kong regulates our business in

Hong Kong; and the Monetary Authority of Singapore regulates our business in Singapore. See also “—Institutional Securities and Wealth Management—Non-U.S. Regulation” herein.

Financial Crimes Program

Our Financial Crimes program is coordinated on an enterprise-wide basis and supports our financial crime prevention efforts across all regions and business units with responsibility for governance, oversight and execution of our Anti-Money Laundering (“AML”), economic sanctions (“Sanctions”) and anti-corruption programs.

In the U.S., the Bank Secrecy Act, as amended by the USA PATRIOT Act of 2001, imposes significant obligations on financial institutions to detect and deter money laundering and terrorist financing activity, including requiring banks, bank holding companies and their subsidiaries, broker-dealers, futures commission merchants, introducing brokers and mutual funds to implement AML programs, verify the identity of customers that maintain accounts, and monitor and report suspicious activity to appropriate law enforcement or regulatory authorities. Outside the U.S., applicable laws, rules and regulations similarly require designated types of financial institutions to implement AML programs. We have implemented policies, procedures and internal controls that are designed to comply with all applicable AML laws and regulations. Regarding Sanctions, we have implemented policies, procedures and internal controls that are designed to comply with the regulations and economic sanctions programs administered by the U.S. Treasury’s Office of Foreign Assets Control (“OFAC”), which target foreign countries, entities and individuals based on external threats to U.S. foreign policy, national security or economic interests, and to comply, as applicable, similar sanctions programs imposed by foreign governments or global or regional multilateral organizations such as the United Nations Security Council and the E.U. Council.

We are also subject to applicable anti-corruption laws, such as the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, in the jurisdictions in which we operate. Anti-corruption laws generally prohibit offering, promising, giving or authorizing others to give anything of value, either directly or indirectly, to a government official or private party in order to influence official action or otherwise gain an unfair business advantage, such as to obtain or retain business. We have implemented policies, procedures and internal controls that are designed to comply with such laws, rules and regulations.

 

 

  9   December 2016 Form 10-K


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Protection of Client Information

Many aspects of our businesses are subject to legal requirements concerning the use and protection of certain customer information, including those adopted pursuant to the Gramm-Leach-Bliley Act and the Fair and Accurate Credit Transactions Act of 2003 in the U.S., the E.U. Data Protection Directive and various laws in Asia, including the Japanese Personal Information (Protection) Law, the Hong Kong Personal Data (Protection) Ordinance and the Australian Privacy Act. We have adopted measures designed to comply with these and related applicable requirements in all relevant jurisdictions.

Compensation Practices and Other Regulation

Our compensation practices are subject to oversight by the Federal Reserve and, with respect to some of our subsidiaries and employees, by other financial regulatory bodies worldwide. In particular, we are subject to the Federal Reserve’s guidance that is designed to help ensure that incentive compensation paid by banking organizations does not encourage imprudent risk taking that threatens the organizations’ safety and soundness. The scope and content of the Federal Reserve’s policies on executive compensation are continuing to develop and may change based on findings from its peer review process, and we expect that these policies will evolve over a number of years.

We are subject to the compensation-related provisions of the Dodd-Frank Act, which may impact our compensation practices. In 2016, pursuant to the Dodd-Frank Act, certain federal regulatory agencies reproposed a rule, which, if implemented as written, would require, among other things, the deferral of a percentage of certain incentive-based compensation for senior executives and certain other employees and, under certain circumstances, “clawback” of incentive-based compensation. In addition, pursuant to the Dodd-Frank Act, in 2015, the SEC proposed rules that would direct stock exchanges to require listed companies to implement clawback policies to recover incentive-based compensation from current or former executive officers in the event of certain financial restatements and would also require companies to disclose their clawback policies and their actions under those policies. We continue to evaluate the proposed rules, both of which are subject to further rulemaking procedures.

Our compensation practices may also be impacted by regulations in other jurisdictions. Our compensation practices with respect to certain employees whose activities have a material impact on the risk profile of our E.U. operations are subject to the Capital Requirements Directive IV (the “CRD IV”) and related E.U. and Member State regulations, including, among others, a cap on the ratio of variable remuneration to fixed

remuneration and clawback arrangements in relation to variable remuneration paid in the past. In the U.K., the remuneration of certain employees of banks and other firms is governed by the Remuneration Code of the FCA and by the PRA Rulebook (Remuneration Part), including provisions that implement the CRD IV, as well as additional U.K. requirements.

For a discussion of certain risks relating to our regulatory environment, see “Risk Factors” in Part I, Item 1A.

Executive Officers of Morgan Stanley

The executive officers of Morgan Stanley and their ages and titles as of February 27, 2017 are set forth below. Business experience for the past five years is provided in accordance with SEC rules.

Jeffrey S. Brodsky (52).    Executive Vice President and Chief Human Resources Officer of Morgan Stanley (since January 2016). Vice President and Global Head of Human Resources (January 2011 to December 2015). Co-Head of Human Resources (January 2010 to December 2011). Head of Morgan Stanley Smith Barney Human Resources (June 2009 to January 2010).

James P. Gorman (58).    Chairman of the Board of Directors and Chief Executive Officer of Morgan Stanley (since January 2012). President and Chief Executive Officer (January 2010 through December 2011) and member of the Board of Directors (since January 2010). Co-President (December 2007 to December 2009) and Co-Head of Strategic Planning (October 2007 to December 2009). President and Chief Operating Officer of Wealth Management (February 2006 to April 2008).

Eric F. Grossman (50).    Executive Vice President and Chief Legal Officer of Morgan Stanley (since January 2012). Global Head of Legal (September 2010 to January 2012). Global Head of Litigation (January 2006 to September 2010) and General Counsel of the Americas (May 2009 to September 2010). General Counsel of Wealth Management (November 2008 to September 2010). Partner at the law firm of Davis Polk & Wardwell LLP (June 2001 to December 2005).

Keishi Hotsuki (54).    Executive Vice President (since May 2014) and Chief Risk Officer of Morgan Stanley (since May 2011). Interim Chief Risk Officer (January 2011 to May 2011) and Head of Market Risk Department (March 2008 to April 2014). Director of Mitsubishi UFJ Morgan Stanley Securities Co., Ltd. (since May 2010). Global Head of Market Risk Management at Merrill Lynch (June 2005 to September 2007).

 

 

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Colm Kelleher (59).    President of Morgan Stanley (since January 2016). Executive Vice President (October 2007 to January 2016). President of Institutional Securities (January 2013 to January 2016). Head of International (January 2011 to January 2016). Co-President of Institutional Securities (January 2010 to December 2012). Chief Financial Officer and Co-Head of Strategic Planning (October 2007 to December 2009). Head of Global Capital Markets (February 2006 to October 2007). Co-Head of Fixed Income Europe (May 2004 to February 2006).

Jonathan M. Pruzan (48).    Executive Vice President and Chief Financial Officer of Morgan Stanley (since May 2015). Co-Head of Global Financial Institutions Group (January 2010 to April 2015). Co-Head of North American Financial Institutions Group M&A (September 2007 to December 2009). Head of the U.S. Bank Group (April 2005 to August 2007).

Daniel A. Simkowitz (51).    Head of Investment Management of Morgan Stanley (since October 2015). Co-Head of Global Capital Markets (March 2013 to September 2015). Chairman of Global Capital Markets (November 2009 to March 2013). Managing Director in Global Capital Markets (December 2000 to November 2009).

 

 

  11   December 2016 Form 10-K


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Item 1A. Risk Factors

For a discussion of the risks and uncertainties that may affect our future results and strategic objectives, see “Forward-Looking Statements” immediately preceding Part I, Item 1 and “Return on Equity Target” and “Effects of Inflation and Changes in Interest and Foreign Exchange Rates” under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7.

Market Risk

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

Our results of operations may be materially affected by market fluctuations and by global and economic conditions and other factors, including changes in asset values.

Our results of operations have been in the past and may, in the future, be materially affected by market fluctuations due to global financial markets, economic conditions, changes to the global trade policies and other factors, including the level and volatility of equity, fixed income and commodity prices (including oil prices), interest rates, currency values and other market indices. The results of our Institutional Securities business segment, particularly results relating to our involvement in primary and secondary markets for all types of financial products, are subject to substantial market fluctuations due to a variety of factors that we cannot control or predict with great certainty. These fluctuations impact results by causing variations in new business flows and in the fair value of securities and other financial products. Fluctuations also occur due to the level of global market activity, which, among other things, affects the size, number and timing of investment banking client assignments and transactions and the realization of returns from our principal investments. During periods of unfavorable market or economic conditions, the level of individual investor participation in the global markets, as well as the level of client assets, may also decrease, which would negatively impact the results of our Wealth Management business segment. In addition, fluctuations in global market activity could impact the flow of investment capital into or from assets under management or supervision and the way customers allocate capital among

money market, equity, fixed income or other investment alternatives, which could negatively impact our Investment Management business segment.

The value of our financial instruments may be materially affected by market fluctuations. Market volatility, illiquid market conditions and disruptions in the credit markets make it extremely difficult to value certain of our financial instruments, particularly during periods of market displacement. Subsequent valuations in future periods, in light of factors then prevailing, may result in significant changes in the values of these instruments and may adversely impact historical or prospective performance-based fees (also known as incentive fees or carried interest) in respect of certain business. In addition, at the time of any sales and settlements of these financial instruments, the price we ultimately realize will depend on the demand and liquidity in the market at that time and may be materially lower than their current fair value. Any of these factors could cause a decline in the value of our financial instruments, which may have an adverse effect on our results of operations in future periods.

In addition, financial markets are susceptible to severe events evidenced by rapid depreciation in asset values accompanied by a reduction in asset liquidity. Under these extreme conditions, hedging and other risk management strategies may not be as effective at mitigating trading losses as they would be under more normal market conditions. Moreover, under these conditions, market participants are particularly exposed to trading strategies employed by many market participants simultaneously and on a large scale. Our risk management and monitoring processes seek to quantify and mitigate risk to more extreme market moves. However, severe market events have historically been difficult to predict and we could realize significant losses if extreme market events were to occur.

Holding large and concentrated positions may expose us to losses.

Concentration of risk may reduce revenues or result in losses in our market-making, investing, block trading, underwriting and lending businesses in the event of unfavorable market movements, or when market conditions are more favorable for our competitors. We commit substantial amounts of capital to these businesses, which often results in our taking large positions in the securities of, or making large loans to, a particular issuer or issuers in a particular industry, country or region. For further information regarding our country risk exposure, see also “Quantitative and Qualitative Disclosures about Market Risk—Risk Management—Credit Risk—Country Risk Exposure” in Item 7A.

 

 

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Credit Risk

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

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

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

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

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

A default by a large financial institution could adversely affect financial markets.

The commercial soundness of many financial institutions may be closely interrelated as a result of credit, trading, clearing or other relationships among the institutions. For example, increased centralization of trading activities through particular clearing houses, central agents or exchanges as required by provisions of the Dodd-Frank Act may increase our concentration of risk with respect to these entities. As a

result, concerns about, or a default or threatened default by, one institution could lead to significant market-wide liquidity and credit problems, losses or defaults by other institutions. This is sometimes referred to as “systemic risk” and may adversely affect financial intermediaries, such as clearing houses, clearing agencies, exchanges, banks and securities firms, with which we interact on a daily basis, and therefore could adversely affect us. See also “Systemic Risk Regime” under “Business—Supervision and Regulation—Financial Holding Company” in Part I, Item 1.

Operational Risk

Operational risk refers to the risk of loss, or of damage to our reputation, resulting from inadequate or failed processes or systems, human factors or from external events (e.g., fraud, theft, legal and compliance risks, cyber attacks or damage to physical assets). We may incur operational risk across the full scope of our business activities, including revenue-generating activities (e.g., sales and trading) and support and control groups (e.g., information technology and trade processing). Legal, regulatory and compliance risk is included in the scope of operational risk and is discussed below under “Legal, Regulatory and Compliance Risk.” For more information on how we monitor and manage operational risk, see “Quantitative and Qualitative Disclosures about Market Risk—Risk Management—Operational Risk” in Part II, Item 7A.

We are subject to operational risks, including a failure, breach or other disruption of our operational or security systems, that could adversely affect our businesses or reputation.

Our businesses are highly dependent on our ability to process and report, on a daily basis, a large number of transactions across numerous and diverse markets in many currencies. In some of our businesses, the transactions we process are complex. In addition, we may introduce new products or services or change processes or reporting, including in connection with new regulatory requirements, resulting in new operational risk that we may not fully appreciate or identify. The trend toward direct access to automated, electronic markets and the move to more automated trading platforms has resulted in using increasingly complex technology that relies on the continued effectiveness of the programming code and integrity of the data to process the trades. We perform the functions required to operate our different businesses either by ourselves or through agreements with third parties. We rely on the ability of our employees, our internal systems and systems at technology centers operated by unaffiliated third parties to process a high volume of transactions. Additionally, we are subject to complex and evolving laws and regulations governing privacy and data protection, which may differ, and potentially conflict, in various jurisdictions.

 

 

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As a major participant in the global capital markets, we maintain extensive controls to reduce the risk of incorrect valuation or risk management of our trading positions due to flaws in data, models, electronic trading systems or processes or due to fraud. Nevertheless, such risk cannot be completely eliminated.

We also face the risk of operational failure or termination of any of the clearing agents, exchanges, clearing houses or other financial intermediaries we use to facilitate our lending. securities and derivatives transactions. In the event of a breakdown or improper operation of our or a third party’s systems or improper or unauthorized action by third parties or our employees, we could suffer financial loss, an impairment to our liquidity, a disruption of our businesses, regulatory sanctions or damage to our reputation. In addition, the interconnectivity of multiple financial institutions with central agents, exchanges and clearing houses, and the increased importance of these entities, increases the risk that an operational failure at one institution or entity may cause an industry-wide operational failure that could materially impact our ability to conduct business.

Despite the business contingency plans we have in place, there can be no assurance that such plans will fully mitigate all potential business continuity risks to us. Our ability to conduct business may be adversely affected by a disruption in the infrastructure that supports our business and the communities where we are located, which are concentrated in the New York metropolitan area, London, Hong Kong and Tokyo as well as Mumbai, Budapest, Glasgow and Baltimore. This may include a disruption involving physical site access, cyber incidents, terrorist activities, disease pandemics, catastrophic events, natural disasters, extreme weather events, electrical outage, environmental hazard, computer servers, communications or other services we use, our employees or third parties with whom we conduct business.

Although we devote significant resources to maintaining and upgrading our systems and networks with measures such as intrusion prevention and detection systems, monitoring firewalls and network traffic to safeguard critical business applications, and supervising third party providers that have access to our systems, there is no guarantee that these measures or any other measures can provide absolute security given the techniques used in cyber attacks are complex and frequently change, and may not be able to be anticipated. Like other financial services firms, the Firm and its third party providers continue to be the subject of attempted unauthorized access, mishandling or misuse of information, computer viruses or malware, cyber attacks designed to obtain confidential information, destroy data, disrupt or degrade service, sabotage

systems or cause other damage, denial of service attacks and other events. These threats may derive from human error, fraud or malice on the part of our employees or third parties, including third party providers, or may result from accidental technological failure. Additional challenges are posed by external extremist parties, including foreign state actors, in some circumstances as a means to promote political ends. Any of these parties may also attempt to fraudulently induce employees, customers, clients, third parties or other users of our systems to disclose sensitive information in order to gain access to our data or that of our customers or clients. There can be no assurance that such unauthorized access or cyber incidents will not occur in the future, and they could occur more frequently and on a more significant scale.

If one or more of these events occur, it could result in a security impact on our systems and jeopardize our or our clients’, partners’ or counterparties’ personal, confidential, proprietary or other information processed and stored in, and transmitted through, our and our third party providers’ computer systems. Furthermore, such events could cause interruptions or malfunctions in our, our clients’, partners’, counterparties’ or third parties’ operations, which could result in reputational damage with our clients and the market, client dissatisfaction, additional costs to us (such as repairing systems or adding new personnel or protection technologies), regulatory investigations, litigation or enforcement, or regulatory fines or penalties, all or any of which could adversely affect our business, financial condition or results of operations.

Given our global footprint and the high volume of transactions we process, the large number of clients, partners and counterparties with which we do business, and the increasing sophistication of cyber attacks, a cyber attack could occur and persist for an extended period of time without detection. We expect that any investigation of a cyber attack would be inherently unpredictable and that it would take time before the completion of any investigation and before there is availability of full and reliable information. During such time we would not necessarily know the extent of the harm or how best to remediate it, and certain errors or actions could be repeated or compounded before they are discovered and remediated, all or any of which would further increase the costs and consequences of a cyber attack.

While many of our agreements with partners and third party vendors include indemnification provisions, we may not be able to recover sufficiently, or at all, under such provisions to adequately offset any losses. In addition, although we maintain insurance coverage that may, subject to policy terms and conditions, cover certain aspects of cyber risks, such insurance coverage may be insufficient to cover all losses.

 

 

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Liquidity and Funding Risk

Liquidity and funding risk refers to the risk that we will be unable to finance our operations due to a loss of access to the capital markets or difficulty in liquidating our assets. Liquidity and funding risk encompasses the risk that our financial condition or overall soundness is adversely affected by an inability or perceived inability to meet our financial obligations in a timely manner. It also includes the associated funding risks triggered by the market or idiosyncratic stress events that may cause unexpected changes in funding needs or an inability to raise new funding. For more information on how we monitor and manage liquidity and funding risk, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” in Part II, Item 7 and “Quantitative and Qualitative Disclosures about Market Risk—Risk Management—Liquidity and Funding Risk” in Part II, Item 7A.

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

Liquidity is essential to our businesses. Our liquidity could be negatively affected by our inability to raise funding in the long-term or short-term debt capital markets or our inability to access the secured lending markets. Factors that we cannot control, such as disruption of the financial markets or negative views about the financial services industry generally, including concerns regarding fiscal matters in the U.S. and other geographic areas, could impair our ability to raise funding.

In addition, our ability to raise funding could be impaired if investors or lenders develop a negative perception of our long-term or short-term financial prospects due to factors such as an incurrence of large trading losses, a downgrade by the rating agencies, a decline in the level of our business activity, or if regulatory authorities take significant action against us or our industry, or we discover significant employee misconduct or illegal activity. If we are unable to raise funding using the methods described above, we would likely need to finance or liquidate unencumbered assets, such as our investment portfolios or trading assets, to meet maturing liabilities. We may be unable to sell some of our assets or we may have to sell assets at a discount to market value, either of which could adversely affect our results of operations, cash flows and financial condition.

