The chain of events that one little tip can start is motion is quite amazing. This morning, newspapers from around the nation devoted staff reporters to covering yesterday's Spitzer and Galvin show. The coverage, which is summarized belorew, makes the Morgan Stanley probe one of the biggest stories of the year for newspaper readers. Because of the length of the coverage, we have organized excerpts of the coverage by topic (see the table).
The first time that each story is referenced, the name of the newspaper acts as a link directly to the original story. The New York Times requires registration to access the story and the Wall Street limits access to subscribers. The other papers put the articles into the paid archives after a short period of time.
The Tip
All of the coverage mention last winter's tip that started Massachusetts' Galvin on his probe into the doings of Morgan Stanley. However, three of the papers shed more light on that tip. The
Wall Street Journal noted that the tip came in the form of "an anonymous letter from a broker in Boston."
The
Boston Globe is the only paper to report the length of Galvin's complaint (eight pages). It also provides the detail that the funds for which Morgan Stanley was sweetening its payout was its new Allocator fund.
In the letter the broker complained that efforts by a branch manager to drive sales of a new Morgan Stanley fund were "nothing short of extortion," adds the Journal. The
Los Angeles Times excerpts a colorful explanation of the manager's motivation for pushing brokers. The said manager was "lining his own pockets," says the LA Times.
No Proper Disclosure
The consensus of the coverage is that it was not Morgan Stanley's favoring its own fund with extra compensation that was its wrongdoing, but that it failed to disclose the payments. Galvin called Morgan Stanley's failure to disclose the extra compensation a ''significant material omission, reports the Globe. ''Profit -- the profit of the broker, the profit of the branch manager, and the profit of the firm -- is being put ahead of the fiduciary duty to the customer,'' he said, according to the paper.
Galvin stressed that Morgan Stanley violated its fiduciary obligation to shareholders by not disclosing the extra incentives for selling its own funds. USA Today notes that "in Massachusetts and most other states, it is illegal not to disclose additional incentives.
The Washington Post provides a regulatory brief. It recalls the 1995 Securities and Exchange Commission recommendation that firms compensate brokers equally for selling proprietary and outside mutual funds. The Post also cites NASD rules that allow firms to compensate brokers at different levels for selling different funds but requires that all payments be disclosed to customers.
The False Statement
Morgan Stanley's next mistake in the case came on May 8, when it falsely or mistakenly told Galvin's office that brokers did not receive extra compensation for selling proprietary funds. Whether you think the letter was in error or intentionally deceptive depends whether you believe the spin provided by Morgan Stanley officials or Galvin. Interestingly, the
Boston Herald reports that Galvin claims the brokerage mislead his office at "least twice" during his probe. The paper does not provide details of the alleged second deception, but it appears that Galvin was referring to Morgan Stanley's misstatements about what proportion of the funds sales in the office where of the Allocator fund (see
Two Payment Grids Revealed).
Again, the Globe provides the most details on this event as provided in the complaint. The paper reports "a lawyer from Galvin's office asked a Morgan Stanley lawyer whether brokers or managers received extra compensation for selling proprietary mutual funds, which are managed by Morgan Stanley, as opposed to shares in any of the thousands of other mutual funds." The lawyer responded: ''There are no higher commission, fees, or other compensation paid to our financial advisers or branch managers for selling our proprietary or affiliated funds than our non-proprietary or non-affiliated funds,'' according to the complaint.
Most of the papers note that Morgan Stanley did not correct its claim until the after the Wall Street Journal published a story on May 22 contradicting the brokerages statement. The Journal is one of those three along with the Boston Herald and LA Times.
According to the Journal, Galvin's office subpoenaed Morgan Stanley on the day its article appeared. Morgan Stanley responded to that subpoena with a written correction to its earlier statement. The LA Times reports that the Morgan Stanley lawyer working with the Galvin's office "later corrected himself, telling investigators he had been 'unaware' that brokers got less for selling funds from outside companies.
The Boston Herald adds that a Morgan spokesman told it that the problem of getting its story straight was a "misunderstanding."
The Journal also discloses that Galvin's office also deposed a Morgan Stanley compensation executive last Thursday (July 10) provided gather more details.
The Mea Culpa
All of the papers provide prominent play to Morgan Stanley's response to yesterday's news. Indeed, a number of Morgan Stanley spokespeople a quoted by the papers. Each time they are essentially saying the same thing.
