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Morgan Stanley Mutual Fund Practices Come Under Fire

Jul 14, 2003 | Thestreet.com The number of regulatory agencies looking into Morgan Stanley's mutual fund business keeps growing.

Just days after the brokerage confirmed that the Securities and Exchange Commission is investigating its mutual fund sales practices, two state regulators announced they are launching their own inquiry of the Wall Street firm.

Heading up the new investigation is New York Attorney General Eliot Spitzer and Massachusetts Secretary of the Commonwealth William Galvin. In a joint press release, the two officials said they are investigating whether Morgan Stanley pressured brokers to sell the firm's in-house mutual fund products at the expense of other funds.

The state officials, who worked together on the Wall Street analyst investigation, contend Morgan Stanley also didn't disclose to customers that its brokers stood to earn higher commissions from selling in-house mutual funds. In a related move, Galvin's office filed a civil complaint against Morgan Stanley, charging the firm with submitting a "false filing" that denied the special compensation system.

A Morgan Stanley spokesman could not be reached for a comment.

The new investigation would appear to overlap with one launched in April by the SEC, which is trying to determine whether Morgan Stanley brokers pushed customers to buy shares in its in-house mutual funds. The SEC investigation focuses specifically on whether Morgan Stanley customers were urged to buy so-called Class B shares in those in-house mutual funds.

In recent years, Class B shares increasingly have drawn scrutiny from regulators at the SEC and the NASD because they tend to be the most costly mutual fund products.

Last week, Prudential Securities and the SEC settled an investigation stemming from allegations that a Prudential broker pushed customers into more expensive Class B mutual fund shares. The firm paid $382,000 in penalties and restitution.

On the surface, Class B shares often look like a good investment because investors generally don't pay any upfront sales charge, or "load." But investors in Class B shares often pay higher annual fees than on shares with upfront sales charges, fees that often exceed any initial savings an investor might reap. Additionally, brokers often waive or reduce the upfront fees on so-called Class A "load" shares for large investors.

Morgan Stanley is facing a host of arbitration complaints filed by customers who contend they were sold Class B shares without knowing all the risks. A class-action lawsuit raising similar allegations also has been filed by some of its customers.

Galvin's office, in the complaint it filed Monday, said its inquiry began after receiving an anonymous letter from an employee in Morgan Stanley's Boston Back Bay office, who complained of being "pressured'' to sell shares in a new in-house fund -- the Morgan Stanley Allocator Fund. The employee described the branch manager's tactics as "nothing short of extortion.''

A December 2002 prospectus for the fund describe the fund as having four different classes of shares: A, B, C and D. It's a fund that invests in stocks, bonds and money market fund in order to "maximize total investment return through different stages of an economic cycle.''

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