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

The cost and availability of unsecured financing generally are impacted by our short-term and long-term credit ratings. The

rating agencies continue to monitor certain issuer specific factors that are important to the determination of our credit ratings, including governance, the level and quality of earnings, capital adequacy, liquidity and funding, risk appetite and management, asset quality, strategic direction, and business mix. Additionally, the rating agencies will look at other industry-wide factors such as regulatory or legislative changes, including, for example, regulatory changes, macro-economic environment, and perceived levels of third party support, and it is possible that they could downgrade our ratings and those of similar institutions.

Our credit ratings also can have a significant impact on certain trading revenues, particularly in those businesses where longer term counterparty performance is a key consideration, such as OTC and other derivative transactions, including credit derivatives and interest rate swaps. In connection with certain OTC trading agreements and certain other agreements associated with our Institutional Securities business segment, we may be required to provide additional collateral to, or immediately settle any outstanding liability balance with, certain counterparties in the event of a credit ratings downgrade. Termination of our trading and other agreements could cause us to sustain losses and impair our liquidity by requiring us to find other sources of financing or to make significant cash payments or securities movements. The additional collateral or termination payments which may occur in the event of a future credit rating downgrade vary by contract and can be based on ratings by either or both of Moody’s Investors Services, Inc. and S&P Global Ratings. See also “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Credit Ratings—Incremental Collateral or Terminating Payments upon Potential Future Rating Downgrade” in Part II, Item 7.

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

The Parent Company has no operations and depends on dividends, distributions and other payments from its subsidiaries to fund dividend payments and to fund all payments on its obligations, including debt obligations. Regulatory, tax restrictions or elections and other legal restrictions may limit our ability to transfer funds freely, either to or from our subsidiaries. In particular, many of our subsidiaries, including our broker-dealer subsidiaries, are subject to laws, regulations and self-regulatory organization rules that limit, as well as authorize regulatory bodies to block or reduce, the flow of funds to the Parent Company, or that prohibit such transfers or dividends altogether in certain circumstances, including steps to “ring fence” entities by regulators outside of the U.S. to protect clients and creditors of such entities in the event of

 

 

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financial difficulties involving such entities. These laws, regulations and rules may hinder our ability to access funds that we may need to make payments on our obligations. Furthermore, as a bank holding company, we may become subject to a prohibition or to limitations on our ability to pay dividends or repurchase our common stock. The OCC, the Federal Reserve and the FDIC have the authority, and under certain circumstances the duty, to prohibit or to limit the payment of dividends by the banking organizations they supervise, including the Firm and its U.S. Bank Subsidiaries.

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

Our ability to raise funding in the long-term or short-term debt capital markets or the equity markets, or to access secured lending markets, has in the past been, and could in the future be, adversely affected by conditions in the U.S. and international markets and economies. Global market and economic conditions have been particularly disrupted and volatile in the last several years and may be in the future. In particular, our cost and availability of funding in the past have been, and may in the future be, adversely affected by illiquid credit markets and wider credit spreads. Significant turbulence in the U.S., the E.U. and other international markets and economies could adversely affect our liquidity and financial condition and the willingness of certain counterparties and customers to do business with us.

Legal, Regulatory and Compliance Risk

Legal, regulatory and compliance risk includes the risk of legal or regulatory sanctions, material financial loss including fines, penalties, judgments, damages and/or settlements, or loss to reputation we may suffer as a result of our failure to comply with laws, regulations, rules, related self-regulatory organization standards and codes of conduct applicable to our business activities. This risk also includes contractual and commercial risk, such as the risk that a counterparty’s performance obligations will be unenforceable. It also includes compliance with AML, anti-corruption and terrorist financing rules and regulations. For more information on how we monitor and manage legal, regulatory and compliance risk, see “Quantitative and Qualitative Disclosures about Market Risk—Risk Management—Legal and Compliance Risk” in Part II, Item 7A.

The financial services industry is subject to extensive regulation, and changes in regulation will impact our business.

Like other major financial services firms, we are subject to extensive regulation by U.S. federal and state regulatory agencies and securities exchanges and by regulators and

exchanges in each of the major markets where we conduct our business. These laws and regulations significantly affect the way we do business and can restrict the scope of our existing businesses and limit our ability to expand our product offerings and pursue certain investments.

The regulation of major financial firms, including the Firm, as well as of the markets in which we operate, is extensive and subject to ongoing change. We are, or will become, subject to (among other things) wide-ranging regulation and supervision, intensive scrutiny of our businesses and any plans for expansion of those businesses, limitations on new activities, a systemic risk regime that imposes heightened capital and liquidity requirements and other enhanced prudential standards, resolution regimes and resolution planning requirements, new requirements for maintaining minimum amounts of external total loss-absorbing capacity and external long-term debt, restrictions on activities and investments imposed by the Volcker Rule, comprehensive derivatives regulation, tax regulations, antitrust laws, trade and transaction reporting obligations, and broadened fiduciary obligations. In some areas, regulatory standards have not yet been finalized, are subject to final rulemaking or transition periods or may otherwise be revised in whole or in part. Ongoing implementation of, or changes in, laws and regulations could materially impact the profitability of our businesses and the value of assets we hold, expose us to additional costs, require changes to business practices or force us to discontinue businesses, adversely affect our ability to pay dividends and repurchase our stock, or require us to raise capital, including in ways that may adversely impact our shareholders or creditors. In addition, regulatory requirements that are being imposed by foreign policymakers and regulators may be inconsistent or conflict with regulations that we are subject to in the U.S. and may adversely affect us. We expect legal and regulatory requirements to be subject to ongoing change for the foreseeable future, which may result in significant new costs to comply with new or revised requirements as well as to monitor for compliance on an ongoing basis.

The application of regulatory requirements and strategies in the United States or other jurisdictions to facilitate the orderly resolution of large financial institutions may pose a greater risk of loss for our security holders, and subject us to other restrictions.

Pursuant to the Dodd-Frank Act, we are required to submit to the Federal Reserve and the FDIC an annual resolution plan that describes our strategy for a rapid and orderly resolution under the U.S. Bankruptcy Code in the event of material financial distress or failure. If the Federal Reserve and the FDIC were to jointly determine that our annual resolution plan submission was not credible or would not facilitate an orderly resolution, and if we were unable to address any defi-

 

 

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ciencies identified by the regulators, we or any of our subsidiaries may be subject to more stringent capital, leverage, or liquidity requirements or restrictions on our growth, activities, or operations, or after a two year period, we may be required to divest assets or operations.

In addition, provided that certain procedures are met, we can be subject to a resolution proceeding under the orderly liquidation authority under Title II of the Dodd-Frank Act with the FDIC being appointed as receiver. The FDIC’s power under the orderly liquidation authority to disregard the priority of creditor claims and treat similarly situated creditors differently in certain circumstances, subject to certain limitations, could adversely impact holders of our unsecured debt. See “Business—Supervision and Regulation” in Part I, Item 1 and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Regulatory Requirements” in Part II, Item 7.

Further, because both our resolution plan contemplates a an SPOE strategy under the U.S. Bankruptcy Code and the FDIC has proposed an SPOE strategy through which it may apply its orderly liquidation authority powers, we believe that the application of an SPOE strategy is the reasonably likely outcome if either our resolution plan were implemented or a resolution proceeding were commenced under the orderly liquidation authority. An SPOE strategy generally contemplates the provision of additional capital and liquidity by the Parent Company to certain of its subsidiaries so that such subsidiaries have the resources necessary to implement the resolution strategy, and the Parent Company expects to enter into an amended and restated secured support agreement with its material subsidiaries pursuant to which it would provide such capital and liquidity.

Under the amended and restated support agreement, upon the occurrence of a resolution scenario, including one in which an SPOE strategy is used, the Parent Company will be obligated to contribute or loan on a subordinated basis all of its material assets, other than shares in subsidiaries of the Parent Company and certain intercompany payables, to provide capital and liquidity, as applicable, to its material subsidiaries. The obligations of the Parent Company under the amended and restated support agreement will be secured on a senior basis by the assets of the Parent Company (other than shares in subsidiaries of the Parent Company). As a result, claims of our material subsidiaries against the assets of the Parent Company (other than shares in subsidiaries of the Parent Company) will be effectively senior to unsecured obligations of the Parent Company. Such unsecured obligations would be at risk of absorbing losses of the Parent Company and its subsidiaries. Although an SPOE strategy, whether applied pursuant to our resolution plan or in a resolution

proceeding under the orderly liquidation authority, is intended to result in better outcomes for creditors overall, there is no guarantee that the application of an SPOE strategy, including the provision of support to the Parent Company’s material subsidiaries pursuant to the amended and restated secured support agreement, will not result in greater losses for holders of our securities compared to a different resolution strategy for the firm.

Regulators have taken and proposed various actions to facilitate an SPOE strategy under the U.S. Bankruptcy Code, the orderly liquidation authority or other resolution regimes. For example, the Federal Reserve has issued a final rule that requires top-tier bank holding companies of U.S. G-SIBs, including Morgan Stanley, to maintain minimum amounts of equity and eligible long-term debt (“total loss-absorbing capacity” or “TLAC”) in order to ensure that such institutions have enough loss-absorbing resources at the point of failure to be recapitalized through the conversion of debt to equity or otherwise by imposing losses on eligible TLAC where the SPOE strategy is used. The combined implication of the SPOE resolution strategy and the TLAC final rule is that our losses will be imposed on the holders of eligible long-term debt and other forms of eligible TLAC issued by the Parent Company before any losses are imposed on the holders of the debt securities of our operating subsidiaries or before putting U.S. taxpayers at risk.

In addition, certain jurisdictions, including the U.K. and other E.U. jurisdictions, have implemented, or are in the process of implementing, changes to resolution regimes to provide resolution authorities with the ability to recapitalize a failing entity organized in such jurisdiction by writing down certain unsecured liabilities or converting certain unsecured liabilities into equity. Such “bail-in” powers are intended to enable the recapitalization of a failing institution by allocating losses to its shareholders and unsecured creditors. Non-U.S. regulators are also considering requirements that certain subsidiaries of large financial institutions maintain minimum amounts of total loss-absorbing capacity that would pass losses up from the subsidiaries to the Parent Company and, ultimately, to security holders of the Parent Company in the event of failure.

We may be prevented from paying dividends or taking other capital actions because of regulatory constraints or revised regulatory capital standards.

We are subject to comprehensive consolidated supervision, regulation and examination by the Federal Reserve, which requires us to submit, on an annual basis, a capital plan describing proposed dividend payments to shareholders,

 

 

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proposed repurchases of our outstanding securities, and other proposed capital actions that we intend to take. The Federal Reserve may object to, or otherwise require us to modify, such plan, or may object or require modifications to a resubmitted capital plan, any of which would adversely affect shareholders. In addition, beyond review of the plan, the Federal Reserve may impose other restrictions or conditions on us that prevent us from paying or increasing dividends, repurchasing securities or taking other capital actions that would benefit shareholders. Finally, the Federal Reserve may change regulatory capital standards to impose higher requirements that restrict our ability to take capital actions, or may modify or impose other regulatory standards that increase our operating expenses and reduce our ability to take capital actions.

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

As a global financial services firm, we face the risk of investigations and proceedings by governmental and self-regulatory organizations in all countries in which we conduct our business. Investigations and proceedings initiated by these authorities may result in adverse judgments, settlements, fines, penalties, injunctions or other relief. In addition to the monetary consequences, these measures could, for example, impact our ability to engage in, or impose limitations on, certain of our businesses. The number of these investigations and proceedings, as well as the amount of penalties and fines sought, has increased substantially in recent years with regard to many firms in the financial services industry, including the Firm, and certain U.S. and international governmental entities have increasingly brought criminal actions against, or have sought criminal convictions, pleas or deferred prosecution agreements from, financial institutions. Significant regulatory or law enforcement action against us could materially adversely affect our business, financial condition or results of operations or cause us significant reputational harm, which could seriously harm our business. The Dodd-Frank Act also provides compensation to whistleblowers who present the SEC or CFTC with information related to securities or commodities law violations that leads to a successful enforcement action. As a result of this compensation, it is possible we could face an increased number of investigations by the SEC or CFTC.

We have been named, from time to time, as a defendant in various legal actions, including arbitrations, class actions, and other litigation, as well as investigations or proceedings brought by regulatory agencies, arising in connection with our activities as a global diversified financial services institution. Certain of the actual or threatened legal or regulatory

actions include claims for substantial compensatory and/or punitive damages, claims for indeterminate amounts of damages, or may result in penalties, fines, or other results adverse to us. In some cases, the issuers that would otherwise be the primary defendants in such cases are bankrupt or are in financial distress. In other cases, including antitrust litigation, we may be subject to claims for joint and several liability with other defendants for treble damages or other relief related to alleged conspiracies involving other institutions. Like any large corporation, we are also subject to risk from potential employee misconduct, including non-compliance with policies and improper use or disclosure of confidential information, or improper sales practices or conduct.

We may be responsible for representations and warranties associated with residential and commercial real estate loans and may incur losses in excess of our reserves.

We originate loans secured by commercial and residential properties. Further, we securitize and trade in a wide range of commercial and residential real estate and real estate-related whole loans, mortgages and other real estate and commercial assets and products, including residential and commercial mortgage-backed securities. In connection with these activities, we have provided, or otherwise agreed to be responsible for, certain representations and warranties. Under certain circumstances, we may be required to repurchase such assets or make other payments related to such assets if such representations and warranties were breached. We have also made representations and warranties in connection with our role as an originator of certain commercial mortgage loans that we securitized in commercial mortgage-backed securities. For additional information, see also Note 12 to the consolidated financial statements in Part II, Item 8.

We currently have several legal proceedings related to claims for alleged breaches of representations and warranties. If there are decisions adverse to us in those legal proceedings, we may incur losses substantially in excess of our reserves. In addition, our reserves are based, in part, on certain factual and legal assumptions. If those assumptions are incorrect and need to be revised, we may need to adjust our reserves substantially.

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

In connection with the commodities activities in our Institutional Securities business segment, we engage in the storage, transportation, marketing and execution of transactions in several commodities, including metals, natural gas, electric power, emission credits, and other commodity products. In

 

 

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addition, we are an electricity power marketer in the U.S. and own a minority interest in Heidmar Holdings LLC, which owns a group of companies that provide international marine transportation and U.S. marine logistics services. As a result of these activities, we are subject to extensive energy, commodities, environmental, health and safety and other governmental laws and regulations. Further, through these activities we are exposed to regulatory, physical and certain indirect risks associated with climate change.

Although we have attempted to mitigate our environmental risks by, among other measures, selling or ceasing most of our prior petroleum storage and transportation activities, adopting appropriate policies and procedures, and implementing emergency response programs, these actions may not prove adequate to address every contingency. In addition, insurance covering some of these risks may not be available, and the proceeds, if any, from insurance recovery may not be adequate to cover liabilities with respect to particular incidents. As a result, our financial condition, results of operations and cash flows may be adversely affected by these events.

During the past several years, intensified scrutiny of certain energy markets by federal, state and local authorities in the U.S. and abroad and the public has resulted in increased regulatory and legal enforcement, litigation and remedial proceedings involving companies conducting the activities in which we are engaged. In addition, new regulation of OTC derivatives markets in the U.S. and similar legislation proposed or adopted abroad will impose significant new costs and impose new requirements on our commodities derivatives activities. We may incur substantial costs or loss of revenue in complying with current or future laws and regulations and our overall businesses and reputation may be adversely affected by the current legal environment. In addition, failure to comply with these laws and regulations may result in substantial civil and criminal fines and penalties. See also “Financial Holding Company—Capital Standards—Commodities-Related Capital Requirements” under “Business—Supervision and Regulation” in Part I, Item 1.

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

As a global financial services firm that provides products and services to a large and diversified group of clients, including corporations, governments, financial institutions and individuals, we face potential conflicts of interest in the normal course of business. For example, potential conflicts can occur when there is a divergence of interests between us and a client, among clients, between an employee on the one hand

and us or a client on the other, or situations in which we may be a creditor of a client. We have policies, procedures and controls that are designed to identify and address potential conflicts of interest. However, identifying and mitigating potential conflicts of interest can be complex and challenging, and can become the focus of media and regulatory scrutiny. Indeed, actions that merely appear to create a conflict can put our reputation at risk even if the likelihood of an actual conflict has been mitigated. It is possible that potential conflicts could give rise to litigation or enforcement actions, which may lead to our clients being less willing to enter into transactions in which a conflict may occur and could adversely affect our businesses and reputation.

Our regulators have the ability to scrutinize our activities for potential conflicts of interest, including through detailed examinations of specific transactions. For example, our status as a bank holding company supervised by the Federal Reserve subjects us to direct Federal Reserve scrutiny with respect to transactions between our U.S. Bank Subsidiaries and their affiliates. Further, the Volcker Rule subjects us to regulatory scrutiny regarding certain transactions between us and our clients.

Risk Management

Our risk management strategies, models and processes may not be fully effective in mitigating our risk exposures in all market environments or against all types of risk.

We have devoted significant resources to develop our risk management capabilities and expect to continue to do so in the future. Nonetheless, our risk management strategies, models and processes, including our use of various risk models for assessing market exposures and hedging strategies, stress testing and other analysis, may not be fully effective in mitigating our risk exposure in all market environments or against all types of risk, including risks that are unidentified or unanticipated. As our businesses change and grow, and the markets in which we operate evolve, our risk management strategies, models and processes may not always adapt with those changes. Some of our methods of managing risk are based upon our use of observed historical market behavior and management’s judgment. As a result, these methods may not predict future risk exposures, which could be significantly greater than the historical measures indicate. In addition, many models we use are based on assumptions or inputs regarding correlations among prices of various asset classes or other market indicators and therefore cannot anticipate sudden, unanticipated or unidentified market or economic movements, which could cause us to incur losses.

