Morgan Stanley 2009 Annual Report Download - page 72

Critical Accounting Policies.
The Company’s consolidated financial statements are prepared in accordance with accounting principles
generally accepted in the U.S., which require the Company to make estimates and assumptions (see Note 1 to the
consolidated financial statements). The Company believes that of its significant accounting policies (see Note 2
to the consolidated financial statements), the following involve a higher degree of judgment and complexity.
Fair Value.
Financial Instruments Measured at Fair Value. A significant number of the Company’s financial instruments
are carried at fair value with changes in fair value recognized in earnings each period. The Company makes
estimates regarding valuation of assets and liabilities measured at fair value in preparing the consolidated
financial statements. These assets and liabilities include but are not limited to:
• Financial instruments owned and Financial instruments sold, not yet purchased;
• Securities received as collateral and Obligation to return securities received as collateral;
• Certain Commercial paper and other short-term borrowings, primarily structured notes;
• Certain Deposits;
• Other secured financings; and
• Certain Long-term borrowings, primarily structured notes and certain junior subordinated debentures.
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the
“exit price”) in an orderly transaction between market participants at the measurement date.
In determining fair value, the Company uses various valuation approaches. A hierarchy for inputs is used in
measuring fair value that maximizes the use of observable prices and inputs and minimizes the use of
unobservable prices and inputs by requiring that the relevant observable inputs be used when available. The
hierarchy is broken down into three levels, wherein Level 1 uses observable prices in active markets, and Level 3
consists of valuation techniques that incorporate significant unobservable inputs and therefore require the
greatest use of judgment. In periods of market disruption, the observability of prices and inputs may be reduced
for many instruments. This condition could cause an instrument to be reclassified from Level 1 to Level 2 or
Level 2 to Level 3. In addition, a continued downturn in market conditions could lead to declines in the valuation
of many instruments. For further information on the fair value definition, Level 1, Level 2, Level 3 and related
valuation techniques, see Notes 2 and 4 to the consolidated financial statements.
The Company’s Level 3 assets before the impact of cash collateral and counterparty netting across the levels of
the fair value hierarchy were $43.4 billion and $83.6 billion as of December 31, 2009 and December 31, 2008,
respectively, and represented approximately 14% and 29% as of December 31, 2009 and December 31, 2008,
respectively, of the assets measured at fair value (6% and 12% of total assets as of December 31, 2009 and
December 31, 2008, respectively). Level 3 liabilities before the impact of cash collateral and counterparty netting
across the levels of the fair value hierarchy were $15.4 billion and $29.8 billion as of December 31, 2009 and
December 31, 2008, respectively, and represented approximately 9% and 17%, respectively, of the Company’s
liabilities measured at fair value.
During 2009, the Company reclassified approximately $6.8 billion of certain Corporate and other debt from
Level 3 to Level 2. The reclassifications were primarily related to certain corporate loans and bonds, state and
municipal securities, commercial mortgage-backed securities (“CMBS”) and other debt. For certain corporate
loans, more liquidity re-entered the market, and external prices and/or spread inputs for these instruments became
observable. For corporate bonds and CMBS, the reclassifications were primarily due to an increase in market
price quotations for these or comparable instruments, or available broker quotes, such that observable inputs
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