Updated from 10:50 a.m. EST

Bear Stearns

(BSC)

and

Morgan Stanley

(MWD)

both reported higher fourth-quarter profits Tuesday, driven by healthy gains in investment banking.

The generally positive results, however, came with a few cautionary notes. Morgan Stanley's top line, for instance, came in below Wall Street expectations, as revenue from its big individual investor group slid 7% from a year ago.

Bear, meanwhile, increased its litigation reserve by about $100 million in the quarter to cover the cost of a potential settlement with securities regulators over the firm's involvement in the mutual fund trading scandal. The firm didn't say how much it has in reserve, which is expected to cover any penalty Bear might face for its role in clearing questionable mutual fund trades, as well as other legal issues.

In midday trading, shares of Bear, which recently hit a new all-time high, were down $2, or 1.9%, to $102.48. Shares of Morgan Stanley fell 20 cents to $53.45.

In the quarter ended Nov. 30, Bear earned $352.6 million, or $2.61 cents a share, up 22% from $288.3 million, or $2.19 cents a share, in the year-ago period. Net revenue rose 19.4% from a year ago to $1.83 billion.

The firm beat the Thomson Financial consensus estimate of $2.14 a share by a wide margin. Bear also soared past the consensus revenue estimate of $1.55 billion.

Bear's earnings, however, got a big boost from an $160 million investment gain in

New York & Co.

(NWY)

, a women's clothing chain that went public in the fourth quarter.

Fox-Pitt Kelton brokerage analyst David Trone estimates that Bear would have earned $2.34 a share in the quarter without the New York & Co. gain.

"While one could debate whether or not to 'count' merchant gains and litigation expenses, either way Bear Stearns again beat expectations, this time on better-than-expected core investment banking revenue,'' says Trone in a research note.

Meanwhile, Morgan Stanley reported $1.2 billion in net income, or $1.09 a share, in its quarter, up 18% from $1 billion, or 94 cents a share, a year ago. Net revenue totaled $5.4 billion.

On the bottom line, the securities firm beat the Thomson consensus estimate of $1.01 a share. But revenue fell short of the estimate of $5.78 billion, even though revenue was up 7% compared with a year ago.

At Morgan Stanley, investment banking revenue rose 6% to $746 million. Revenue from trading was down 6% to $934 million.

Morgan Stanley attributed some of the 7% decline in revenue in the individual investor division to a new accounting formula for recognizing asset management fees. The firm also said a decline in principal transactions also contributed to the decline.

Bear, meanwhile, reported $458 million in investment-banking revenue, an 83% gain over last year. But that figure included the gain from its stake in the New York & Co. IPO. Without the IPO gain, investment-banking revenue rose a more modest 38%.

The firm's big stock clearing division, which includes its lucrative hedge fund lending operation, reported a 15.6% gain in revenue to $254 million. Bear's clearing operation has come under fire in the mutual fund trading scandal because it allegedly processed trades for many small brokerages and hedge funds that were implicated in the far-reaching inquiry.

Overall, total net revenue rose 19% at Bear to $1.83 billion.

"I think our results have been the best if not among the best in the industry,'' says Bear Chief Financial Officer Samuel Molinaro, speaking during an analyst conference call.

Looking at next year, Molinaro sounded an upbeat tone, noting that Bear has a sizable backlog of stock offerings and corporate deals it's advising on it is investment-banking pipeline.

"The outlook for '05 looks pretty promising,'' says Molinaro.

Morgan Stanley's Chief Financial Officer David Sidwell, however, was a bit more cautious in his assessment for 2005. Despite an improving stock market environment in the fourth quarter, Sidwell says there "is still a fair amount of uncertainty'' among the firm's institutional clients.