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Morgan Stanley's Mutual Fund Sales Face State Probe

Jul 14, 2003 |

Morgan Stanley, the second-biggest securities firm by capital, misled regulators investigating whether it pressured brokers to sell in-house mutual funds, according to the Massachusetts Secretary of the Commonwealth.

States are asserting their authority to police Wall Street after a Congressional panel voted last week to limit their ability to negotiate accords with executives or companies that violate U.S. securities laws. Morgan Stanley paid $125 million as part of a $1.4 billion settlement in April by 10 firms to settle state and federal claims they misled investors with biased stock research.

New York Attorney General Eliot Spitzer and Massachusetts Secretary of the Commonwealth William Galvin are investigating whether Morgan Stanley ``improperly pressured brokers and branch managers'' to sell the firm's own funds ahead of those of rivals, they said in a joint statement. They also will ask other firms about their mutual fund sales practices.

``Usually when you see one ant at a picnic, you'll find a lot more, and I think this is a similar case,'' Galvin said at a news conference in Boston. ``Where you see a practice that is so endemic to a company as this apparently was with Morgan Stanley, it is certainly not a secret in the industry.''

`False Filing'

Morgan Stanley ``was driven to sell its own products first,'' Galvin said, and made a ``false filing'' on May 8 to regulators, denying the practice. The firm ``put profits ahead of its fiduciary duty,'' he said. The probe began in March after an anonymous tip from a Morgan Stanley broker in Boston.

Citigroup Inc. Chief Financial Officer Todd Thomson said he did not know of a similar inquiry into funds sold by the world's biggest bank by assets, which paid $400 million as part of the April settlement. ``Not that I've heard of,'' he said on a conference call with reporters after the release of second-quarter earnings.

The National Association of Securities dealers may also penalize Morgan Stanley for its allocations of shares sold in initial public offerings, the firm said in regulatory filings. Andrea Slattery, a Morgan Stanley spokeswoman, declined to comment, saying the firm would issue a statement later today.

Morgan Stanley, led by Chief Executive Officer Philip Purcell, was sued by investors in March who claimed that the company's brokers failed to give them appropriate discounts when they bought shares in its funds. The lawsuit alleged that brokers invested the plaintiffs' savings in a group of more expensive funds that would raise higher fees for the company.

Funds' Performance

Equity funds sold by Morgan Stanley have gained 15.5 percent this year and had an average loss of 11.5 percent per year over the past three years. All equity funds gained 16.5 percent this year and lost 9.8 percent a year over the past 3 years.

Investors have withdrawn more than $1.5 billion from Morgan Stanley's mutual funds this year through the end of May even as they have added $83 billion to funds industrywide, according to Financial Research Corp. Morgan Stanley has the fifth-most withdrawals among the top 25 fund companies.

The struggle between state and federal authorities over who should regulate the securities industry intensified during the yearlong probe of Wall Street stock research, when Harvey Pitt was chairman of the Securities and Exchange Commission.

Spitzer today challenged SEC Chairman William Donaldson, New York Stock Exchange Chairman Richard Grasso, and Chairman of the National Association of Securities Dealers Robert Glauber to ``prove you learned a lesson'' and reject the house amendment.

Some members of Congress are ``trying to remove the cop from the beat,'' Spitzer said at the Boston news conference. ``I hope the leadership in Washington and Wall Street back away from this idea.''

SEC spokesman John Heine declined to comment. NASD spokeswoman Nancy Condon did not return calls for comment and NYSE spokesman Raymond Pellechia said he could not comment.


After the investigation of conflicts of interest in Wall Street research by state and federal regulators that led to the April settlement, Richard Baker, the Republican chairman of the House Financial Services Committee's capital markets subcommittee, and other legislators complained about the ``Balkanization of securities regulation.''

Baker's subcommittee voted 24-18 to approved the Republican- backed restrictions on states' powers to impose nationwide settlements. Democrats criticized the amendment, saying it would have prevented the $1.4 billion settlement. Baker could not be reached for comment.

``The SEC is the only regulator that has a view of all the pieces of the market,'' said Peggy Peterson, spokeswoman for the House Financial Services Committee chaired by Representative Michael Oxley, an Ohio Republican. ``Shouldn't all broker dealers have to practice the same rules no matter where they're located?''

Spitzer, using New York's Martin Act, filed charges against Merrill Lynch, Morgan Stanley and eight other investment banks for publishing research biased by their investment banking departments, and won the settlement. Pitt resigned last November.

Investors may not benefit from the states' assertion of their powers, said Philip Feigin, a lawyer at Rothgerber Johnson and Lyons in Denver, Colorado, and former executive director of the North American Securities Administrators Association.

``There is a real danger here with some of these galactic fines that the regulators are seeking,'' Feigin said. ``Some of these regulators are elected officials who run on how well they do in collecting money and not on how much actually gets returned to investors.''

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