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Forget Facebook, Morgan Stanley Can't Trade Its Way Out of a Paper Bag

The brokerage unit, which is one of the largest in the world, is a strategic fit with Morgan Stanley's investment banking unit that was the leading underwriter of IPO's globally in the first half of 2012. In recent quarters, Morgan Stanley's brokerage took in client funds as its investment banking unit led the underwriting of Zynga (ZNGA), Groupon (GRPN) and LinkedIn (LNKD) shares. Even after a challenged Facebook share listing, Morgan Stanley was hired to lead the upcoming IPO's of Kayak and Palo Alto Networks.

By pushing into brokerage, Morgan Stanley is also trying to move from capital intensive trading and proprietary investment operations like merchant banking and into low capital and low risk businesses like wealth management, which may bolster the bank's liquidity and its return on equity, as new regulations like Basel III and the Dodd Frank Act kick in.

Morgan Stanley also made progress in cutting compensation costs and operating expense -- primarily at its Institutional Securities unit. Compensation expense declined by $1 billion to $3.6 billion, while non-compensation expense fell $200 million to $2.4 from year-ago levels. Credit Suisse analysts had expected a compensation ratio nearing 60%.

Chief executive James Gorman said on an earnings call that the bank would cut headcount by 7% this year compared with 2011. "Although global economic uncertainty remains a headwind, we are proactively positioning the Firm for success," said Gorman, in a statement released with earnings. He also said that the bank would look to complete a 14% stake acquisition of MSSB by September and indicated that the bank may recover from a challenging quarter.

"While it is still early days, we're seeing some signs of improvement in the third quarter," said Gorman on the call.

In afternoon trading, Morgan Stanley shares fell over 6% to $13.05. Year-to-date, the bank's shares are off over 13%.

For more on Morgan Stanley's earnings, see why it needs to move past Facebook's IPO and ratings downgrades , for more on the bank's shares.

-- Written by Antoine Gara in New York

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