 

 

  19   December 2016 Form 10-K


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Management of market, credit, liquidity, operational, legal, regulatory and compliance risks requires, among other things, policies and procedures to record properly and verify a large number of transactions and events, and these policies and procedures may not be fully effective. Our trading risk management strategies and techniques also seek to balance our ability to profit from trading positions with our exposure to potential losses. While we employ a broad and diversified set of risk monitoring and risk mitigation techniques, those techniques and the judgments that accompany their application cannot anticipate every economic and financial outcome or the timing of such outcomes. For example, to the extent that our trading or investing activities involve less liquid trading markets or are otherwise subject to restrictions on sales or hedging, we may not be able to reduce our positions and therefore reduce our risk associated with such positions. We may, therefore, incur losses in the course of our trading or investing activities. For more information on how we monitor and manage market and certain other risks and related strategies, models and processes, see “Quantitative and Qualitative Disclosures about Market Risk—Risk Management—Market Risk” in Part II, Item 7A.

Competitive Environment

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

The financial services industry and all aspects of our businesses are intensely competitive, and we expect them to remain so. We compete with commercial banks, brokerage firms, insurance companies, electronic trading and clearing platforms, financial data repositories, sponsors of mutual funds, hedge funds, energy companies and other companies offering financial or ancillary services in the U.S., globally and through the internet. We compete on the basis of several factors, including transaction execution, capital or access to capital, products and services, innovation, technology, reputation, risk appetite and price. Over time, certain sectors of the financial services industry have become more concentrated, as institutions involved in a broad range of financial services have left businesses, been acquired by or merged into other firms, or have declared bankruptcy. Such changes could result in our remaining competitors gaining greater capital and other resources, such as the ability to offer a broader range of products and services and geographic diversity, or new competitors may emerge. We have experienced and may continue to experience pricing pressures as a result of these factors and as some of our competitors seek to obtain market share by reducing prices. In addition, certain of our competitors may be subject to different, and, in some cases, less stringent, legal and regulatory regimes, than we are, thereby putting us at a competitive disadvantage. For more informa-

tion regarding the competitive environment in which we operate, see “Business—Competition” and “Business—Supervision and Regulation” in Part I, Item 1.

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

We have experienced intense price competition in some of our businesses in recent years. In particular, the ability to execute securities, derivatives and other financial instrument trades electronically on exchanges, swap execution facilities, and other automated trading platforms has increased the pressure on bid-offer spreads, commissions, markups or comparable fees. The trend toward direct access to automated, electronic markets will likely continue and will likely increase as additional markets move to more automated trading platforms. We have experienced and it is likely that we will continue to experience competitive pressures in these and other areas in the future as some of our competitors may seek to obtain market share by reducing bid-offer spreads, commissions, markups or comparable fees.

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

Our people are our most important resource and competition for qualified employees is intense. If we are unable to continue to attract and retain highly qualified employees, or do so at rates or in forms necessary to maintain our competitive position, or if compensation costs required to attract and retain employees become more expensive, our performance, including our competitive position, could be materially adversely affected. The financial industry has experienced and may continue to experience more stringent regulation of employee compensation, including limitations relating to incentive-based compensation, clawback requirements and special taxation, which could have an adverse effect on our ability to hire or retain the most qualified employees.

International Risk

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

We are subject to political, economic, legal, tax, operational, franchise and other risks that are inherent in operating in many countries, including risks of possible nationalization, expropriation, price controls, capital controls, exchange controls, increased taxes and levies, and other restrictive governmental actions, as well as the outbreak of hostilities or political and governmental instability. In many countries, the

 

 

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

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

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

As a U.S. company, we are required to comply with the economic sanctions and embargo programs administered by OFAC and similar multi-national bodies and governmental agencies worldwide, as well as applicable anti-corruption laws in the jurisdictions in which we operate, such as the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act. A violation of a sanction, embargo program, or anti-corruption law could subject us, and individual employees, to a regulatory enforcement action as well as significant civil and criminal penalties.

The U.K.’s anticipated withdrawal from the E.U. could adversely affect us.

On June 23, 2016, the U.K. electorate voted to leave the E.U. It is difficult to predict the future of the U.K.’s relationship with the E.U., which uncertainty may increase the volatility in the global financial markets in the short- and medium-term. The U.K. Prime Minister has confirmed the U.K. will invoke Article 50 of the Lisbon Treaty by no later than the end of March 2017, subject to the passing of necessary legislation by the U.K. Parliament. This will trigger a two-year period, subject to extension, during which the U.K. government is expected to negotiate its withdrawal agreement with the E.U. Absent any changes to this time schedule, the U.K.

is expected to leave the E.U. in early 2019. The terms and conditions of the anticipated withdrawal from the E.U., and which of the several alternative models of relationship that the U.K. might seek to negotiate with the E.U., remain uncertain. However, the U.K. government has stated that the U.K. will leave the E.U. single market and will seek a phased period of implementation for the new relationship that may cover the legal and regulatory framework applicable to financial institutions with significant operations in Europe, such as the Firm. Potential effects of the U.K. exit from the E.U. and potential mitigation actions may vary considerably depending on the timing of withdrawal and the nature of any transition or successor arrangements. Any future limitations on providing financial services into the E.U. from our U.K. operations could require us to make potentially significant changes to our operations in the U.K. and Europe and our legal structure there, which could have an adverse effect on our business and financial results.

Acquisition, Divestiture and Joint Venture Risk

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

In connection with past or future acquisitions, divestitures, joint ventures, minority stakes or strategic alliances (including with Mitsubishi UFJ Financial Group, Inc.), we face numerous risks and uncertainties combining, transferring, separating or integrating the relevant businesses and systems, including the need to combine or separate accounting and data processing systems and management controls and to integrate relationships with clients, trading counterparties and business partners. In the case of joint ventures and minority stakes, we are subject to additional risks and uncertainties because we may be dependent upon, and subject to liability, losses or reputational damage relating to systems, controls and personnel that are not under our control.

In addition, conflicts or disagreements between us and any of our joint venture partners may negatively impact the benefits to be achieved by the relevant joint venture.

There is no assurance that any of our acquisitions or divestitures will be successfully integrated or disaggregated or yield all of the positive benefits anticipated. If we are not able to integrate or disaggregate successfully our past and future acquisitions or dispositions, there is a risk that our results of operations, financial condition and cash flows may be materially and adversely affected.

Certain of our business initiatives, including expansions of existing businesses, may bring us into contact, directly or

 

 

  21   December 2016 Form 10-K


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

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

 

Item 1B. Unresolved Staff Comments

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

 

 

Item 2. Properties

We have offices, operations and data centers located around the world. Our properties that are not owned are leased on terms and for durations that are reflective of commercial standards in the communities where these properties are located. We believe the facilities we own or occupy are adequate for the purposes for which they are currently used and are well maintained. Our principal offices include the following properties:

 

Location   

Owned/

Leased

     Lease
Expiration
     Approximate Square Footage
as of December 31, 20161
 

U.S. Locations

 

1585 Broadway

New York, New York

(Global Headquarters and Institutional Securities Headquarters)

     Owned        N/A        1,335,500 square feet  

2000 Westchester Avenue

Purchase, New York

(Wealth Management Headquarters)

     Owned        N/A        626,100 square feet  

522 Fifth Avenue

New York, New York

(Investment Management Headquarters)

     Owned        N/A        564,900 square feet  

International Locations

     

20 Bank Street

London

(London Headquarters)

     Leased        2038        546,500 square feet  

1 Austin Road West

Kowloon

(Hong Kong Headquarters)

     Leased        2019        499,900 square feet  

Otemachi Financial City South Tower

Otemachi, Chiyoda-ku

(Tokyo Headquarters)

     Leased        2028        245,600 square feet  
1.

The indicated total aggregate square footage leased does not include space leased by our branch offices.

 

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Item 3. Legal Proceedings

 

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

The Firm is also involved, from time to time, in other reviews, investigations and proceedings (both formal and informal) by governmental and self-regulatory agencies regarding the Firm’s business, and involving, among other matters, sales and trading activities, financial products or offerings sponsored, underwritten or sold by the Firm, and accounting and operational matters, certain of which may result in adverse judgments, settlements, fines, penalties, injunctions or other relief.

The Firm contests liability and/or the amount of damages as appropriate in each pending matter. Where available information indicates that it is probable a liability had been incurred at the date of the consolidated financial statements and the Firm can reasonably estimate the amount of that loss, the Firm accrues the estimated loss by a charge to income. The Firm’s future legal expenses may fluctuate from period to period, given the current environment regarding government investigations and private litigation affecting global financial services firms, including the Firm.

In many proceedings and investigations, however, it is inherently difficult to determine whether any loss is probable or even possible, or to estimate the amount of any loss. The Firm cannot predict with certainty if, how or when such proceedings or investigations will be resolved or what the eventual settlement, fine, penalty or other relief, if any, may be, particularly for proceedings and investigations where the factual record is being developed or contested or where plaintiffs or government entities seek substantial or indeterminate damages, restitution, disgorgement or penalties. Numerous issues may need to be resolved, including through potentially lengthy discovery and determination of important factual matters, determination of issues related to class certification and the calculation of damages or other relief, and by addressing novel or unsettled legal questions relevant to the proceedings or investigations in question, before a loss or additional loss or range of loss or additional loss can be reasonably estimated for a proceeding or investigation. Subject to the foregoing, the Firm believes, based on current

knowledge and after consultation with counsel, that the outcome of such proceedings and investigations will not have a material adverse effect on the consolidated financial condition of the Firm, although the outcome of such proceedings or investigations could be material to the Firm’s operating results and cash flows for a particular period depending on, among other things, the level of the Firm’s revenues or income for such period.

Over the last several years, the level of litigation and investigatory activity (both formal and informal) by government and self-regulatory agencies has increased materially in the financial services industry. As a result, the Firm expects that it will continue to be the subject of elevated claims for damages and other relief and, while the Firm has identified below certain proceedings that the Firm believes to be material, individually or collectively, there can be no assurance that additional material losses will not be incurred from claims that have not yet been asserted or are not yet determined to be material.

Residential Mortgage and Credit Crisis Related Matters

On July 15, 2010, China Development Industrial Bank (“CDIB”) filed a complaint against the Firm, styled China Development Industrial Bank v. Morgan Stanley & Co. Incorporated et al., which is pending in the Supreme Court of the State of New York, New York County (“Supreme Court of NY”). The complaint relates to a $275 million credit default swap referencing the super senior portion of the STACK 2006-1 CDO. The complaint asserts claims for common law fraud, fraudulent inducement and fraudulent concealment and alleges that the Firm misrepresented the risks of the STACK 2006-1 CDO to CDIB, and that the Firm knew that the assets backing the CDO were of poor quality when it entered into the credit default swap with CDIB. The complaint seeks compensatory damages related to the approximately $228 million that CDIB alleges it has already lost under the credit default swap, rescission of CDIB’s obligation to pay an additional $12 million, punitive damages, equitable relief, fees and costs. On February 28, 2011, the court denied the Firm’s motion to dismiss the complaint.

On August 7, 2012, U.S. Bank, in its capacity as trustee, filed a complaint on behalf of Morgan Stanley Mortgage Loan Trust 2006-4SL and Mortgage Pass-Through Certificates, Series 2006-4SL against the Firm styled Morgan Stanley Mortgage Loan Trust 2006-4SL, et al. v. Morgan Stanley Mortgage Capital Inc., pending in the Supreme Court of NY. The complaint asserts claims for breach of contract and alleges, among other things, that the loans in the trust, which had an original principal balance of approximately $303 million, breached various representations and warran-

 

 

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ties. The complaint seeks, among other relief, rescission of the mortgage loan purchase agreement underlying the transaction, specific performance and unspecified damages and interest. On August 8, 2014, the court granted in part and denied in part the defendants’ motion to dismiss the complaint. On December 2, 2016, the Firm moved for summary judgment and the plaintiffs moved for partial summary judgment.

On August 8, 2012, U.S. Bank, in its capacity as trustee, filed a complaint on behalf of Morgan Stanley Mortgage Loan Trust 2006-14SL, Mortgage Pass-Through Certificates, Series 2006-14SL, Morgan Stanley Mortgage Loan Trust 2007-4SL and Mortgage Pass-Through Certificates, Series 2007-4SL against the Firm styled Morgan Stanley Mortgage Loan Trust 2006-14SL, et al. v. Morgan Stanley Mortgage Capital Holdings LLC, as successor in interest to Morgan Stanley Mortgage Capital Inc., pending in the Supreme Court of NY. The complaint asserts claims for breach of contract and alleges, among other things, that the loans in the trusts, which had original principal balances of approximately $354 million and $305 million respectively, breached various representations and warranties. The complaint seeks, among other relief, rescission of the mortgage loan purchase agreements underlying the transactions, specific performance and unspecified damages and interest. On August 16, 2013, the court granted in part and denied in part the Firm’s motion to dismiss the complaint. On August 16, 2016, the Firm moved for summary judgment and the plaintiffs moved for partial summary judgment.

On September 28, 2012, U.S. Bank, in its capacity as trustee, filed a complaint on behalf of Morgan Stanley Mortgage Loan Trust 2006-13ARX against the Firm styled Morgan Stanley Mortgage Loan Trust 2006-13ARX v. Morgan Stanley Mortgage Capital Holdings LLC, as successor in interest to Morgan Stanley Mortgage Capital Inc., pending in the Supreme Court of NY. Plaintiff filed an amended complaint on January 17, 2013, which asserts claims for breach of contract and alleges, among other things, that the loans in the trust, which had an original principal balance of approximately $609 million, breached various representations and warranties. The amended complaint seeks, among other relief, declaratory judgment relief, specific performance and unspecified damages and interest. By order entered September 30, 2014, the court granted in part and denied in part the Firm’s motion to dismiss the amended complaint, which the plaintiff appealed. On August 11, 2016, the Appellate Division, First Department reversed in part the trial court’s order that granted the Firm’s motion to dismiss. On December 13, 2016, the Appellate Division granted the Firm’s motion for leave to appeal to the New York Court of Appeals. The Firm filed its opening letter brief with the Court of Appeals on February 6, 2017.

On December 14, 2012, Royal Park Investments SA/NV filed a complaint against the Firm, certain affiliates, and other defendants in the Supreme Court of NY, styled Royal Park Investments SA/NV v. Merrill Lynch et al. On October 24, 2013, plaintiff filed a new complaint against the Firm in the Supreme Court of NY, styled Royal Park Investments SA/NV v. Morgan Stanley et al., alleging that defendants made material misrepresentations and omissions in the sale to plaintiff of certain mortgage pass-through certificates backed by securitization trusts containing residential mortgage loans. The total amount of certificates allegedly sponsored, underwritten and/or sold by the Firm to plaintiff was approximately $597 million. The complaint raises common law claims of fraud, fraudulent inducement, negligent misrepresentation, and aiding and abetting fraud and seeks, among other things, compensatory and punitive damages. The plaintiff filed an amended complaint on December 1, 2015. On April 29, 2016, the Firm filed a motion to dismiss the amended complaint.

On January 10, 2013, U.S. Bank, in its capacity as trustee, filed a complaint on behalf of Morgan Stanley Mortgage Loan Trust 2006-10SL and Mortgage Pass-Through Certificates, Series 2006-10SL against the Firm styled Morgan Stanley Mortgage Loan Trust 2006-10SL, et al. v. Morgan Stanley Mortgage Capital Holdings LLC, as successor in interest to Morgan Stanley Mortgage Capital Inc., pending in the Supreme Court of NY. The complaint asserts claims for breach of contract and alleges, among other things, that the loans in the trust, which had an original principal balance of approximately $300 million, breached various representations and warranties. The complaint seeks, among other relief, an order requiring the Firm to comply with the loan breach remedy procedures in the transaction documents, unspecified damages, and interest. On August 8, 2014, the court granted in part and denied in part the Firm’s motion to dismiss the complaint.

On May 3, 2013, plaintiffs in Deutsche Zentral-Genossenschaftsbank AG et al. v. Morgan Stanley et al. filed a complaint against the Firm, certain affiliates, and other defendants in the Supreme Court of NY. The complaint alleges that defendants made material misrepresentations and omissions in the sale to plaintiffs of certain mortgage pass-through certificates backed by securitization trusts containing residential mortgage loans. The total amount of certificates allegedly sponsored, underwritten and/or sold by the Firm to plaintiff was approximately $644 million. The complaint alleges causes of action against the Firm for common law fraud, fraudulent concealment, aiding and abetting fraud, negligent misrepresentation, and rescission and seeks, among other things, compensatory and punitive damages. On June 10, 2014, the court granted in part and denied in part the defendants’ motion to dismiss the complaint. The Firm perfected its appeal from that decision on June 12, 2015.

 

 

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On May 17, 2013, plaintiff in IKB International S.A. in Liquidation, et al. v. Morgan Stanley, et al. filed a complaint against the Firm and certain affiliates in the Supreme Court of NY. The complaint alleges that defendants made material misrepresentations and omissions in the sale to plaintiff of certain mortgage pass-through certificates backed by securitization trusts containing residential mortgage loans. The total amount of certificates allegedly sponsored, underwritten and/or sold by the Firm to plaintiff was approximately $132 million. The complaint alleges causes of action against the Firm for common law fraud, fraudulent concealment, aiding and abetting fraud, and negligent misrepresentation, and seeks, among other things, compensatory and punitive damages. On October 29, 2014, the court granted in part and denied in part the Firm’s motion to dismiss. All claims regarding four certificates were dismissed. After these dismissals, the remaining amount of certificates allegedly issued by the Firm or sold to plaintiff by the Firm was approximately $116 million. On August 11, 2016, the Appellate Division, First Department affirmed the trial court’s order denying in part the Firm’s motion to dismiss the complaint.

On July 2, 2013, Deutsche Bank, in its capacity as trustee, became the named plaintiff in Federal Housing Finance Agency, as Conservator for the Federal Home Loan Mortgage Corporation, on behalf of the Trustee of the Morgan Stanley ABS Capital I Inc. Trust, Series 2007-NC1 (MSAC 2007-NC1) v. Morgan Stanley ABS Capital I Inc., and filed a complaint in the Supreme Court of NY under the caption Deutsche Bank National Trust Company, as Trustee for the Morgan Stanley ABS Capital I Inc. Trust, Series 2007-NC1 v. Morgan Stanley ABS Capital I, Inc. On February 3, 2014, the plaintiff filed an amended complaint, which asserts claims for breach of contract and breach of the implied covenant of good faith and fair dealing and alleges, among other things, that the loans in the trust, which had an original principal balance of approximately $1.25 billion, breached various representations and warranties. The amended complaint seeks, among other relief, specific performance of the loan breach remedy procedures in the transaction documents, unspecified damages, rescission and interest. On April 12, 2016, the court granted in part and denied in part the Firm’s motion to dismiss the amended complaint, dismissing all claims except a single claim, regarding which the motion was denied without prejudice. On January 17, 2017, the First Department affirmed the lower court’s April 12, 2016 order.

