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Morgan Stanley Fined for Incentives

Firm will pay $2 million over rewards used to get its brokers to pitch in-house mutual funds.

September 17, 2003|Josh Friedman | Times Staff Writer

Securities regulators Tuesday fined brokerage Morgan Stanley a record $2 million, saying the firm improperly used incentives to get its brokers to push in-house mutual funds over other products.

For the firm's Southern California brokers, those incentives ranged from Britney Spears concert seats and Lakers playoff tickets to resort stays.

The case brought by NASD, the brokerage industry's self-regulatory agency, isn't related to New York Atty. Gen. Eliot Spitzer's investigation of fund trading practices. Instead, the allegations against Morgan Stanley show regulators' increasing concern with how brokers market mutual funds, and whether investors are getting a fair shake in their purchases.

"The lesson of this case is that firms have to create a compensation structure that is transparent and that aligns the interests of brokers and investors," said Mary Schapiro, NASD's regulatory chief.

Morgan Stanley's fine, the largest ever imposed by NASD for fund-related abuses, stemmed from a series of contests from 1999 to 2002 in which brokers and branch managers vied for an estimated $1 million worth of incentives for selling the firm's in-house funds.

NASD said the contests violated industry rules that prohibit brokerages from offering non-cash rewards for sales of specific funds, to the exclusion of others.

What's more, Morgan Stanley "failed to have any supervisory systems or procedures in place to detect and prevent this widespread misconduct," NASD said.

It said the brokerage appeared to work hard to keep the contests from being publicized outside the firm, noting that e-mail messages from a regional manager directed branch managers and other employees to refrain from putting in writing details regarding the contests.

As part of the settlement, Bruce Alonso, who runs Morgan Stanley's national sales team, was fined $250,000 and censured.

Morgan Stanley did not admit or deny wrongdoing. "We're pleased to have this problem behind us," said spokesman Bret Gallaway in New York.

He said no one, including Alonso, had been fired as a result of NASD's probe. Alonso, who could not be reached for comment, is "a highly valued, longtime member of our management team," Gallaway said.

Morgan Stanley also said that in January it adopted a policy on non-cash compensation that is stricter than NASD rules.

NASD is stepping up its efforts to clamp down on an array of sales abuses involving mutual funds, Schapiro said.

She promised a "series of cases" this year, saying several other brokerages are being investigated as NASD focuses on issues such as sales contests; "break points," or discounts on sales charges that larger investors are entitled to but not necessarily given; and the sale of Class B shares, which may be unsuitable for some investors because of their high ongoing fees.

Some brokerages have long paid employees more for selling in-house funds than for selling competitors' funds. The benefit to a brokerage is that its own funds generate ongoing management fees for the firm.

Regulators' concern is that brokers may sell funds that aren't appropriate for investors, simply to earn a bigger payout.

Under current rules, brokers don't have to disclose to investors if they earn more for selling in-house funds. But on Aug. 7, NASD proposed a rule requiring such disclosure. The agency is seeking comments on the proposal.

Morgan Stanley dangled an array of goodies to boost sales of its funds, NASD said. In a contest to promote the fledgling Morgan Stanley Small-Mid Special Value fund in 2002, brokers at the firm's Santa Ana office vied for prizes including Britney Spears tickets and a $500 Nordstrom gift certificate.

The Southern California regional manager offered tickets to a 2002 National Basketball Assn. finals game between the Lakers and the New Jersey Nets.

Other contest prizes included tickets for a Rolling Stones concert, dinner and lodging at the Sonoma Mission Inn in Northern California and a whitewater rafting trip in West Virginia.

Even as Morgan Stanley settled the NASD case Tuesday, the firm issued a harsh written response to a complaint filed last month by Massachusetts regulators. The complaint alleged that the firm violated state securities law by failing to disclose that its brokers got incentives for pitching in-house funds.

William Galvin, Massachusetts' securities chief, is seeking undisclosed fines and as much as $8 million in commissions returned to investors.

Morgan Stanley said Galvin is trying to hold the brokerage liable "for violating disclosure rules that do not exist." The firm said appellate courts have ruled that brokerages aren't required to disclose that "a compensation structure may result in different compensation rates on sales of different mutual fund products."

Further, it said NASD's Aug. 7 disclosure proposal "confirms that there currently is no duty to disclose internal compensation programs."

Some attorneys who represent individual investors in securities fraud suits said the NASD case against Morgan Stanley threatens to further undermine small investors' confidence in financial markets.

"These are anti-customer practices that have to stop," said Jacob Zamansky, a New York-based lawyer. "If they don't clean up their act, you're not going to have individuals investing."

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Times staff writer Tom Petruno contributed to this report.

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