It Isn’t Just Goldman, Anymore

Sometimes it’s good to get knocked out of the spotlight. And on Wednesday Morgan Stanley did just that for beleaguered Goldman.

Investors likely forgot about Goldman, if only for a moment, after reports surfaced that rival Morgan Stanley was also facing a federal probe.

The Allegations

According to the Wall Street Journal, federal prosecutors are investigating whether Morgan Stanley misled investors about its role in a pair of $200 million derivatives whose performance was tied to mortgage-backed securities.

The newspaper said Morgan Stanley sometimes bet against the success of the derivatives, which were underwritten and marketed to investors by Citigroup Inc. and UBS AG.

The Response

Morgan Stanley refutes the report.

A spokesman from Morgan Stanley said the bank has not been contacted by the Justice Department about the deals in question and has no knowledge of an ongoing investigation.

And in case you’re wondering, the spokesman also said the bank has not received a Wells Notice from the Securities and Exchange Commission. A Wells Notice informs a company that the SEC's staff is recommending bringing charges against the company.

Similar Yet Different

In both the Goldman and Morgan Stanley probes, investigators are examining whether investors were told the institutions helping select underlying investments for the CDOs might be betting against them, writes the WSJ.

But there are key differences, the paper says. Morgan Stanley bet against the investments in the CDOs, but didn't sell the deals to investors. In the Goldman case, the firm underwrote the deal, but didn't bet against it.

Looking at these developments broadly, it suggests the Obama administration is stepping up efforts to probe possible causes of the credit crisis. And it also comes at a time when lawmakers are discussing a major overhaul of the financial system

What’s the trade?

Option investors are selling the June 25 puts which suggests to me that's the price where they think the stock will settle, explains Mike Khouw of Cantor Fitzgerald.

I think an industry wide settlement may be on the horizon, says Stephen Weiss, author of “The Billion Dollar Mistake” and hedge fund manager MSW Asset Management.

But with so much overhang and litigation risk, the best way to play the financials right now is through the regionals , Weiss counsels.

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Trader disclosure: On May 12, 2010, the following stocks and commodities mentioned or intended to be mentioned on CNBC’s Fast Money were owned by the Fast Money traders; Seymour Owns (AAPL), (BAC), (DRYS), (INTC), (TIE); Adami Owns (AGU), (C), (GS), (INTC), (MSFT), (NUE), (BTU); Kelly Owns (FXE) Puts; Kelly Owns (FXB) Puts; Terranova Owns (PFE), (GLD), (XCO), (SWN), (TER); Terranova Owns Gold; Karabell Owns (GOOG), (AAPL), (IBM), (CSCO), (TIE), (GS), (C); Levy Owns (GS), (GS) Calls

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