On July 8, 2013, U.S. Bank National Association, in its capacity as trustee, filed a complaint against the Firm styled U.S. Bank National Association, solely in its capacity as Trustee of the Morgan Stanley Mortgage Loan Trust 2007-2AX (MSM 2007-2AX) v. Morgan Stanley Mortgage Capital Holdings LLC, Successor-By-Merger to Morgan

Stanley Mortgage Capital Inc. and GreenPoint Mortgage Funding, Inc., pending in the Supreme Court of NY. The complaint asserts claims for breach of contract and alleges, among other things, that the loans in the trust, which had an original principal balance of approximately $650 million, breached various representations and warranties. The complaint seeks, among other relief, specific performance of the loan breach remedy procedures in the transaction documents, unspecified damages and interest. On November 24, 2014, the court granted in part and denied in part the Firm’s motion to dismiss the complaint.

On August 26, 2013, a complaint was filed against the Firm and certain affiliates in the Supreme Court of NY, styled Phoenix Light SF Limited et al v. Morgan Stanley et al., which was amended on April 23, 2015. The amended complaint alleges that defendants made untrue statements and material omissions in the sale to plaintiffs, or their assignors, of certain mortgage pass-through certificates backed by securitization trusts containing residential mortgage loans. The total amount of certificates allegedly issued by the Firm and/or sold to plaintiffs or their assignors by the Firm was approximately $344 million. The amended complaint raises common law claims of fraud, fraudulent inducement, aiding and abetting fraud, negligent misrepresentation and rescission based on mutual mistake and seeks, among other things, compensatory damages, punitive damages or alternatively rescission or rescissionary damages associated with the purchase of such certificates. On April 23, 2015, the court granted the Firm’s motion to dismiss the amended complaint, and on May 21, 2015, the plaintiffs filed a notice of appeal of that order.

On November 6, 2013, Deutsche Bank, in its capacity as trustee, became the named plaintiff in Federal Housing Finance Agency, as Conservator for the Federal Home Loan Mortgage Corporation, on behalf of the Trustee of the Morgan Stanley ABS Capital I Inc. Trust, Series 2007-NC3 (MSAC 2007-NC3) v. Morgan Stanley Mortgage Capital Holdings LLC, and filed a complaint in the Supreme Court of NY under the caption Deutsche Bank National Trust Company, solely in its capacity as Trustee for Morgan Stanley ABS Capital I Inc. Trust, Series 2007-NC3 v. Morgan Stanley Mortgage Capital Holdings LLC, as Successor-by-Merger to Morgan Stanley Mortgage Capital Inc. The complaint asserts claims for breach of contract and breach of the implied covenant of good faith and fair dealing and alleges, among other things, that the loans in the trust, which had an original principal balance of approximately $1.3 billion, breached various representations and warranties. The complaint seeks, among other relief, specific performance of the loan breach remedy procedures in the transaction documents, unspecified damages, rescission, interest and costs. On April 12, 2016, the court granted the Firm’s motion

 

 

  25   December 2016 Form 10-K


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to dismiss the complaint, and granted the plaintiff the ability to seek to replead certain aspects of the complaint. On May 25, 2016, Deutsche Bank filed a notice of appeal of that order. On January 17, 2017, the First Department affirmed the lower court’s order granting the motion to dismiss the complaint.

On December 30, 2013, Wilmington Trust Company, in its capacity as trustee for Morgan Stanley Mortgage Loan Trust 2007-12, filed a complaint against the Firm styled Wilmington Trust Company v. Morgan Stanley Mortgage Capital Holdings LLC et al., pending in the Supreme Court of NY. The complaint asserts claims for breach of contract and alleges, among other things, that the loans in the trust, which had an original principal balance of approximately $516 million, breached various representations and warranties. The complaint seeks, among other relief, unspecified damages, interest and costs. On June 14, 2016, the court granted in part and denied in part the Firm’s motion to dismiss the complaint. On August 17, 2016, plaintiff filed a notice of appeal of that order.

On April 28, 2014, Deutsche Bank National Trust Company, in its capacity as trustee for Morgan Stanley Structured Trust I 2007-1, filed a complaint against the Firm styled Deutsche Bank National Trust Company v. Morgan Stanley Mortgage Capital Holdings LLC, pending in the United States District Court for the Southern District of New York (“SDNY”). The complaint asserts claims for breach of contract and alleges, among other things, that the loans in the trust, which had an original principal balance of approximately $735 million, breached various representations and warranties. The complaint seeks, among other relief, specific performance of the loan breach remedy procedures in the transaction documents, unspecified compensatory and/or rescissory damages, interest and costs. On April 3, 2015, the court granted in part and denied in part the Firm’s motion to dismiss the complaint.

On September 19, 2014, Financial Guaranty Insurance Company (“FGIC”) filed a complaint against the Firm in the Supreme Court of NY, styled Financial Guaranty Insurance Company v. Morgan Stanley ABS Capital I Inc. et al. relating to a securitization issued by Basket of Aggregated Residential NIMS 2007-1 Ltd. The complaint asserts claims for breach of contract and alleges, among other things, that the net interest margin securities (“NIMS”) in the trust breached various representations and warranties. FGIC issued a financial guaranty policy with respect to certain notes that had an original balance of approximately $475 million. The complaint seeks, among other relief, specific performance of the NIMS breach remedy procedures in the transaction documents, unspecified damages, reimbursement of certain payments made pursuant to the transaction documents, attorneys’ fees and interest. On

November 24, 2014, the Firm filed a motion to dismiss the complaint, which the court denied on January 19, 2017.

On September 23, 2014, FGIC filed a complaint against the Firm in the Supreme Court of NY styled Financial Guaranty Insurance Company v. Morgan Stanley ABS Capital I Inc. et al. relating to the Morgan Stanley ABS Capital I Inc. Trust 2007-NC4. The complaint asserts claims for breach of contract and fraudulent inducement and alleges, among other things, that the loans in the trust breached various representations and warranties and defendants made untrue statements and material omissions to induce FGIC to issue a financial guaranty policy on certain classes of certificates that had an original balance of approximately $876 million. The complaint seeks, among other relief, specific performance of the loan breach remedy procedures in the transaction documents, compensatory, consequential and punitive damages, attorneys’ fees and interest. On January 23, 2017, the court denied the Firm’s motion to dismiss the complaint.

On January 23, 2015, Deutsche Bank National Trust Company, in its capacity as trustee, filed a complaint against the Firm styled Deutsche Bank National Trust Company solely in its capacity as Trustee of the Morgan Stanley ABS Capital I Inc. Trust 2007-NC4 v. Morgan Stanley Mortgage Capital Holdings LLC as Successor-by-Merger to Morgan Stanley Mortgage Capital Inc., and Morgan Stanley ABS Capital I Inc., pending in the Supreme Court of NY. The complaint asserts claims for breach of contract and alleges, among other things, that the loans in the trust, which had an original principal balance of approximately $1.05 billion, breached various representations and warranties. The complaint seeks, among other relief, specific performance of the loan breach remedy procedures in the transaction documents, compensatory, consequential, rescissory, equitable and punitive damages, attorneys’ fees, costs and other related expenses, and interest. On December 11, 2015, the court granted in part and denied in part the Firm’s motion to dismiss the complaint. On February 11, 2016, plaintiff filed a notice of appeal of that order.

On April 1, 2016, the California Attorney General’s Office filed an action against the Firm in California state court styled California v. Morgan Stanley, et al., on behalf of California investors, including the California Public Employees’ Retirement System and the California Teachers’ Retirement System. The complaint alleges that the Firm made misrepresentations and omissions regarding residential mortgage-backed securities and notes issued by the Cheyne SIV, and asserts violations of the California False Claims Act and other state laws and seeks treble damages, civil penalties, disgorgement, and injunctive relief. On September 30, 2016, the court granted the Firm’s demurrer, with leave to replead. On October 21, 2016, the California Attorney General filed

 

 

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an amended complaint. On January 25, 2017, the court denied the Firm’s demurrer with respect to the amended complaint.

Currency Related Matters

The Firm is responding to a number of regulatory and governmental inquiries both in the United States and abroad related to its foreign exchange business. In addition, on June 29, 2015, the Firm and a number of other financial institutions were named as respondents in a proceeding before Brazil’s Council for Economic Defense related to alleged anticompetitive activity in the foreign exchange market for the Brazilian Real.

The Firm, as well as other foreign exchange dealers, are defendants in In Re Foreign Exchange Benchmark Rates Antitrust Litigation, pending in the SDNY. On July 16, 2015, plaintiffs filed an amended complaint generally alleging that defendants engaged in a conspiracy to fix, maintain or make artificial prices for key benchmark rates, to manipulate bid/ask spreads, and, by their behavior in the over-the-counter market, to thereby cause corresponding manipulation in the foreign exchange futures market. Plaintiffs seek declaratory relief as well as treble damages in an unspecified amount. On December 16, 2016, the Firm and plaintiffs reached an agreement in principle to settle the litigation with respect to the Firm. After it is finalized by the parties, the settlement will be subject to court approval.

European Matters

On June 26, 2006, the public prosecutor in Parma, Italy brought criminal charges against certain present and former employees of the Firm related to the bankruptcy of Parmalat in 2003. The trial commenced in September 2009 and the evidence phase concluded in January 2017. A verdict is expected during the course of 2017. While the Firm is not a defendant in the criminal proceeding, certain investors have asserted civil claims against the Firm related to the proceedings. These claims seek, among other relief, moral damages and loss of opportunity damages related to their purchase of approximately €327 million in bonds issued by Parmalat. In addition, on October 11, 2011, an Italian financial institution, Banco Popolare Societá Cooperativa (“Banco Popolare”), filed a civil claim against the Firm in the Milan courts, styled Banco Popolare Societá Cooperativa v Morgan Stanley & Co. International plc & others (File number 63671/2011), related to its purchase of €100 million of bonds issued by Parmalat. The claim asserted by Banco Popolare alleges, among other things, that the Firm was aware of Parmalat’s impending insolvency and conspired with others to deceive Banco Popolare into buying bonds by concealing both Parmalat’s true financial condition and certain features

of the bonds from the market and Banco Popolare. Banco Popolare seeks damages of €76 million (approximately $80 million) plus damages for loss of opportunity and moral damages. The Firm filed its answer on April 20, 2012, and the hearing on the parties’ final submissions is scheduled for March 20, 2018.

On May 12, 2016, the Austrian state of Land Salzburg filed a claim against the Firm in the Regional Court in Frankfurt, Germany, styled Land Salzburg v. Morgan Stanley & Co. International plc (the “German Proceedings”) seeking €209 million (approximately $220 million) plus interest, attorneys’ fees and other relief relating to certain fixed income and commodities derivative transactions which Land Salzburg entered into with the Firm between 2005 and 2012. Land Salzburg has alleged that it had neither the capacity nor authority to enter into such transactions, which should be set aside, and that the Firm breached certain advisory and other duties which the Firm had owed to it. On April 28, 2016, the Firm filed an action against Land Salzburg in the High Court in London, England styled Morgan Stanley Capital Services LLC and Morgan Stanley & Co. International plc v. Land Salzburg (the “English Proceedings”) in which the Firm is seeking declarations that Land Salzburg had both the capacity and authority to enter into the transactions, and that the Firm has no liability to Land Salzburg arising from them. On July 25, 2016, the Firm filed an application with the Regional Court in Frankfurt to stay the German Proceedings on the basis that the High Court in London was first seized of the dispute between the parties and, pending determination of that application, filed its statement of defense on December 23, 2016. On December 8, 2016, Land Salzburg filed an application with the High Court in London challenging its jurisdiction to determine the English Proceedings.

On July 11, 2016, the Firm received an invitation to respond to a proposed claim (“Proposed Claim”) by the public prosecutor for Court of Accounts for the Republic of Italy. The Proposed Claim relates to certain derivative transactions between the Republic of Italy and the Firm. The transactions were originally entered into between 1999 and 2005, and were terminated in December 2011 and January 2012. The Proposed Claim alleges, inter alia, that the Firm was acting as an agent of the Republic of Italy, that some or all of the derivative transactions were improper and that the termination of the transactions was also improper. The Proposed Claim indicates that, if a proceeding is initiated against the Firm, the public prosecutor would be asserting administrative claims against the Firm for €2.879 billion (approximately $3 billion). The Firm does not agree with the Proposed Claim and presented its defenses to the public prosecutor.

 

 

  27   December 2016 Form 10-K


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Other Litigation

On October 20, 2014, a purported class action complaint was filed against the Firm and other defendants styled Genesee County Employees’ Retirement System v. Bank of America Corporation et al. in the SDNY. The action was later consolidated with four similar actions in SDNY under the lead case styled Alaska Electrical Pension Fund v. Bank of America Corporation et al. A consolidated amended complaint was filed on February 2, 2015 asserting claims for alleged violations of the Sherman Act, breach of contract, breach of the implied covenant of good faith and fair dealing, unjust enrichment, and tortious interference with contract. The consolidated amended complaint alleges, among other things, that the defendants engaged in antitrust violations with regards to the process of setting ISDAfix, a financial benchmark and seeks treble damages, injunctive relief, attorneys’ fees and other relief. On March 28, 2016, the court granted in part and denied in part the defendants’ motion to dismiss the consolidated amended complaint. On February 7, 2017, the plaintiffs filed a second consolidated amended complaint.

The following matters were terminated during or following the quarter ended December 31, 2016:

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

things, to rescind the plaintiff’s purchase of such certificates. On January 23, 2017, the parties reached an agreement to settle the litigation.

On March 15, 2010, the Federal Home Loan Bank of San Francisco filed a complaint against the Firm and other defendants in the Superior Court of the State of California styled Federal Home Loan Bank of San Francisco v. Deutsche Bank Securities Inc. et al. An amended complaint, filed on June 10, 2010, alleges that defendants made untrue statements and material omissions in connection with the sale to plaintiff of certain mortgage pass-through certificates backed by securitization trusts containing residential mortgage loans. The amount of certificates allegedly sold to plaintiff by the Firm was approximately $276 million. The complaint raises claims under both the federal securities laws and California law and seeks, among other things, to rescind the plaintiff’s purchase of such certificates. On December 21, 2016, the parties reached an agreement to settle the litigation.

On January 25, 2011, the Firm was named as a defendant in The Bank of New York Mellon Trust, National Association v. Morgan Stanley Mortgage Capital, Inc., a litigation pending in the SDNY. The suit, brought by the trustee of a series of commercial mortgage pass-through certificates, alleges that the Firm breached certain representations and warranties with respect to an $81 million commercial mortgage loan that was originated and transferred to the trust by the Firm in 2007. The complaint seeks, among other things, to have the Firm repurchase the loan and pay additional monetary damages, and interest. On February 17, 2017, the parties reached an agreement in principle to settle the litigation.

Item 4. Mine Safety Disclosures

Not applicable.

 

 

December 2016 Form 10-K   28  


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Part II

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

Morgan Stanley’s common stock trades under the symbol “MS” on the New York Stock Exchange. As of February 17, 2017, we had 64,798 holders of record; however, we believe the number of beneficial owners of common stock exceeds this number.

The table below sets forth, for each of the last eight quarters, the low and high sales prices per share of our common stock and the amount of dividends declared per common share by our Board of Directors for such quarter.

 

     2016      2015  
      High      Low      Dividend
Declared per
Common Share
     High      Low      Dividend
Declared per
Common Share
 

First quarter

   $   31.70      $   21.16      $ 0.15      $   39.15      $   33.72      $ 0.10  

Second quarter

     28.29        23.11        0.15        40.26        35.36        0.15  

Third quarter

     32.44        24.57        0.20        41.04        30.40        0.15  

Fourth quarter

     44.04        30.96        0.20        35.74        30.15        0.15  

The following table sets forth the information with respect to purchases made by us or on our behalf of our common stock during the fourth quarter of the year ended December 31, 2016.

Issuer Purchases of Equity Securities

 

$ in millions, except per share data    Total Number of
Shares
Purchased
    

Average Price

Paid Per Share

     Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs1
     Approximate
Dollar Value of
Shares that May
Yet be Purchased
Under the Plans or
Programs
 

Month #1 (October 1, 2016-October 31, 2016)

           

Share Repurchase Program2

     4,857,000      $ 33.28        4,857,000      $ 2,088  

Employee transactions3

     63,861      $ 32.21                

Month #2 (November 1, 2016-November 30, 2016)

           

Share Repurchase Program2

     14,074,500      $ 36.09        14,074,500      $ 1,580  

Employee transactions3

     196,639      $ 39.10                

Month #3 (December 1, 2016-December 31, 2016)

           

Share Repurchase Program2

     7,751,467      $ 42.63        7,751,467      $ 1,250  

Employee transactions3

     337,765      $ 42.91                

Quarter ended December 31, 2016

           

Share Repurchase Program2

     26,682,967      $ 37.48        26,682,967      $ 1,250  

Employee transactions3

     598,265      $ 40.52                

 

1.

Share purchases under publicly announced programs are made pursuant to open-market purchases, Rule 10b5-1 plans or privately negotiated transactions (including with employee benefit plans) as market conditions warrant and at prices we deem appropriate and may be suspended at any time.

2.

Our Board of Directors has authorized the repurchase of our outstanding stock under a share repurchase program (the “Share Repurchase Program”). The Share Repurchase Program is a program for capital management purposes that considers, among other things, business segment capital needs, as well as stock-based compensation and benefit plan requirements. The Share Repurchase Program has no set expiration or termination date. Share repurchases are subject to regulatory approval. In June 2016, we received a conditional non-objection from the Federal Reserve to our 2016 capital plan, which included a share repurchase of up to $3.5 billion of our outstanding common stock during the period beginning July 1, 2016 through June 30, 2017. During the quarter ended December 31, 2016, we repurchased approximately $1.0 billion of our outstanding common stock as part of our Share Repurchase Program. For further information, see “Liquidity and Capital Resources—Capital Management” in Part II, Item 7.

3.

Includes shares acquired by us in satisfaction of the tax withholding obligations on stock-based awards and the exercise of stock options granted under our stock-based compensation plans.

