States Focus on Morgan Fund Sales

Securities regulators from New York and Massachusetts said Monday that they are investigating mutual fund sales at Morgan Stanley as part of a broader probe into marketing and trading practices throughout the fund industry.

The Morgan Stanley investigation centers on whether the New York-based brokerage giant pressured its brokers to sell Morgan’s brand-name mutual funds, and paid brokers extra money for such sales without disclosing the arrangement to customers.

It’s usually more profitable for brokerages to sell funds run by their in-house investment divisions rather than those of outside fund companies, with whom they must split profits.

Regulators fear that customers aren’t being told that brokers have a hidden financial incentive to push funds that may not be the best-performing fund available or the most appropriate for a particular investor.

The investigation of Morgan is one of a series of larger examinations by New York Atty. Gen. Eliot Spitzer and other regulators into a variety of fund issues. Spitzer, who spearheaded the recent crackdown on Wall Street stock analysts, said his office is conducting inquiries into “a number of aspects of mutual fund marketing and trading.”

“We want to make sure that the sorts of conflicts of interest at the heart of the analyst investigation are not being repeated in the mutual fund context,” Spitzer said.

A Morgan spokesman confirmed that brokers receive greater compensation for selling in-house funds over many outside funds. But he would not comment on whether brokers should have or did disclose the payments to customers.

“Morgan Stanley supports enhanced disclosure in the fund industry and will continue to cooperate fully with the various regulators examining the brokerage industry’s sale of mutual funds,” said Bret Gallaway, the Morgan spokesman.

As part of its investigation, Massachusetts filed a complaint against Morgan on Monday alleging that the company gave false information to state investigators when first asked about the issue. The state is seeking a $1-million fine.

Morgan Stanley “deeply regrets the errors” made in an initial letter to Massachusetts officials and has sought to “rectify any misunderstanding,” Gallaway said.

The announcement about the fund inquiries came as state regulators began trying to beat back a proposal in Congress that would greatly curtail their ability to crack down on Wall Street.

State regulators are incensed at a bill passed last week by a House subcommittee, and lashed out at it on Monday.

At a news conference in Boston, state officials said investigations such as the fund probe would be stymied if the proposal became law.

Some federal legislators have complained that Spitzer and other state officials overstepped their bounds last year by aggressively going after stock analysts, which they saw as a national issue under the purview of the Securities and Exchange Commission.

But state officials say the SEC was slow to react to evidence of analyst wrongdoing, and that the landmark $1.4-billion analyst settlement announced in April would not have occurred without their initiative.

“If you feel [the SEC’s] vigilance left something lacking then you should view this bill ... as a travesty,” Spitzer said.

SEC Chairman William H. Donaldson said his agency would not publicly debate the merits of the bill.

After hammering out the analyst settlement, regulators are turning their attention to other parts of the financial industry. One is the mutual fund industry, including brokerage firms that sell funds to investors.

Investigators have focused in part on fund fees and whether they are being properly disclosed to investors.

William Galvin, the Massachusetts secretary of the commonwealth, said firms can pay extra compensation for selling one fund over another. But investors must be told about the payments, he said.

His office soon will ask other brokerages to disclose the existence of any similar arrangements, Galvin said.

“Our experience is that when you see a practice that is so widespread within a particular firm, chances are that other firms have similar policies,” he said.

The Massachusetts inquiry began with a tip from a Morgan Stanley employee who complained that a branch manager was forcing brokers to push a particular Morgan fund. According to the employee, the manager’s goal was “lining his own pockets.”

A Morgan lawyer initially claimed that brokers received the same compensation regardless of which fund they were recommending to clients, the complaint says.

But the lawyer later corrected himself, telling investigators he had been “unaware” that brokers got less for selling funds from outside companies.