Galvin, Spitzer Announce Joint Inquiry Into Sale Of Mutual Funds By Morgan Stanley
Boston (July 14, 2003) - Secretary of the Commonwealth William Francis Galvin and New York Attorney General Spitzer today announced a joint inquiry into whether Morgan Stanley improperly pressured brokers and branch managers to sell proprietary mutual funds to investors who were not made aware that their brokers received additional compensation for pitching in-house funds. Further, Morgan Stanley is alleged to have misled regulators investigating the practice.
Galvin and Spitzer intend to find out the extent of the practice at Morgan Stanley and to determine if the practice exists at other Wall Street firms. They also warned that state regulators could be barred from settling this or similar investigations under legislation now before a key committee in the U.S. House of Representatives.
The inquiry stems from a complaint Massachusetts regulators filed today against Morgan Stanley that alleges the brokerage firm submitted a false filing to regulators in which the firm denied that brokers and branch managers receive special compensation for selling certain funds and that investors are kept in the dark about this practice.
"This is a legitimate and important inquiry, of vital importance to millions of investors who buy mutual funds from their brokers, but unfortunately it's the sort of investigation that could be prohibited if a bill now before the House Financial Services Committee becomes law," Galvin said.
Galvin, Spitzer and others at an early afternoon news conference pointed to high-profile actions by state securities regulators in recent years that they said would be impossible if the legislation, H.R. 2179, became law. They listed actions against penny stock and Amicrocap" stock fraud, day trading firms, misleading online brokerage advertising and, most recently, the investigation that lead to the $1.4 billion settlement with 10 major Wall Street firms over analyst conflicts of interest.
New York Attorney General Spitzer called the bill a "travesty and a cynical slap in the face for Main Street investors. Think about it: After Enron, WorldCom and the analyst conflict of interest cases the securities industry is saying, 'Trust us. We don't need this regulation.' The arrogance of it simply takes your breath away," Spitzer said. "The most important lesson of the past year is the essential role played by state enforcement entities in protecting investors against investment fraud. It makes no sense to disarm the local cop on the securities beat at a time when we need to strengthen, not weaken, investor protection."
The Massachusetts Securities Division began an investigation into Morgan Stanley's mutual fund sales practices in March after receiving an anonymous tip from a Morgan Stanley broker in Boston who said there was pressure from management to sell certain proprietary mutual funds to investors.
"While few would be surprised to learn that a used car salesman would put you in a lemon for an extra two hundred buck commission, how many people know their broker might be doing the same thing?" Galvin asked. "You would think that investors should have a right to know this goes on. We sure do. We intend to find out how widespread this practice is," he said.
Securities regulators in Massachusetts and New York initially plan to send letters to major Wall Street firms asking them, among other things, if they steer investors to certain funds, to detail commissions and other compensation paid to brokers, branch managers and others, and whether such costs are disclosed to investors.
Last Thursday H.R.2179 passed out of the House Capital Markets Subcommittee, chaired by one of the bill's sponsors, Rep. Richard H. Baker (R-Louisiana), on a largely party line vote.
Dubbed by its sponsors the "Securities Fraud Deterrence and Investor Restitution Act," the bill would effectively strip state securities regulators of their authority to bring actions against emerging cases of fraud and sales abuse, said Galvin, Spitzer and others at the press conference. The bill language reads, in part: "No law, rule, regulation, judgment, agreement or order, or other action of any State or political subdivision thereof shall establish capital, custody, margin financial responsibility, making and keeping records, bonding or financial or operational reporting, disclosure, or conflict of interest requirements for brokers, dealers, municipal securities dealers, government securities brokers, or government securities dealers that differ from, or are in addition to, the requirements in those areas established by the Commission or by a national securities exchange or other self regulatory organization."
Rep. Barney Frank (D-Massachusetts), the ranking member of the House Financial Services Committee, told the news conference: "This bill is a blatant attempt by the securities industry to prevent regulators from doing their jobs. It would undermine our complementary system of state, industry and federal regulation that helps make our securities markets the envy of the world. Calling this bill 'Securities Fraud Deterrence' is the equivalent of holding out a Three Stooges movie as high drama. If the securities industry prevails on this, it will only make investors more cynical and more wary and that will not be good for Wall Street or our markets."
In its written response to Massachusetts regulators, filed on May 8, Morgan Stanley strongly denied that brokers and branch managers received additional compensation for steering clients to house mutual funds. Yet in late May the Wall Street Journal published an article describing in detail the firm's compensation practices for proprietary mutual funds.
Late last week, as part of their investigation, Massachusetts regulators deposed Morgan Stanley's in-house compensation expert. Regulators said that under oath the Morgan Stanley executive admitted that brokers and branch managers have a financial incentive to pitch house mutual funds, something they don't disclose to investors. "What he told us flatly contradicted what the firm said in its earlier filing with my office," said Galvin.
In its case against Morgan Stanley, Massachusetts has retained prominent securities law expert Joseph F. Long, a professor emeritus at the University of Oklahoma Law School. Long will serve as a consultant in the investigation and as an expert witness at hearing or trial.