 

  29   December 2016 Form 10-K


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Stock Performance Graph

The following graph compares the cumulative total shareholder return (rounded to the nearest whole dollar) of our common stock, the Standard & Poor’s 500 (“S&P 500”) Stock Index and the S&P 500 Financials Index for the last five years. The graph assumes a $100 investment at the closing price on December 31, 2011 and reinvestment of dividends on the respective dividend payment dates without commissions. This graph does not forecast future performance of our common stock.

Cumulative Total Return

December 31, 2011—December 31, 2016

 

 

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     At December 31,  
      2011      2012      2013      2014      2015      2016  

Morgan Stanley

   $   100.00      $   127.93      $   211.50      $   264.56      $   220.24      $   299.66  

S&P 500 Stock Index

     100.00        115.99        153.55        174.55        176.95        198.10  

S&P 500 Financials Index

     100.00        128.75        174.57        201.07        197.92        242.94  

 

December 2016 Form 10-K   30  


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Item 6. Selected Financial Data

 

Morgan Stanley Selected Financial Data

 

$ in millions   2016     2015     2014     2013     2012  

Income Statement Data

         

Revenues:

         

Total non-interest revenues

  $   30,933     $   32,062     $   32,540     $   31,715     $   26,383  

Interest income

    7,016       5,835       5,413       5,209       5,692  

Interest expense

    3,318       2,742       3,678       4,431       5,897  

Net interest

    3,698       3,093       1,735       778       (205

Net revenues

    34,631       35,155       34,275       32,493       26,178  

Non-interest expenses:

         

Compensation and benefits

    15,878       16,016       17,824       16,277       15,615  

Other

    9,905       10,644       12,860       11,658       9,967  

Total non-interest expenses

    25,783       26,660       30,684       27,935       25,582  

Income from continuing operations before income taxes

    8,848       8,495       3,591       4,558       596  

Provision for (benefit from) income taxes

    2,726       2,200       (90     902       (161

Income from continuing operations

    6,122       6,295       3,681       3,656       757  

Income (loss) from discontinued operations, net of income taxes

    1       (16     (14     (43     (41

Net income

    6,123       6,279       3,667       3,613       716  

Net income applicable to redeemable non- controlling interests

                      222       124  

Net income applicable to nonredeemable non- controlling interests

    144       152       200       459       524  

Net income applicable to Morgan Stanley

  $ 5,979     $ 6,127     $ 3,467     $ 2,932     $ 68  

Preferred stock dividends and other

    471       456       315       277       98  

Earnings (loss) applicable to Morgan Stanley common shareholders1

  $ 5,508     $ 5,671     $ 3,152     $ 2,655     $ (30

Amounts applicable to Morgan Stanley:

 

     

Income from continuing operations

  $ 5,978     $ 6,143     $ 3,481     $ 2,975     $ 138  

Income (loss) from discontinued operations

    1       (16     (14     (43     (70

Net income applicable to Morgan Stanley

  $ 5,979     $ 6,127     $ 3,467     $ 2,932     $ 68  
in millions, except per
share amounts
  2016     2015     2014     2013     2012  

Per Share Data

         

Earnings (loss) per basic common share2:

 

     

Income from continuing operations

  $ 2.98     $ 2.98     $ 1.65     $ 1.42     $ 0.02  

Income (loss) from discontinued operations

          (0.01     (0.01     (0.03     (0.04

Earnings (loss) per basic common share

  $ 2.98     $ 2.97     $ 1.64     $ 1.39     $ (0.02

Earnings (loss) per diluted common share2:

 

     

Income from continuing operations

  $ 2.92     $ 2.91     $ 1.61     $ 1.38     $ 0.02  

Income (loss) from discontinued operations

          (0.01     (0.01     (0.02     (0.04

Earnings (loss) per diluted common share

  $ 2.92     $ 2.90     $ 1.60     $ 1.36     $ (0.02

Book value per common share3

  $ 36.99     $ 35.24     $ 33.25     $ 32.24     $ 30.70  

Common shares outstanding at December 31st

    1,852       1,920       1,951       1,945       1,974  

Dividends declared per common share

    0.70       0.55       0.35       0.20       0.20  

Average common shares outstanding1:

 

     

Basic

    1,849       1,909       1,924       1,906       1,886  

Diluted

    1,887       1,953       1,971       1,957       1,919  

Balance Sheet and Other Operating Data

 

     

Trading assets

  $   262,154     $   239,505     $   278,117     $   301,252     $   281,881  

Loans4

    94,248       85,759       66,577       42,874       29,046  

Total assets

    814,949       787,465       801,510       832,702       780,960  

Total deposits

    155,863       156,034       133,544       112,379       83,266  

Long-term borrowings

    164,775       153,768       152,772       153,575       169,571  

Morgan Stanley shareholders’ equity

    76,050       75,182       70,900       65,921       62,109  

Common shareholders’ equity

    68,530       67,662       64,880       62,701       60,601  

Return on average common equity5

    8.0     8.5     4.8     4.3     N/M  

N/M—Not Meaningful

1.

Amounts shown are used to calculate earnings (loss) per basic and diluted common share.

2.

For the calculation of basic and diluted earnings (loss) per common share, see Note 16 to the consolidated financial statements in Part II, Item 8.

3.

Book value per common share equals common shareholders’ equity divided by common shares outstanding.

4.

Amounts include loans held for investment and loans held for sale but exclude loans at fair value, which are included in Trading assets in the consolidated balance sheets (see Note 7 to the consolidated financial statements in Part II, Item 8).

5.

The calculation of return on average common equity equals net income applicable to Morgan Stanley less preferred dividends as a percentage of average common equity. The return on average common equity is a non-generally accepted accounting principle financial measure that the Firm considers to be a useful measure to the Firm, investors and analysts to assess operating performance.

 

 

  31   December 2016 Form 10-K


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

Introduction

 

Morgan Stanley, a financial holding company, is a global financial services firm that maintains significant market positions in each of its business segments—Institutional Securities, Wealth Management and Investment Management. Morgan Stanley, through its subsidiaries and affiliates, provides a wide variety of products and services to a large and diversified group of clients and customers, including corporations, governments, financial institutions and individuals. Unless the context otherwise requires, the terms “Morgan Stanley,” “Firm,” “us,” “we,” or “our” mean Morgan Stanley (the “Parent Company”) together with its consolidated subsidiaries.

A description of the clients and principal products and services of each of our business segments is as follows:

Institutional Securities provides investment banking, sales and trading, lending and other services to corporations, governments, financial institutions, and high to ultra-high net worth clients. Investment banking services consist of capital raising and financial advisory services, including services relating to the underwriting of debt, equity and other securities, as well as advice on mergers and acquisitions, restructurings, real estate and project finance. Sales and trading services include sales, financing and market-making activities in equity and fixed income products, including foreign exchange and commodities, as well as prime brokerage services. Lending services include originating and/or purchasing corporate loans, commercial and residential mortgage lending, asset-backed lending, financing extended to equities and commodities customers, and loans to municipalities. Other activities include investments and research.

Wealth Management provides a comprehensive array of financial services and solutions to individual investors and small to medium-sized businesses and institutions covering brokerage and investment advisory services, financial and

wealth planning services, annuity and insurance products, credit and other lending products, banking and retirement plan services.

Investment Management provides a broad range of investment strategies and products that span geographies, asset classes, and public and private markets to a diverse group of clients across institutional and intermediary channels. Strategies and products include equity, fixed income, liquidity and alternative/other products. Institutional clients include defined benefit/defined contribution plans, foundations, endowments, government entities, sovereign wealth funds, insurance companies, third-party fund sponsors and corporations. Individual clients are serviced through intermediaries, including affiliated and non-affiliated distributors.

The results of operations in the past have been, and in the future may continue to be, materially affected by competition; risk factors; and legislative, legal and regulatory developments; as well as other factors. These factors also may have an adverse impact on our ability to achieve our strategic objectives. Additionally, the discussion of our results of operations herein may contain forward-looking statements. These statements, which reflect management’s beliefs and expectations, are subject to risks and uncertainties that may cause actual results to differ materially. For a discussion of the risks and uncertainties that may affect our future results, see “Forward-Looking Statements” immediately preceding Part I, Item 1, “Business—Competition” and “Business—Supervision and Regulation” in Part I, Item 1, “Risk Factors” in Part I, Item 1A and “Liquidity and Capital Resources—Regulatory Requirements” herein.

 

 

December 2016 Form 10-K   32  


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Executive Summary

Overview of Financial Results

Selected Financial Information and Other Statistical Data

 

$ in millions, except per share
amounts
  2016     2015     2014  

Net revenues by segment

     

Institutional Securities

  $       17,459     $       17,953     $       16,871  

Wealth Management

    15,350       15,100       14,888  

Investment Management

    2,112       2,315       2,712  

Intersegment Eliminations

    (290     (213     (196

Consolidated net revenues

  $ 34,631     $ 35,155     $ 34,275  

Net revenues by region1

     

Americas

  $ 25,487     $ 25,080     $ 25,140  

EMEA

    4,994       5,353       4,772  

Asia-Pacific

    4,150       4,722       4,363  

Consolidated net revenues

  $ 34,631     $ 35,155     $ 34,275  

Income from continuing operations applicable to Morgan Stanley

 

Institutional Securities

  $ 3,650     $ 3,713     $ (77

Wealth Management

    2,104       2,085       3,192  

Investment Management

    223       345       366  

Intersegment Eliminations

    1              

Income from continuing operations applicable to Morgan Stanley

  $ 5,978     $ 6,143     $ 3,481  

Income (loss) from discontinued operations applicable to Morgan Stanley

    1       (16     (14

Net income applicable to Morgan Stanley

    5,979       6,127       3,467  

Preferred stock dividends and other

    471       456       315  

Earnings applicable to Morgan Stanley common shareholders

  $ 5,508     $ 5,671     $ 3,152  

Earnings per basic common share2

  $ 2.98     $ 2.97     $ 1.64  

Earnings per diluted common share2

    2.92       2.90       1.60  

Effective income tax rate from continuing operations

    30.8     25.9     (2.5 )% 
      At December 31,
2016
     At December 31,
2015
 

Capital ratios (Transitional)3

     

Common Equity Tier 1 capital ratio

     16.9%        15.5%  

Tier 1 capital ratio

     19.0%        17.4%  

Total capital ratio

     22.0%        20.7%  

Tier 1 leverage ratio4

     8.4%        8.3%  

 

$ in millions, except per share
amounts
   At December 31,
2016
     At December 31,
2015
 

Loans5

   $ 94,248      $ 85,759  

Total assets

   $ 814,949      $ 787,465  

Global Liquidity Reserve6

   $ 202,297      $ 203,264  

Deposits

   $ 155,863      $ 156,034  

Long-term borrowings

   $ 164,775      $ 153,768  

Common shareholders’ equity

   $ 68,530      $ 67,662  

Common shares outstanding

     1,852        1,920  

Book value per common share7

   $ 36.99      $ 35.24  

Worldwide employees

     55,311        56,218  

EMEA—Europe, Middle East and Africa

1.

For a discussion of how the geographic breakdown for net revenues is determined, see Note 21 to the consolidated financial statements in Item 8.

2.

For the calculation of basic and diluted earnings per common share, see Note 16 to the consolidated financial statements in Item 8.

3.

For a discussion of our regulatory capital ratios, see “Liquidity and Capital Resources—Regulatory Requirements” herein.

4.

See Note 14 to the consolidated financial statements in Item 8 for information on the Tier 1 leverage ratio.

5.

Amounts include loans held for investment (net of allowance) and loans held for sale but exclude loans at fair value, which are included in Trading assets in the consolidated balance sheets (see Note 7 to the consolidated financial statements in Item 8).

6.

For a discussion of Global Liquidity Reserve, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Liquidity Risk Management Framework—Global Liquidity Reserve” herein.

7.

Book value per common share equals common shareholders’ equity divided by common shares outstanding.

Consolidated Results: 2016 Compared with 2015

 

 

We reported net revenues of $34,631 million in 2016, compared with $35,155 million in 2015. For 2016, net income applicable to Morgan Stanley was $5,979 million, or $2.92 per diluted common share, compared with $6,127 million, or $2.90 per diluted common share, in 2015.

 

 

Results for 2016 included net discrete tax benefits of $68 million or $0.04 per diluted common share, primarily related to the remeasurement of reserves and related interest due to new information regarding the status of a multi-year tax authority examination, partially offset by adjustments for other tax matters. Results for 2015 included net discrete tax benefits of $564 million or $0.29 per diluted common share, primarily associated with the repatriation of non-U.S. earnings at a cost lower than originally estimated, and positive revenues due to the impact of debt valuation adjustment (“DVA”) of $618 million or $0.20 per diluted common share. For a further discussion of the net discrete tax bene-

 

 

  33   December 2016 Form 10-K


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fits, see “Supplemental Financial Information and Disclosures—Income Tax Matters” herein.

 

 

Effective January 1, 2016, we early adopted a provision of the accounting update Recognition and Measurement of Financial Assets and Financial Liabilities that requires unrealized gains and losses from debt-related credit spreads and other credit factors (i.e., DVA) to be presented in other comprehensive income (loss) (“OCI”) as opposed to Trading revenues. Results for 2015 and 2014 are not restated pursuant to that guidance.

 

 

Net revenues were $34,631 million and net income applicable to Morgan Stanley was $5,979 million, or $2.92 per diluted common share, in 2016 compared with net revenues of $34,537 million and net income applicable to Morgan Stanley of $5,728 million, or $2.70 per diluted common share, excluding DVA in 2015. Excluding the net discrete tax benefits, net income applicable to Morgan Stanley was $5,911 million, or $2.88 per diluted common share, in 2016 compared with net income applicable to Morgan Stanley of $5,164 million, or $2.41 per diluted common share, excluding both DVA and the net discrete tax benefits in 2015. (see “Selected Non-Generally Accepted Accounting Principles (“Non-GAAP”) Financial Information” herein).

Consolidated Results: 2015 Compared with 2014

 

 

We reported net revenues of $35,155 million in 2015, compared with $34,275 million in 2014. In 2015, net income applicable to Morgan Stanley was $6,127 million, or $2.90 per diluted common share, compared with $3,467 million, or $1.60 per diluted common share in 2014.

 

 

Results for 2015 included net discrete tax benefits of $564 million, or $0.29 per diluted common share, primarily associated with the repatriation of non-U.S. earnings at a cost lower than originally estimated, and positive revenues due to the impact of DVA of $618 million, or $0.20 per diluted common share. Results for 2014 included net discrete tax benefits of $2,226 million, or $1.13 per diluted common share, due to the release of a deferred tax liability associated with a legal entity restructuring, remeasurement of reserves and related interest due to new information regarding the status of a multi-year tax examination, and the repatriation of non-U.S. earnings at a cost lower than originally estimated. For a further discussion of these net discrete tax benefits, see “Supplemental Financial Information and Disclosures—Income Tax Matters” herein. Results for 2014 also included positive revenues associated with DVA of $651 million, or $0.21 per diluted common share. Results for 2014 also included litigation costs related to residential mortgage-backed securities and credit crisis matters of $3,083 million, or a loss of $1.47 per diluted common share, 2014 compensation actions of approxi-

   

mately $1,137 million (see also “Supplemental Financial Information and Disclosures—Discretionary Incentive Compensation” herein), or a loss of $0.39 per diluted common share, and a funding valuation adjustment (“FVA”) implementation charge of $468 million, or a loss of $0.17 per diluted common share.

 

 

Excluding DVA, net revenues were $34,537 million and net income applicable to Morgan Stanley was $5,728 million, or $2.70 per diluted common share, in 2015 compared with net revenues of $33,624 million, and net income applicable to Morgan Stanley of $3,049 million, or $1.39 per diluted common share, in 2014. Excluding both DVA and the net discrete tax benefits, net income applicable to Morgan Stanley was $5,164 million, or $2.41 per diluted common share, in 2015 compared with net income applicable to Morgan Stanley of $823 million, or $0.26 per diluted common share, in 2014 (see “Selected Non-Generally Accepted Accounting Principles (“Non-GAAP”) Financial Information” herein). For a further discussion of the net discrete tax benefits, see “Supplemental Financial Information and Disclosures—Income Tax Matters” herein.

Business Segment Net Revenues: 2016 Compared with 2015

 

 

Institutional Securities net revenues of $17,459 million in 2016 decreased 3% compared with $17,953 million in 2015, primarily as a result of lower Investment banking and sales and trading revenues, partially offset by higher Other revenues.

 

 

Wealth Management net revenues of $15,350 million in 2016 increased 2% from $15,100 million in 2015, primarily as a result of growth in Net interest income, partially offset by lower Commissions and fees and Investment banking revenues.

 

 

Investment Management net revenues of $2,112 million in 2016 decreased 9% from $2,315 million in 2015, primarily reflecting weaker investment performance compared with 2015. This was partially offset by carried interest losses in 2015 associated with Asia private equity that did not re-occur in 2016. Asset management fees in 2016 were relatively unchanged from 2015.

Business Segment Net Revenues: 2015 Compared with 2014

 

 

Institutional Securities net revenues of $17,953 million in 2015 increased 6% compared with $16,871 million in 2014, primarily as a result of higher sales and trading net revenues, partially offset by lower Other revenues and lower revenues in Investment banking.

 

 

Wealth Management net revenues of $15,100 million in 2015 increased 1% from $14,888 million in 2014, primarily as a result of higher Net interest income and asset management revenues, partially offset by lower transactional revenues.

 

 

December 2016 Form 10-K   34  


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Investment Management net revenues of $2,315 million in 2015 decreased 15% from $2,712 million in 2014, primarily reflecting the reversal of previously accrued carried interest, reduction in revenues attributable to non-controlling interests and markdowns on principal investments.

Consolidated Non-Interest Expenses: 2016 Compared with 2015

 

 

Compensation and benefits expenses of $15,878 million in 2016 decreased 1% from $16,016 million in 2015, primarily due to a decrease in salaries, severance costs, discretionary incentive compensation and employer taxes, partially offset by an increase in the fair value of deferred compensation plan referenced investments.

 

 

Non-compensation expenses were $9,905 million in 2016 compared with $10,644 million in 2015, representing a 7% decrease, primarily due to lower litigation costs and expense management.

Consolidated Non-Interest Expenses: 2015 Compared with 2014

 

 

Compensation and benefits expenses of $16,016 million in 2015 decreased 10% from $17,824 million in 2014, primarily as a result of the 2014 compensation actions, and a decrease in the fair value of deferred compensation plan referenced investments, related carried interest, and the level of discretionary incentive compensation in 2015 (see also “Supplemental Financial Information and Disclosures—Discretionary Incentive Compensation” herein).

