June 18 (Bloomberg) -- Morgan Stanley suspended a credit trader and disclosed a $120 million ``negative adjustment'' related to erroneous valuations of his positions, Chief Financial Officer Colm Kelleher said.

The New York-based firm is cooperating with authorities in London and is conducting an internal review after discovering the error last month, Kelleher said in an interview today. He declined to identify the trader. Joseph Eyre, a London-based spokesman for Britain's Financial Services Authority, declined to comment.

Morgan Stanley, the second-biggest U.S. securities firm by market value, joins at least three competitors in identifying incorrect pricing this year. Credit Suisse Group, Switzerland's second-largest bank, announced $2.65 billion of writedowns on asset-backed securities in March after an internal review found intentional ``mismarkings'' by a group of traders.

``There is a greater degree of scrutiny than before,'' said Peter Hahn, a research fellow at City University's Cass Business School in London and a former managing director at Citigroup Inc. ``We are in an environment where prudence is more highly valued than earnings. You don't want to test market confidence on internal controls.''

Morgan Stanley fell as much as 7.8 percent, and was 1.5 percent lower at $39.97 at 1:33 p.m. in New York Stock Exchange composite trading. The stock is down 25 percent so far this year.

`Dealt With'

``I do believe it's isolated, it's a very different situation from a `prop' trading bet going wrong,'' Kelleher said on a conference call with analysts. ``It's just something we caught, our controls caught, and we dealt with it. In these sort of stressed environments you'd expect to see people try to behave inappropriately.''

Morgan Stanley reported a 57 percent drop in second-quarter profit today as revenue from asset management and investment banking declined, while equities and fixed-income traders generated less profit. Morgan Stanley's fixed-income sales and trading revenue decreased 85 percent to $414 million, reflecting a drop in income from interest rate, credit, and currency products and commodities. The firm also had losses of $436 million on mortgage-related trades.

In March, Lehman Brothers Holdings Inc., the fourth-largest U.S. securities firm, suspended two London-based equity traders after internal controls identified ``issues'' on share valuations. The sums involved were ``not material,'' an official for the company said at the time.

Enforced Vacations

New York-based Merrill Lynch & Co. said last month it was probing a trading desk in London and had suspended a trader after discovering he may have overstated the value of some of the bank's equity derivatives.

Deutsche Bank AG, saying it was seeking to avoid fraud, last month introduced a policy forcing traders and some bankers to take 10 consecutive working days of vacation every year, according to an internal memorandum to employees. Credit Suisse obliges all employees to take five consecutive days of annual leave each year, regardless of their position.

Morgan Stanley makes traders and other selected employees take at least five, or as many as 10 consecutive days of vacation, depending on their role and location.

To contact the reporters on this story: Joyce Moullakis in London at jmoullakis@bloomberg.net; Christine Harper in New York at charper@bloomberg.net.

Last Updated: June 18, 2008 13:47 EDT