New York and Massachusetts are investigating mutual fund sales practices at Morgan Stanley, and a new study shows that problems with mutual fund sales practices might be widespread.
In a complaint filed Monday in Boston, Massachusetts Secretary of State William Galvin says Morgan Stanley offered brokers higher commissions for selling its own funds, but didn’t tell investors about the incentives.
New York will join Massachusetts in investigating whether other brokerages do the same, said New York Attorney General Eliot Spitzer, architect of a $1.4 billion settlement with 10 big investment banks earlier this year.
Brokers are supposed to put their clients’ interests before their own. In Massachusetts and most other states, it is illegal not to disclose additional incentives.
The company had denied giving extra compensation for selling its funds in a May 8 letter to state regulators. Morgan Stanley later reversed itself, telling Massachusetts officials that brokers and branch managers get extra pay for pitching Morgan Stanley funds and that investors weren’t told about it.
”The whole strategy was to force you to sell (Morgan Stanley) product,” says Galvin.
In a statement, Morgan Stanley said it ”deeply regrets the errors made in one of our communications to state investigators.”
The company also said that it pays brokers more for selling its proprietary funds, as well as funds from 14 other companies, including AIM, Fidelity Advisors, Pimco and the American funds. Morgan Stanley also said it promotes those sales through programs for branch managers.
Morgan disclosed Friday that it is under investigation by the Securities and Exchange Commission for its sales of pricey B shares. The SEC would not comment.
Meanwhile, a new survey of 3,000 financial advisers by Furman University confirms suspicions that problems in mutual fund sales could be industrywide.
Companies that sell their proprietary funds through advisers tend to sell more B and C shares, even though A shares are cheaper for long-term investors. B and C shares are more profitable for fund companies. Brokerage companies’ incentive systems may be designed to push those classes, says Tom Smythe, professor of economics and business administration.
Many broker-sold funds offer several share classes of the same fund. The share classes differ in fee structure. A fund’s A shares carry an upfront sales charge, or load, while B and C shares have no upfront sales charge but higher ongoing fees.
The study showed that brokers push funds when their commissions are raised.
”Surprise, surprise,” Smythe says.
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