 

 

Non-compensation expenses were $10,644 million in 2015 compared with $12,860 million in 2014, representing a 17% decrease, primarily due to lower litigation costs in the Institutional Securities business segment associated with residential mortgage-backed securities and credit crisis-related matters.

Return on Average Common Equity

 

 

For 2016, the return on average common equity and the return on average common equity, excluding DVA was 8.0%, or 7.9% excluding DVA and the net discrete tax benefits. For 2015, the return on average common equity was 8.5%, or 7.8% excluding DVA, and 7.0% excluding DVA and the net discrete tax benefits. For 2014, the return on average common equity was 4.8%, or 4.1% excluding DVA, and 0.8% excluding DVA and the net discrete tax benefits. See “Selected Non-Generally Accepted Accounting Principles (“Non-GAAP”) Financial Information” herein.

 

Selected Non-Generally Accepted Accounting Principles (“Non-GAAP”) Financial Information

We prepare our consolidated financial statements using accounting principles generally accepted in the United States of America (“U.S. GAAP”). From time to time, we may disclose certain “non-GAAP financial measures” in this document, or in the course of our earnings releases, earnings and other conference calls, financial presentations and otherwise. A “non-GAAP financial measure” excludes, or includes, amounts from the most directly comparable measure calculated and presented in accordance with U.S. GAAP. Non-GAAP financial measures disclosed by us are provided as additional information to investors and analysts in order to provide them with further transparency about, or as an alternative method for assessing, our financial condition, operating results or prospective regulatory capital requirements. These measures are not in accordance with, or a substitute for, U.S. GAAP and may be different from or inconsistent with non-GAAP financial measures used by other companies. Whenever we refer to a non-GAAP financial measure, we will also generally define it or present the most directly comparable financial measure calculated and presented in accordance with U.S. GAAP, along with a reconciliation of the differences between the U.S. GAAP financial measure and the non-GAAP financial measure.

The principal Non-GAAP financial measures presented in this document are set forth below.

Non-GAAP Financial Measures by Business Segment

 

$ in billions    2016     2015     2014  

Pre-tax profit margin1

      

Institutional Securities

     29     26     N/M  

Wealth Management

     22     22     20

Investment Management

     14     21     24

Consolidated

     26     24     10

Average common equity2

      

Institutional Securities

   $     43.2     $     34.6     $     32.2  

Wealth Management

     15.3       11.2       11.2  

Investment Management

     2.8       2.2       2.9  

Parent Company

     7.6       18.9       19.0  

Consolidated average common equity

   $ 68.9     $ 66.9     $ 65.3  

Return on average common equity2

 

   

Institutional Securities

     7.6     9.9     N/M  

Wealth Management

     13.3     16.9     27.5

Investment Management

     7.7     15.8     13.0

Consolidated

     8.0     8.5     4.8
 

 

  35   December 2016 Form 10-K


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Reconciliations from U.S. GAAP to Non-GAAP Consolidated Financial Measures

 

$ in millions, except per share data    2016     2015     2014  

Net revenues

 

 

U.S. GAAP

   $ 34,631     $ 35,155     $ 34,275  

Impact of DVA3

           (618     (651

Net revenues, excluding DVA—non-GAAP4

   $ 34,631     $ 34,537     $ 33,624  

Net income applicable to Morgan Stanley

 

 

U.S. GAAP

   $ 5,979     $ 6,127     $ 3,467  

Impact of DVA, net of tax3

           (399     (418

Net income applicable to Morgan Stanley, excluding DVA—non-GAAP4

   $ 5,979     $ 5,728     $ 3,049  

Impact of net discrete tax benefits5

     (68     (564     (2,226

Net income applicable to Morgan Stanley, excluding DVA and net discrete tax benefits—non GAAP4

   $ 5,911     $ 5,164     $ 823  

Earnings per diluted common share

 

 

U.S. GAAP

   $ 2.92     $ 2.90     $ 1.60  

Impact of DVA3

           (0.20     (0.21

Earnings per diluted common share, excluding DVA—non-GAAP4

   $ 2.92     $ 2.70     $ 1.39  

Impact of net discrete tax benefits5

     (0.04     (0.29     (1.13

Earnings per diluted common share, excluding DVA and net discrete tax benefits—non-GAAP4

   $ 2.88     $ 2.41     $ 0.26  

Effective income tax rate

 

 

U.S. GAAP

     30.8     25.9     (2.5 )% 

Impact of net discrete tax benefits5

     0.8     6.6     62.0

Effective income tax rate from continuing operations, excluding net discrete tax benefits—non-GAAP4

     31.6     32.5     59.5

N/M—Not Meaningful

DVA represents the change in the fair value resulting from fluctuations in our credit spreads and other credit factors related to liabilities carried at fair value under the fair value option, primarily certain Long-term and Short-term borrowings.

1.

Pre-tax profit margin is a non-GAAP financial measure that we consider to be a useful measure to us, investors and analysts to assess operating performance and represents income from continuing operations before income taxes as a percentage of net revenues.

2.

Average common equity and return on average common equity are non-GAAP financial measures we consider to be useful measures to us, investors and analysts to assess capital adequacy and to allow better comparability of period-to-period operating performance. Average common equity for each business segment is determined using our Required Capital framework, an internal capital adequacy measure (see “Liquidity and Capital Resources—Regulatory Requirements—Attribution of Average Common Equity according to the Required Capital Framework” herein). Each business segment’s return on average common equity equals net income applicable to Morgan Stanley less an allocation of preferred dividends as a percentage of average common equity for that segment. Consolidated return on average common equity equals consolidated net income applicable to Morgan Stanley less preferred dividends as a percentage of average common equity.

3.

In 2016, in accordance with the early adoption of a provision of the accounting update Recognition and Measurement of Financial Assets and Financial Liabilities, unrealized DVA gains (losses) are recorded within OCI in the consolidated comprehensive income statements. For 2015 and 2014, DVA gains (losses) were recorded within Trading revenues in the consolidated income statements. See Notes 2 and 15 to the consolidated financial statements in Item 8 for further information.

4.

Net revenues, excluding DVA, net income applicable to Morgan Stanley, excluding DVA, net income applicable to Morgan Stanley, excluding DVA and net discrete tax benefits, earnings per diluted common share, excluding DVA, earnings per diluted common share, excluding DVA and net discrete tax benefits and effective income tax rate from continuing operations, excluding net discrete tax benefits, are non-GAAP financial measures we consider to be useful measures to us, investors and analysts to allow better comparability of period-to-period operating performance.

5.

For a discussion of our net discrete tax benefits, see “Supplemental Financial Information and Disclosures—Income Tax Matters” herein.

Consolidated Non-GAAP Financial Measures

 

$ in billions    2016     2015     2014  

Average common equity1, 3

 

 

Unadjusted

   $     68.9     $     66.9     $     65.3  

Excluding DVA

     69.1       67.6       66.4  

Excluding DVA and net discrete tax benefits

     69.1       67.1       65.7  

Return on average common equity1, 2

 

 

Unadjusted

     8.0     8.5     4.8

Excluding DVA

     8.0     7.8     4.1

Excluding DVA and net discrete tax benefits

     7.9     7.0     0.8

Average tangible common equity1, 3

 

 

Unadjusted

   $ 59.5     $ 57.3     $ 55.5  

Excluding DVA

     59.6       57.9       56.7  

Excluding DVA and net discrete tax benefits

     59.7       57.5       55.9  

Return on average tangible common equity1, 4

 

 

Unadjusted

     9.3     9.9     5.7

Excluding DVA

     9.2     9.1     4.8

Excluding DVA and net discrete tax benefits

     9.1     8.2     0.9

 

      At December 31,
2016
     At December 31,
2015
 

Tangible book value per common share1, 5

   $ 31.98      $ 30.26  

 

1.

The Average common equity, return on average common equity, average tangible common equity, return on average tangible common equity and tangible book value per common share measures set forth in this table are all non-GAAP financial measures we consider to be useful measures to us, investors and analysts to assess capital adequacy and to allow better comparability of period-to-period operating performance. For a discussion of tangible common equity, see “Liquidity and Capital Resources—Tangible Equity” herein.

2.

Return on average common equity equals consolidated net income applicable to Morgan Stanley less preferred dividends as a percentage of average common equity. Effective January 1, 2016, as a result of the adoption of a provision of the accounting update related to DVA, we have redefined the calculations of the return on average common equity excluding DVA, and excluding DVA and net discrete tax benefits to adjust for DVA only in the denominator. Prior to January 1, 2016, for the return on average common equity measures, where DVA is excluded, both the numerator and denominator were adjusted to exclude the impact of DVA. When excluding the net discrete tax benefits, both the numerator and denominator are adjusted to exclude that item in all periods.

3.

The impact of DVA on average common equity and average tangible common equity was approximately $(183) million, $(637) million and $(1,108) million in 2016, 2015 and 2014, respectively. The impact of the net discrete tax benefits on average common equity and average tangible common equity was approximately $(40) million, $434 million and $713 million in 2016, 2015 and 2014, respectively.

4.

Return on average tangible common equity equals net income applicable to Morgan Stanley less preferred dividends as a percentage of average tangible common equity. Effective January 1, 2016, as a result of the adoption of a provision of the accounting update related to DVA, we have redefined the calculations of return on average tangible common equity excluding DVA, and excluding DVA and net discrete tax benefits to adjust for DVA only in the denominator. Prior to January 1, 2016, for the return on average tangible common equity measures, where DVA is excluded, both the numerator and the denominator were adjusted to exclude the impact of DVA. When excluding the net discrete tax benefits, both the numerator and denominator are adjusted to exclude that item in all periods. The impact of DVA was insignificant in 2016 and 0.8% and 0.9% in 2015 and 2014, respectively. The impact of the net discrete tax benefits was 0.1%, 0.9% and 3.9% in 2016, 2015 and 2014, respectively.

5.

Tangible book value per common share equals tangible common equity of $59,234 million at December 31, 2016 and $58,098 million at December 31, 2015 divided by common shares outstanding of 1,852 million at December 31, 2016 and 1,920 million at December 31, 2015.

 

 

December 2016 Form 10-K   36  


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Return on Equity Target

We are aiming to improve our return to shareholders and, accordingly, have established a target return on average common equity (“Return on Equity Target”) of 9% to 11%, excluding DVA to be achieved by 2017, subject to the successful execution of our strategic objectives. We plan to progress toward achieving our Return on Equity Target through the following key elements of our strategy:

 

 

Revenue and profitability growth:

 

   

Wealth Management pre-tax margin improvement to approximately 23% to 25% through net interest income growth via continued high-quality lending, expense efficiency and business growth;

 

   

Continued strength in Investment Banking and Equity Sales and Trading results;

 

   

Stable performance in Fixed Income Sales and Trading and Investment Management;

 

 

Expense efficiency:

 

   

Successful completion of Project Streamline, our expense savings program launched in 2016 to reduce expenses by $1 billion by 2017 (not including any outsized litigation expense or penalties) assuming a flat revenue environment, resulting in an expense efficiency target ratio of 74%;

 

 

Sufficient capital:

 

   

Increasing capital returns to shareholders, subject to regulatory approval.

Our Return on Equity Target and the related strategies and goals are forward-looking statements that may be materially affected by many factors, including, among other things: macroeconomic and market conditions; legislative and regulatory developments; industry trading and investment banking volumes; equity market levels; interest rate environment; legal expenses and the ability to reduce expenses in general; capital levels; and discrete tax items. Given the uncertainties surrounding these and other factors, there are significant risks that our Return on Equity Target and the related strategies and goals may not be realized. Actual results may differ from our goals and targets, and the differences may be material and adverse. Accordingly, we caution that undue reliance should not be placed on any of these forward-looking statements. See “Forward-Looking Statements” immediately preceding Part I, Item 1 and “Risk Factors” in Part I, Item 1A for additional information regarding these forward-looking statements.

Return on average common equity and pre-tax margin are non-GAAP financial measures that we consider to be a useful measure to us, investors and analysts to assess operating performance. See “Selected Non-Generally Accepted Accounting Principles (“Non-GAAP”) Financial Information” herein. Our expense efficiency ratio represents total non-interest expenses as a percentage of net revenues. For 2016, our expense efficiency ratio was 74.5%, which was calculated as non-interest expenses of $25,783 million divided by net revenues of $34,631 million.

Business Segments

Substantially all of our operating revenues and operating expenses are directly attributable to our business segments. Certain revenues and expenses have been allocated to each business segment, generally in proportion to its respective net revenues, non-interest expenses or other relevant measures.

As a result of treating certain intersegment transactions as transactions with external parties, we include an Intersegment Eliminations category to reconcile the business segment results to our consolidated results.

Net Revenues

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

Trading.    Trading revenues include revenues from customers’ purchases and sales of financial instruments in which we act as a market maker, as well as gains and losses on our related positions and other positions carried at fair value. Trading revenues include the realized gains and losses from sales of cash instruments and derivative settlements, unrealized gains and losses from ongoing fair value changes of our positions related to market-making activities, and gains and losses related to investments associated with certain employee deferred compensation plans and other positions carried at fair value. In many markets, the realized and unrealized gains and losses from the purchase and sale transactions will include any spreads between bids and offers. Certain fees received on loans carried at fair value and dividends from equity securities are also recorded in Trading revenues since they relate to positions carried at fair value.

As a market maker, we stand ready to buy, sell or otherwise transact with customers under a variety of market conditions and to provide firm or indicative prices in response to customer requests. Our liquidity obligations can be explicit in some cases, and in others, customers expect us to be willing to transact with them. In order to most effectively fulfill our

 

 

  37   December 2016 Form 10-K


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market-making function, we engage in activities across all of our trading businesses that include, but are not limited to:

 

(i)

taking positions in anticipation of, and in response to, customer demand to buy or sell and—depending on the liquidity of the relevant market and the size of the position—to hold those positions for a period of time;

 

(ii)

managing and assuming basis risk (risk associated with imperfect hedging) between customized customer risks and the standardized products available in the market to hedge those risks;

 

(iii)

building, maintaining and rebalancing inventory, through trades with other market participants, and engaging in accumulation activities to accommodate anticipated customer demand;

 

(iv)

trading in the market to remain current on pricing and trends; and

 

(v)

engaging in other activities to provide efficiency and liquidity for markets.

Although not included in Trading revenues, Interest income and expense are also impacted by market-making activities, as debt securities held by us earn interest and securities are loaned, borrowed, sold with agreement to repurchase and purchased with agreement to resell.

We often invest in investments or other financial instruments to economically hedge our obligations under certain deferred compensation plans. Changes in the value of such investments are recorded in either Trading revenues or Investments revenues. Expenses associated with the related deferred compensation plans are recorded in Compensation and benefits. Generally, changes in compensation expense resulting from changes in fair value of the referenced investment will be offset by changes in fair value of the investments made by us.

Investments.    Our investments generally are held for long-term appreciation, or as discussed above, for hedging purposes and generally are subject to significant sales restrictions. Estimates of the fair value of the investments may involve significant judgment and may fluctuate significantly over time in light of business, market, economic and financial conditions generally or in relation to specific transactions. In some cases, such investments are required or are a necessary part of offering other products.

The revenues recorded are the result of realized gains and losses from sales and unrealized gains and losses from ongoing fair value changes of our holdings, as well as from investments associated with certain employee deferred compensation and co-investment plans.

Typically, there are no fee revenues from these investments. The sales restrictions on the investments relate primarily to redemption and withdrawal restrictions on investments in certain Investment Management funds, which include investments made in connection with certain employee deferred compensation plans (see Note 3 to the consolidated financial statements in Item 8). Restrictions on interests in exchanges and clearinghouses generally include a requirement to hold those interests for the period of time where we are clearing trades on that exchange or clearinghouse. Additionally, there are certain sponsored Investment Management funds consolidated by us primarily related to holders of noncontrolling interests.

Commissions and Fees.    Commission and fee revenues primarily arise from agency transactions in listed and over-the-counter (“OTC”) equity securities, services related to sales and trading activities, and sales of mutual funds, futures, insurance products and options. Commissions received for purchasing and selling listed equity securities and options are recorded separately in Commissions and fees. Other cash and derivative instruments typically do not have fees associated with them, and fees for any related services are recorded in Commissions and fees.

Asset Management, Distribution and Administration Fees.    Asset management, distribution and administration fees include fees associated with the management and supervision of assets, account services and administration, performance-based fees relating to certain funds, separately managed accounts, shareholder servicing and the distribution of certain open-ended mutual funds.

Asset management, distribution and administration fees in the Wealth Management business segment also include revenues from individual and institutional investors electing a fee-based pricing arrangement and fees for Investment Management. Mutual fund distribution fees in the Wealth Management business segment are based on either the average daily fund net asset balances or average daily aggregate net fund sales and are affected by changes in the overall level and mix of assets under management or supervision.

Asset management fees in the Investment Management business segment arise from investment management services we provide to investment vehicles pursuant to various contractual arrangements. We receive fees primarily based upon mutual fund daily average net assets or based on monthly or quarterly invested equity for other vehicles. Performance-based fees in the Investment Management business segment are earned on certain products as a percentage of appreciation earned by those products and, in certain cases, are based upon the achievement of performance criteria. These fees are normally earned annually and are recognized on a monthly or quarterly basis.

 

 

December 2016 Form 10-K   38  


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Net Interest.    Interest income and Interest expense are a function of the level and mix of total assets and liabilities, including Trading assets and Trading liabilities; Investment securities, which include available-for-sale (“AFS”) securities and held-to-maturity (“HTM”) securities; Securities borrowed or purchased under agreements to resell; Securities loaned or sold under agreements to repurchase; Loans; Deposits; Other short-term borrowings; Long-term borrowings; trading strategies; customer activity in the prime brokerage business; and the prevailing level, term structure and volatility of interest rates.

Other.    Other revenues include revenues from equity method investments, realized gains and losses on AFS securities, gains and losses on loans held for sale, provision for loan losses, and other miscellaneous revenues.

Net Revenues by Segment

Institutional Securities.    Net revenues are composed of Investment banking revenues, Sales and trading net revenues, Investments and Other revenues.

For information about the composition of Investment banking revenues, see “Net Revenues” herein. 

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

Sales and trading revenues are broken down into major business lines as follows: equity, fixed income and other. See “Sales and Trading Activities—Equity and Fixed Income” for a description of the activities within equity and fixed income. Other sales and trading revenues include impacts from certain central treasury functions, such as liquidity costs and gains (losses) on economic hedges related to long-term borrowings, as well as certain activities associated with corporate lending activities.

For information about revenue from Investments, see “Net Revenues” herein.

Other revenues include revenues from equity method investments, gains and losses on loans held for sale, provision for loan losses, and other miscellaneous revenues.

Wealth Management.    Net revenues are composed of Transactional, Asset management, Net interest and Other revenues.

Transactional revenues include Investment banking, Trading, and Commissions and fees. Investment banking revenues include revenues from the distribution of equity and fixed income securities, including initial public offerings, secondary offerings, closed-end funds and unit trusts. Trading revenues include revenues from customers’ purchases and sales of financial instruments, in which we act as principal, and gains and losses associated with certain employee deferred compensation plans. Revenues from Commissions and fees primarily arise from agency transactions in listed and OTC equity securities and sales of mutual funds, futures, insurance products and options.

Asset management revenues include Asset management, distribution and administration fees, and referral fees related to the bank deposit program.

Net interest income includes interest related to the bank deposit program, interest on AFS securities and HTM securities, interest on lending activities and other net interest. Interest income and Interest expense are a function of the level and mix of total assets and liabilities. Net interest is driven by securities-based lending, mortgage lending, margin loans, securities borrowed and securities loaned transactions, and bank deposit program activity.

Other revenues include revenues from realized gains and losses on AFS securities, provision for loan losses, referral fees and other miscellaneous revenues.

Investment Management.    Investments revenue is primarily earned on investments in certain closed-end funds that generally are held for long-term appreciation and generally subject to sales restrictions. Estimates of the fair value of the investments involve significant judgment and may fluctuate materially over time in light of business, market, economic and financial conditions generally or in relation to specific transactions.

For information about the composition of Asset Management, Distribution and Administration Fees, see “Net Revenues” herein. 

Compensation Expense

Compensation and benefits expense includes accruals for base salaries and fixed allowances, formulaic programs, discretionary incentive compensation, amortization of deferred cash and equity awards, changes in fair value of deferred compensation plan referenced investments, carried interest, severance costs, and other items such as health and welfare benefits. The factors that drive compensation for our employees vary from quarter to quarter, from segment to segment and within a segment. For certain revenue-producing employees in the Wealth Management and Investment Management business segments, compensation is largely paid

 

 

  39   December 2016 Form 10-K


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on the basis of formulaic payouts that link employee compensation to revenues. Compensation for certain employees, including revenue-producing employees in the Institutional Securities business segment, may also include incentive compensation that is determined following the assessment of the Firm, business unit and individual performance. Compensation for our remaining employees is largely fixed in nature (e.g., base salary, benefits, etc.).

Compensation expense for deferred cash-based compensation plans is calculated based on the notional value of the award granted, adjusted for upward and downward changes in fair value of the referenced investment, and is recognized ratably over the prescribed vesting period for the award. However, there may be a timing difference between the immediate revenue recognition of gains and losses on our investments and the deferred recognition of the related compensation expense over the vesting period.

Income Taxes

The income tax provision for our business segments is generally determined based on the revenues, expenses and activities directly attributable to each business segment. Certain items have been allocated to each business segment, generally in proportion to its respective net revenues or other relevant measures.

 

 

December 2016 Form 10-K   40  


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Institutional Securities

Income Statement Information

 

          % Change  
$ in millions   2016     2015     2014     2016     2015  

Revenues

         

Investment banking

  $     4,476     $     5,008     $     5,203       (11)%       (4)%  

Trading

    9,387       9,400       8,445             11%  

Investments

    147       274       240       (46)%       14%  

Commissions and fees

    2,456       2,616       2,610       (6)%        

Asset management, distribution and administration fees

    293       281       281       4%        

Other

    535       221       684       142%       (68)%  

Total non-interest revenues

    17,294       17,800       17,463       (3)%       2%  

Interest income

    4,005       3,190       3,389       26%       (6)%  

Interest expense

    3,840       3,037       3,981       26%       (24)%  

Net interest

    165       153       (592     8%       N/M  

Net revenues

    17,459       17,953       16,871       (3)%       6%  

Compensation and benefits

    6,275       6,467       7,786       (3)%       (17)%  

Non-compensation expenses

    6,061       6,815       9,143       (11)%       (25)%  

Total non-interest expenses

    12,336       13,282       16,929       (7)%       (22)%  

Income (loss) from continuing operations before income taxes

    5,123       4,671       (58     10%       N/M  

Provision for (benefit from) income taxes

    1,318       825       (90     60%       N/M  

Income from continuing operations

    3,805       3,846       32       (1)%       N/M  

Income (loss) from discontinued operations, net of income taxes

    (1     (17     (19     94%       11%  

Net income

    3,804       3,829       13       (1)%       N/M  

Net income applicable to noncontrolling interests

    155       133       109       17%       22%  

Net income (loss) applicable to Morgan Stanley

  $ 3,649     $ 3,696     $ (96     (1)%       N/M  

N/M—Not Meaningful

Investment Banking

Investment Banking Revenues

 

          % Change  
$ in millions   2016     2015     2014     2016     2015  

Advisory revenues

  $     2,220     $     1,967     $     1,634       13%       20%  

Underwriting revenues:

         

Equity underwriting revenues

    887       1,398       1,613       (37)%       (13)%  

Fixed income underwriting revenues

    1,369       1,643       1,956       (17)%       (16)%  

Total underwriting revenues

    2,256       3,041       3,569       (26)%       (15)%  

Total investment banking revenues

  $ 4,476     $ 5,008     $ 5,203       (11)%       (4)%  

Investment Banking Volumes

 

$ in billions    20161      20151      20141  

Completed mergers and acquisitions2

   $ 1,006      $ 662      $ 625  

Equity and equity-related offerings3

     45        67        72  

Fixed income offerings4

     239        256        265  

 

1.

Source: Thomson Reuters, data at January 17, 2017. Completed mergers and acquisitions volumes are based on full credit to each of the advisors in a transaction. Equity and equity-related offerings and fixed income offerings are based on full credit for single book managers and equal credit for joint book managers. Transaction volumes may not be indicative of net revenues in a given period. In addition, transaction volumes for prior periods may vary from amounts previously reported due to the subsequent withdrawal or change in the value of a transaction.

2.

Amounts include transactions of $100 million or more.

3.

Amounts include Rule 144A issuances and registered public offerings of common stock and convertible securities and rights offerings.

4.

Amounts include non-convertible preferred stock, mortgage-backed and asset-backed securities, and taxable municipal debt. Amounts include publicly registered and Rule 144A issues. Amounts exclude leveraged loans and self-led issuances.

2016 Compared with 2015

Investment banking revenues of $4,476 million in 2016 decreased 11% from 2015 due to lower underwriting revenues, partially offset by an increase in advisory revenues in 2016.

 

 

Advisory revenues increased reflecting the higher dollar volume of completed merger, acquisition and restructuring transactions (“M&A”) activity (see Investment Banking Volumes table). As the number of completed transactions decreased in 2016 versus 2015, the 2016 revenue increase was at a lower rate than the percentage increase in dollar volume.

 

 

Equity underwriting revenues decreased as a result of lower equity-related offerings in 2016 (see Investment Banking Volumes table). Fixed income underwriting revenues decreased in 2016, primarily due to lower bond and loan fees.

2015 Compared with 2014

Investment banking revenues of $5,008 million in 2015 decreased 4% from 2014 due to lower underwriting revenues, partially offset by higher advisory revenues.

 

 

Advisory revenues increased led primarily by M&A fee realization in the Americas.

 

 

Equity underwriting revenues decreased on reduced volumes driven by lower initial public offerings (see Investment Banking Volumes table). Fixed income underwriting revenues decreased primarily driven by lower non-investment grade bond and loan fees.

 

 

  41   December 2016 Form 10-K


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Sales and Trading Net Revenues

By Income Statement Line Item

 

$ in millions    2016      2015      2014  

Trading

   $ 9,387      $ 9,400      $ 8,445  

Commissions and fees

     2,456        2,616        2,610  

Asset management, distribution and administration fees

     293        281        281  

Net interest

     165        153        (592

Total sales and trading net revenues

   $     12,301      $     12,450      $     10,744  

By Business

 

                      % Change  
$ in millions   2016     2015     2014     2016     2015  

Equity—U.S. GAAP

  $ 8,037     $ 8,288     $ 7,135       (3 )%      16

Impact of DVA1

          (163     (232     100     30

Impact of FVA2

                2             (100 )% 

Equity—non-GAAP

  $ 8,037     $ 8,125     $ 6,905       (1 )%      18

Fixed income—U.S. GAAP3

  $ 5,117     $ 4,758     $ 4,214       8     13

Impact of DVA1

          (455     (419     100     (9 )% 

Impact of FVA2

                466             (100 )% 

Fixed income—non-GAAP

  $ 5,117     $ 4,303     $ 4,261       19     1

Other—U.S. GAAP

    (853     (596     (605     (43 )%      1

Total—U.S. GAAP

  $ 12,301     $ 12,450     $ 10,744       (1 )%      16

Total—Impact of DVA1

          (618     (651     100     5

Total—Impact of FVA2

                468             (100 )% 

Total—non-GAAP

  $ 12,301     $ 11,832     $ 10,561       4     12

 

1.

In 2016, in accordance with the early adoption of a provision of the accounting update Recognition and Measurement of Financial Assets and Financial Liabilities, unrealized DVA gains (losses) are recorded within OCI in the consolidated comprehensive income statements. In 2015 and 2014, DVA gains (losses) were recorded within Trading revenues in the consolidated income statements. See Notes 2 and 15 to the consolidated financial statements in Item 8 for further information.

2.

Represents the initial implementation of FVA.

3.

Effective in 2016, the Institutional Securities “Fixed Income and Commodities” business has been renamed the “Fixed Income” business.

Sales and trading net revenues, including equity and fixed income sales and trading net revenues that exclude the impact of DVA in 2015, or exclude the impact of DVA and the initial implementation of FVA in 2014, are non-GAAP financial measures that we consider useful for us, investors and analysts to allow further comparability of period-to-period operating performance.

Sales and Trading ActivitiesEquity and Fixed Income

Following is a description of the sales and trading activities within our equities and fixed income businesses as well as

how their results impact the income statement line items, followed by a presentation and explanation of results.

Equities—Financing.    We provide financing and prime brokerage services to our clients active in the equity markets through a variety of products including margin lending, securities lending and swaps. Results from this business are largely driven by the difference between financing income earned and financing costs incurred, which are reflected in Net interest for securities and equity lending products and in Trading revenues for derivative products.

Equities—Execution services.    We make markets for our clients in equity-related securities and derivative products, including providing liquidity and hedging products. A significant portion of the results for this business is generated by commissions and fees from executing and clearing client transactions on major stock and derivative exchanges as well as from OTC transactions. Market-making also generates gains and losses on inventory, which are reflected in Trading revenues.

Fixed income—Within fixed income we make markets in order to facilitate client activity as part of the following products and services.

 

 

Global macro products.    We make markets for our clients in interest rate, foreign exchange and emerging market products, including exchange-traded and OTC securities, loans and derivative instruments. The results of this market-making activity are primarily driven by gains and losses from buying and selling positions to stand ready for and satisfy client demand and are recorded in Trading revenues.

 

 

Credit products.    We make markets in credit-sensitive products, such as corporate bonds and mortgage securities and other securitized products, and related derivative instruments. The value of positions in this business are sensitive to changes in credit spreads and interest rates, which result in gains and losses reflected in Trading revenues. Due to the amount and type of the interest-bearing securities and loans making up this business, a significant portion of the results is also reflected in Net interest revenues.

 

 

Commodities products.    We make markets in various commodity products related primarily to electricity, natural gas, oil, and precious metals, with the results primarily reflected in Trading revenues.

 

 

December 2016 Form 10-K   42  


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Sales and Trading Net Revenues—Equity and Fixed Income

 

     2016  
$ in millions    Trading      Fees1      Net
Interest2
    Total  

Financing

   $ 3,668      $ 347      $ (283   $   3,732  

Execution services

     2,231        2,241        (167     4,305  

Total Equity

   $ 5,899      $ 2,588      $ (450   $ 8,037  

Total Fixed Income

   $ 4,115      $ 162      $ 840     $ 5,117  

 

     2015  
$ in millions    Trading      Fees1      Net
Interest2
    Total  

Financing

   $ 3,300      $ 322      $ 126     $   3,748  

Execution services

     2,210        2,437        (270     4,377  

Impact of DVA3

     163                     163  

Total Equity

   $ 5,673      $ 2,759      $ (144   $ 8,288  

Fixed Income

   $ 3,333      $ 139      $ 831     $ 4,303  

Impact of DVA3

     455                     455  

Total Fixed Income

   $ 3,788      $ 139      $ 831     $ 4,758  

 

     2014  
$ in millions    Trading     Fees1      Net
Interest2
    Total  

Financing

   $ 2,843     $ 283      $ 23     $   3,149  

Execution services

     1,623       2,473        (340     3,756  

Impact of DVA3

     232                    232  

Impact of FVA

     (2                  (2

Total Equity

   $ 4,696     $ 2,756      $ (317   $ 7,135  

Fixed Income

   $ 3,824     $ 136      $ 301     $ 4,261  

Impact of DVA3

     419                    419  

Impact of FVA

     (466                  (466

Total Fixed Income

   $ 3,777     $ 136      $ 301     $ 4,214  

 

1.

Includes Commissions and fees and Asset management, distribution and administration fees.

2.

Funding costs are allocated to the businesses based on funding usage and are included in Net interest in the previous tables. Such allocations were estimated for prior periods to conform to the current presentation.

3.

In 2016, in accordance with the early adoption of a provision of the accounting update Recognition and Measurement of Financial Assets and Financial Liabilities, unrealized DVA gains (losses) are recorded within OCI in the consolidated comprehensive income statements. In 2015 and 2014, the DVA gains (losses) were recorded within Trading revenues in the consolidated income statements. See Notes 2 and 15 to the consolidated financial statements in Item 8 for further information.

As discussed in “Net Revenues by Segment” herein, we manage each of the sales and trading businesses based on its aggregate net revenues, which are comprised of the consolidated income statement line items quantified in the previous table. Trading revenues are affected by a variety of market dynamics, including volumes, bid-offer spreads, and inventory prices, as well as impacts from hedging activity, which are interrelated. We provide qualitative commentary in the discussion of results that follow on the key drivers of period

over period variances, as the quantitative impact of the various market dynamics typically cannot be disaggregated.

For additional information on total Trading revenues, see the table “Trading Revenues by Product Type” in Note 4 to the consolidated financial statements in Item 8.

2016 Compared with 2015

Equity

Excluding the $163 million positive impact of DVA on 2015 results, equity sales and trading net revenues of $8,037 million in 2016 were lower than 2015, reflecting lower results in both financing and execution services revenues.

 

 

Financing revenues were in line with the results from 2015 as Net interest revenues declined from higher net interest costs, reflecting the business’ increased portion of global liquidity reserve requirements, offset by increased client activity in equity swaps reflected in Trading.

 

 

Execution services decreased 2% from 2015, primarily reflecting a decrease in fee revenues of $196 million due to reduced client activity.

Fixed Income

Excluding the $455 million positive impact of DVA on 2015 results, fixed income net revenues of $5,117 million in 2016 were 19% higher than 2015, primarily due to improved results in credit products.

 

 

Credit products Trading revenues were the primary driver for the overall increase in fixed income Trading revenues of $782 million, reflecting an improved credit market environment that resulted in gains on inventory in 2016 compared with losses in 2015.

 

 

Overall results from other fixed income businesses were relatively unchanged. There was a net increase in Trading revenues from global macro products, reflecting gains on inventory in interest rate products, offset by declines in commodities activities, primarily due to the absence of revenues from the global oil merchanting business, which was sold on November 1, 2015. For more information on the sale of the global oil merchanting business, see “Investments, Other Revenues, Non-interest Expenses, Income Tax Items, Dispositions and Other Items—2015 Compared with 2014—Dispositions” herein.

Other

 

 

Other sales and trading net losses of $853 million in 2016 increased from 2015, primarily reflecting losses in 2016 associated with corporate loan hedging activity.

 

 

  43   December 2016 Form 10-K


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2015 Compared with 2014

Equity

Equity sales and trading net revenues, excluding the impact of DVA and the implementation of FVA, increased reflecting higher results in financing and execution services revenues.

 

 

Financing revenues increased 19% from 2014 with an increase in client balances and derivative activity reflected in the $457 million increase in Trading revenues primarily from equity swaps and a $103 million increase in Net interest revenues for securities.

 

 

Execution services increased 17% from 2014, primarily due to the $587 million increase in Trading revenues from client activity in derivatives and reduced inventory losses compared with the prior year.

Fixed Income

Excluding the $455 million positive impact of DVA on 2015 results, and the $419 million positive impact of DVA and the $466 million negative impact from the implementation of FVA on 2014 results, fixed income net revenues of $4,303 million in 2015 were 1% higher than 2014 due to improved results in global macro and commodities products, offset by lower results in credit products.

 

 

Global macro products results increased from 2014, primarily due to an increase in Trading revenues due to improved results in interest rate products as a result of inventory gains and improved performance in foreign exchange products

 

 

Credit products decreased, primarily driven by a decrease in Trading revenues from lower results in credit and securitized products from a widening credit spread environment, which led to inventory losses. This decrease was partially offset by an increase in Net interest revenues, driven primarily by a change in the product mix in the securitized products group assets.

 

 

Commodities products net revenues increased, primarily reflecting higher revenues from the global oil merchanting business, which was sold on November 1, 2015. The increase was partially offset by credit-driven losses and the absence of revenues from TransMontaigne Inc., which was sold on July 1, 2014 (see “Investments, Other Revenues, Non-interest Expenses, Income Tax Items, Dispositions and Other Items—2015 Compared with 2014—Dispositions” herein).

Investments, Other Revenues, Non-interest Expenses, Income Tax Items, Dispositions and Other Items

2016 Compared with 2015

Investments

 

 

Net investment gains of $147 million in 2016 decreased from 2015 as a result of lower gains on real estate and business-related investments and losses on investments associated with our compensation plans compared with gains in 2015.

Other

 

 

Other revenues of $535 million in 2016 increased from 2015, primarily reflecting mark-to-market gains on loans held for sale in 2016 compared with mark-to-market losses in 2015, partially offset by lower results related to our 40% stake in Mitsubishi UFJ Morgan Stanley Securities Co., Ltd. (“MUMSS”) (see Note 8 to the consolidated financial statements in Item 8 for further information).

Non-interest Expenses

Non-interest expenses of $12,336 million in 2016 decreased from 2015, primarily reflecting a 3% reduction in Compensation and benefits expenses and an 11% reduction in Non-compensation expenses in 2016.

 

 

Compensation and benefits expenses decreased in 2016, primarily due to a decrease in salaries, severance costs, discretionary incentive compensation and employer taxes, partially offset by an increase in the fair value of deferred compensation plan referenced investments.

 

 

Non-compensation expenses decreased in 2016, primarily due to lower litigation costs and Professional services expense. In 2015, Non-compensation expenses included increases to reserves for the settlement of a credit default swap (“CDS”) antitrust litigation matter and legacy residential mortgage-backed securities matters.

2015 Compared with 2014

Investments

 

 

Net investment gains of $274 million in 2015 increased 14% from 2014 driven by gains on business-related investments.

Other

 

 

Other revenues of $221 million in 2015 decreased 68% from 2014 due to the absence of gains realized on certain assets sold in 2014 (see Note 1 to the consolidated financial statements in Item 8) and markdowns and provisions on loans held for sale and held for investment.

 

 

December 2016 Form 10-K   44  


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Non-interest Expenses

Non-interest expenses of $13,282 million in 2015 decreased 22% from 2014 driven by a 25% reduction in Non-compensation expenses and a 17% reduction in Compensation and benefits expenses.

 

 

Compensation and benefits expenses decreased, primarily due to the 2014 compensation actions, a decrease in the fair value of deferred compensation plan referenced investments and a decrease in the level of discretionary incentive compensation in 2015 (see also “Supplemental Financial Information and Disclosures—Discretionary Incentive Compensation” herein).

 

 

Non-compensation expenses decreased, primarily due to lower litigation costs.

Income Tax Items

In 2016, we recognized in Provision for (benefit from) income taxes net discrete tax benefits of $83 million. These net discrete tax benefits were primarily related to the remeasurement of reserves and related interest due to new information regarding the status of a multi-year tax authority examination, partially offset by adjustments for other tax matters.

In 2015, we recognized in Provision for (benefit from) income taxes net discrete tax benefits of $564 million. These net discrete tax benefits were primarily associated with the repatriation of non-U.S. earnings at a cost lower than originally estimated due to an internal restructuring to simplify our legal entity organization in the United Kingdom (“U.K.”).

In 2014, we recognized in Provision for (benefit from) income taxes net discrete tax benefits of $839 million. This included net discrete tax benefits of $612 million principally associated with remeasurement of reserves and related interest due to new information regarding the status of a multi-year tax authority examination and $237 million primarily associated with the repatriation of non-U.S. earnings at a cost lower than originally estimated. In addition, our Provision for (benefit from) income taxes was impacted by approximately $900 million of tax provision as a result of non-deductible expenses related to litigation and regulatory matters.

Dispositions

On November 1, 2015, we completed the sale of our global oil merchanting unit of the commodities division to Castleton Commodities International LLC. The loss on sale of approximately $71 million was recognized in Other revenues.

On July 1, 2014, we completed the sale of our ownership stake in TransMontaigne Inc., a U.S.-based oil storage, marketing and transportation company, as well as related physical inventory and the assumption of our obligations under certain terminal storage contracts, to NGL Energy Partners LP. The gain on sale of $112 million was recognized in Other revenues.

On March 27, 2014, we completed the sale of Canterm Canadian Terminals Inc., a public storage terminal operator for refined products with two distribution terminals in Canada. The gain on sale was approximately $45 million and was recognized in Other revenues.

Other Items

Japanese Securities Joint Venture

We hold a 40% voting interest and Mitsubishi UFJ Financial Group, Inc. (“MUFG”) holds a 60% voting interest in MUMSS.

To the extent that losses incurred by MUMSS result in a requirement to restore its capital level, MUFG is solely responsible for providing this additional capital to a minimum level, whereas we are not obligated to contribute additional capital to MUMSS. To the extent that MUMSS is required to increase its capital level due to factors other than losses, such as changes in regulatory requirements, both MUFG and we are required to contribute the necessary capital based upon the economic interest as set forth above.

See Note 8 to the consolidated financial statements in Item 8 for further information.

Noncontrolling Interests

Noncontrolling interests primarily relate to MUFG’s interest in Morgan Stanley MUFG Securities Co., Ltd.

 

 

  45   December 2016 Form 10-K


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Wealth Management

Income Statement Information

 

                      % change  
$ in millions   20161     2015     2014     2016     2015  

Revenues

         

Investment banking

  $ 484     $ 623     $ 791       (22)%       (21)%  

Trading

    861       731       957       18%       (24)%  

Investments

          18       9       N/M       100%  

Commissions and fees

    1,745       1,981       2,127       (12)%       (7)%  

Asset management, distribution and administration fees

    8,454       8,536       8,345       (1)%       2%  

Other

    277       255       320       9%       (20)%  

Total non-interest revenues

    11,821       12,144       12,549       (3)%       (3)%  

Interest income

    3,888       3,105       2,516       25%       23%  

Interest expense

    359       149       177       141%       (16)%  

Net interest

    3,529       2,956       2,339       19%       26%  

Net revenues

    15,350       15,100       14,888       2%       1%  

Compensation and benefits

    8,666       8,595       8,825       1%       (3)%  

Non-compensation expenses

    3,247       3,173       3,078       2%       3%  

Total non-interest expenses

    11,913       11,768       11,903       1%       (1)%  

Income from continuing operations before income taxes

    3,437       3,332       2,985       3%       12%  

Provision for (benefit from) income taxes

    1,333       1,247       (207     7%       N/M  

Net income applicable to Morgan Stanley

  $ 2,104     $ 2,085     $ 3,192       1%       (35)%  

N/M—Not Meaningful

1.

Effective July 1, 2016, the Institutional Securities and Wealth Management business segments entered into an agreement, whereby Institutional Securities assumed management of Wealth Management’s fixed income client-driven trading activities and employees. Institutional Securities now pays fees to Wealth Management based on distribution activity (collectively, the “Fixed Income Integration”). Prior periods have not been recast for this new intersegment agreement due to immateriality.

Statistical Data

Financial Information and Statistical Data

 

$ in billions    At
December 31,
2016
     At
December 31,
2015
 

Client assets

   $ 2,103      $ 1,985  

Fee-based client assets1

   $ 877      $ 795  

Fee-based client assets as a percentage of total client assets

     42%        40%  

Client liabilities2

   $ 73      $ 64  

Bank deposit program

   $ 153      $ 149  

Investment securities portfolio

   $ 63.9      $ 57.9  

Loans and lending commitments

   $ 68.7      $ 55.3  

Wealth Management representatives

     15,763        15,889  

Retail locations

     601        608  

 

      2016     2015      2014     

Revenues per representative

       

(dollars in thousands)3

   $   968     $   950      $   914     

Client assets per representative

       

(dollars in millions)4

   $ 133     $ 125      $ 126     

Fee-based asset flows5

       

(dollars in billions)

   $ 48.5     $ 46.3      $ 58.8     

 

1.

Fee-based client assets represent the amount of assets in client accounts where the basis of payment for services is a fee calculated on those assets.

2.

Client liabilities include securities-based and tailored lending, residential real estate loans and margin lending.

3.

Revenues per representative equal Wealth Management’s net revenues divided by the average representative headcount.

4.

Client assets per representative equal total period-end client assets divided by period-end representative headcount.

5.

Fee-based asset flows include net new fee-based assets, net account transfers, dividends, interest and client fees and exclude institutional cash management-related activity.

Transactional Revenues

 

                          % Change  
$ in millions    2016      2015      2014      2016      2015  

Investment banking

   $ 484      $ 623      $ 791        (22)%        (21 )% 

Trading

     861        731        957        18%        (24 )% 

Commissions and fees

     1,745        1,981        2,127        (12)%        (7 )% 

Total

   $   3,090      $   3,335      $   3,875        (7)%        (14 )% 
 

 

December 2016 Form 10-K   46  


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2016 Compared with 2015

Net Revenues

Transactional Revenues

Transactional revenues of $3,090 million in 2016 decreased 7% from the prior year, primarily reflecting lower revenues related to commissions and fees and investment banking revenues, partially offset by higher trading revenues.

 

 

Investment banking revenues decreased in 2016, primarily due to lower revenues from the distribution of unit investment trusts, equity and structured products.

 

 

Trading revenues increased in 2016, primarily due to gains related to investments associated with certain employee deferred compensation plans compared with losses in 2015.

 

 

Commissions and fees decreased in 2016 reflecting lower daily average commissions, primarily due to reduced client activity in equity, annuity and mutual fund products. This decrease was partially offset by increased fees due to the Fixed Income Integration.

Asset Management

Asset management, distribution and administration fees of $8,454 million in 2016 decreased 1% from the prior year, primarily due to the decrease in mutual fund fees. Revenues from fee-based accounts were relatively flat with decreased client fee rates, partially offset by positive flows. See “Fee-Based Client Assets Activity and Average Fee Rate by Account Type” herein for more details.

Net Interest

Net interest of $3,529 million in 2016 increased 19% from the prior year, primarily due to higher loan balances and investment portfolio yields.

Other

Other revenues of $277 million in 2016 increased 9% from the prior year due to the combination of higher referral fees in 2016 and a decrease in provision for loan losses in 2016.

Non-interest Expenses

Non-interest expenses of $11,913 million in 2016 increased 1% from the prior year.

 

 

Compensation and benefits expenses increased in 2016, primarily due to an increase in the fair value of deferred compensation plan referenced investments.

 

Non-compensation expenses increased in 2016, primarily as a result of a $70 million provision related to certain brokerage service reporting activities. See “Other Items” herein.

2015 Compared with 2014

Net Revenues

Transactional Revenues

Transactional revenues of $3,335 million in 2015 decreased 14% from the prior year due to lower revenues in each of Trading, Investment banking, and Commissions and fees.

 

 

Investment banking revenues decreased, primarily due to lower revenues from the distribution of underwritten offerings.

 

 

Trading revenues decreased, primarily due to losses related to investments associated with certain employee deferred compensation plans and lower revenues from fixed income products.

 

 

Commissions and fees decreased, primarily due to lower revenues from equity, mutual fund and annuity products, partially offset by higher revenues from alternative asset classes.

Asset Management

Asset management, distribution and administration fees of $8,536 million in 2015 increased 2% from the prior year, primarily due to higher fee-based revenues that resulted from positive flows and higher average market values over 2015 as compared with the average market values during 2014. The increase in fee-based revenues was partially offset by lower referral fees from the bank deposit program, reflecting the completion of the transfer of deposits from Citigroup Inc. (“Citi”) to us in connection with the former retail securities joint venture between the Firm and Citi. See “Fee-Based Client Assets Activity and Average Fee Rate by Account Type” herein for more details.

Net Interest

Net interest of $2,956 million in 2015 increased 26% from the prior year, primarily due to higher balances in the bank deposit program and growth in loans and lending commitments.

Other

Other revenues of $255 million in 2015 decreased 20% from the prior year, primarily due to a $40 million gain on sale of a retail property space in the prior year and an increase in the provision for loan losses in 2015.

 

 

  47   December 2016 Form 10-K


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Non-interest Expenses

Non-interest expenses of $11,768 million in 2015 decreased 1% from the prior year, primarily due to lower Compensation and benefit expenses, partially offset by higher Non-compensation expenses.

 

 

Compensation and benefits expenses decreased, primarily due to the 2014 compensation actions, a decrease in the fair value of deferred compensation plan referenced investments and a decrease in the level of discretionary incentive compensation in 2015 (see also “Supplemental Financial Information and Disclosures—Discretionary Incentive Compensation” herein).

 

 

Non-compensation expenses increased, primarily due to an increase in Professional services, resulting from increased consulting and legal fees, partially offset by a provision related to a rescission offer in the prior year. Other expenses in 2014 included $50 million related to a rescission offer to Wealth Management clients who may not have received a prospectus for certain securities transactions, for which delivery of a prospectus was required.

Income Tax Items

In 2014, we recognized in Provision for (benefit from) income taxes net discrete tax benefits of $1,390 million due

to the release of a deferred tax liability as a result of an internal restructuring to simplify our legal entity organization. For a further discussion of these net discrete tax benefits, see “Supplemental Financial Information and Disclosures—Income Tax Matters” herein.

Other Items

The Firm has identified operational issues that resulted in the reporting of incorrect cost basis tax information to the Internal Revenue Service (“IRS”) and retail brokerage clients for tax years 2011 through 2016. Most of our clients are not impacted by these issues. However, these issues have affected a significant number of client accounts. In the case of clients for whom the Firm has determined that there have been tax underpayments to the IRS as a result of these issues, the Firm is in advanced discussions with the IRS to resolve client tax underpayments to the IRS caused by these issues at no expense to our clients. In the case of clients for whom the Firm has determined that there have been tax overpayments to the IRS as a result of these issues, the Firm plans to notify them and to offer to pay them an amount equivalent to their overpayment to the IRS. The $70 million provision referred to above is based on currently available information and analyses, and our review of these issues is continuing.

 

 

Fee-Based Client Assets Activity and Average Fee Rate by Account Type

Wealth Management earns fees based on a contractual percentage of fee-based client assets related to certain account types that we offer. These fees, which we record in the Asset management, distribution and administration fees line on its income statement, are earned based on the client assets in the specific account types in which the client participates and are generally not driven by asset class. For most account types, fees are billed in the first month of each quarter based on the related client assets as of the end of the prior quarter. Across the account types, fees will vary based on both the distinct services provided within each account type and on the level of household assets under supervision in Wealth Management.

 

$ in billions, fee rate in bps    At
December 31,
2015
     Inflows      Outflows      Market
Impact
     At
December 31,
2016
     Average for the
Year Ended
December 31, 2016
 
                  Fee Rate  

Separately managed accounts1

   $ 283      $ 33      $ (97    $ 3      $ 222        27  

Unified managed accounts

     105        107        (17      9        204        105  

Mutual fund advisory

     25        2        (6             21        121  

Representative as advisor

     115        31        (26      5        125        88  

Representative as portfolio manager

     252        63        (41      11        285        101  

Subtotal

   $ 780      $ 236      $ (187    $ 28      $ 857        74  

Cash management

     15        14        (9             20        6  

Total fee-based client assets

   $ 795      $ 250      $ (196    $ 28      $ 877        72  

 

December 2016 Form 10-K   48  


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$ in billions, fee rate in bps    At
December 31,
2014
     Inflows      Outflows      Market
Impact
     At
December 31,
2015
     Average for the
Year Ended
December 31, 2015
 
                  Fee Rate  

Separately managed accounts1

   $ 285      $ 42      $ (32    $ (12    $ 283        34  

Unified managed accounts

     93        29        (14      (3      105        113  

Mutual fund advisory

     31        3        (6      (3      25        121  

Representative as advisor

     119        29        (25      (8      115        89  

Representative as portfolio manager

     241        58        (38      (9      252        104  

Subtotal

   $ 769      $ 161      $ (115    $ (35    $ 780        76  

Cash management

     16        9        (10             15        6  

Total fee-based client assets

   $ 785      $ 170      $ (125    $ (35    $ 795        74  

 

$ in billions, fee rate in bps    At
December 31,
2013
     Inflows      Outflows      Market
Impact
     At
December 31,
2014
     Average for the
Year Ended
December 31, 2014
 
                  Fee Rate  

Separately managed accounts1

   $ 260      $ 41      $ (31    $ 15      $ 285        35  

Unified managed accounts

     78        24        (11      2        93        116  

Mutual fund advisory

     34        5        (8             31        121  

Representative as advisor

     111        30        (23      1        119        90  

Representative as portfolio manager

     201        60        (28      8        241        106  

Subtotal

   $ 684      $ 160      $ (101    $ 26      $ 769        77  

Cash management

     13        12        (9             16        6  

Total fee-based client assets

   $ 697      $ 172      $ (110    $ 26      $ 785        75  

bps—Basis points

1.

Includes non-custody account values reflecting prior quarter-end balances due to a lag in the reporting of asset values by third-party custodians.

 

 

Inflows—include new accounts, account transfers, deposits, dividends and interest.

 

 

Outflows—include closed or terminated accounts, account transfers, withdrawals and client fees.

 

 

Market impact—includes realized and unrealized gains and losses on portfolio investments.

 

 

Separately managed accounts—Accounts by which third-party asset managers are engaged to manage clients’ assets with investment decisions made by the asset manager. One third-party asset manager strategy can be held per account.

 

 

Unified managed accounts—Accounts that provide the client with the ability to combine separately managed accounts, mutual funds and exchange traded funds all in one aggregate account. Unified managed accounts can be client-directed, financial advisor-directed or directed by us (with “directed” referring to the investment direction or decision/discretion/power of attorney).

 

Mutual fund advisory—Accounts that give the client the ability to systematically allocate assets across a wide range of mutual funds. Investment decisions are made by the client.

 

 

Representative as advisor—Accounts where the investment decisions must be approved by the client and the financial advisor must obtain approval each time a change is made to the account or its investments.

 

 

Representative as portfolio manager—Accounts where a financial advisor has discretion (contractually approved by the client) to make ongoing investment decisions without the client’s approval for each individual change.

 

 

Cash management—Accounts where the financial advisor provides discretionary cash management services to institutional clients, whereby securities or proceeds are invested and reinvested in accordance with the client’s investment criteria. Generally, the portfolio will be invested in short- term fixed income and cash equivalent investments.

 

 

  49   December 2016 Form 10-K


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Investment Management

Income Statement Information

 

                      % Change  
$ in millions   2016     2015     2014     2016     2015  
Revenues          
Investment banking   $     $ 1     $ 5       N/M       (80)%  
Trading     (2     (1     (19     (100)%       95%  
Investments     13       249       587       (95)%       (58)%  
Commissions and fees     3       1             200%       N/M  

Asset management, distribution and administration fees

    2,063       2,049       2,049       1%        
Other     31       32       106       (3)%       (70)%  
Total non-interest revenues     2,108       2,331       2,728       (10)%       (15)%  
Interest income     5       2       2       150%        
Interest expense     1       18       18       (94)%        
Net interest     4       (16     (16     N/M        
Net revenues     2,112       2,315