"(Morgan Stanley) deeply regrets the errors made in one of our communications to state investigators," Morgan Stanley spokesman Bret Gallaway told both the Boston Herald and LA Times and other papers. "We have endeavored to correct the information and rectify any misunderstanding." Galloway also told the LA Times that the broker "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."
The
New York Times quotes Andrea Slattery, another Morgan spokesperson, as saying that the broker is cooperating with the investigation. "Morgan Stanley has the utmost respect for the Massachusetts security division and deeply regrets the errors made in one of our communications to state investigators. Morgan Stanley pays its brokers more for the sale of its proprietary funds and for 14 other nonproprietary fund partners, than it does for selling nonproprietary funds," the New York Times quotes Slattery as saying.
Two Payment Grids Revealed
All of the media calls did flush out a practice that even took some industry consultants by surprise. A Morgan Stanley "official" acknowledged to the
Washington Post that firm has two "pay grids" for mutual fund sales and that the "higher grid" includes both proprietary funds and funds from 14 other companies.
Other papers provide the names of six of those 14 non-proprietary fund families for which Morgan Stanley brokers are specially rewarded for selling (
readers, let us know if you have the names of the others). They include AIM, Fidelity Advisors, Pimco and American Funds, according to
USA Today. Also on the list are MFS Investment Management, Eaton Vance, Evergreen Investments and Fidelity Investments, says the Boston Herald.
One comment in the Globe points out just how secretive Morgan Stanley's practice was. ''Higher payment on a proprietary product is something that's more or less gone by the wayside,'' it reports Matthew McGuinness, senior analyst at Cerulli Associates as saying. ''I'm hard-pressed to believe that's still going on.''
Despite the extra-incentive for selling funds from the 14 families, more than 50 percent of the funds sold by Morgan Stanley are proprietary, according to the New York Times.
The Times conclusion is contradicted by details reported in the Globe, though. The Boston paper reports that Massachusetts' investigators specifically asked whether the Morgan Stanley Back Bay office sold more of the Allocator fund than other offices. Morgan Stanley responded that sales were ''evenly spread'' among branch offices, according to the complaint.
That story also changed after the second inquiry. During the follow-up questioning Morgan Stanley officials admitted that the Back Bay office sold more than four times as much of the Allocator fund as the other office in Boston.
USA Today reports that Morgan Stanley said it promotes the sales of the funds through "programs for branch managers," seemingly supporting the story of the tipster. However, the spokesperson would not comment on whether brokers should have or did disclose the payments to customers, reports the LA Times.
Fund Industry Arrogance
The regulators are not planning to limit their attention to just Morgan Stanley. Indeed, earlier battles between the fund industry and regulators may have played as much a role in the coming investigation as the practices at Morgan Stanley. Both Galvin and Spitzer plan to send letters to all Wall Street firms asking them how they compensate their brokers for selling different types of mutual funds and whether such arrangements were disclosed to investors, reports the New York Times.
"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," the LA Times quotes Spitzer as saying. Galvin also plans to ask other brokerages to disclose the existence of any similar arrangements. "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," the paper quotes Galvin as saying.
Spitzer especially want to conduct a broader investigation into the fund industry investigation is much broader, says the Globe. The paper notes that Spitzer failed to offer details of his probe, but said the industry is "arrogant and deserves more scrutiny - particularly after they fought a rule that would require proxy-voting disclosures."
"They made an egregious mistake when they showed the arrogance they did in opposing something as simple as disclosure of their proxy votes," the Globe quotes Spitzer as saying. "That was a clue to many of us that there was something here that deserves fair attention."
The Globe also said Spitzer is investigating sales of mutual funds. ''We have other significant issues with regard to the marketing of mutual funds that we think are intriguing,'' he said.
However, the Wall Street Journal posits that Morgan Stanley's practices don't appear widespread among larger Wall Street firms. "For example, neither Merrill nor the Smith Barney brokerage unit of Citigroup Inc. appears to pay branch managers more for in-house fund sales, according to the companies and industry specialists," states the paper.
USA Today goes an extra mile to ferret out practices at other brokerages. It uncovers a Furman University survey of 3,000 financial advisers that suggests that "problems in mutual fund sales could be industrywide." It does not elaborate on Furman University's credentials though.
The survey reportedly found that fund firms "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." Tom Smythe, professor of economics and business administration told the paper that "brokerage companies' incentive systems may be designed to push those classes." USA Today adds that the study "showed that brokers push funds when their commissions are raised." "Surprise, surprise," is Smythe's reported response.
Paying the Piper
Surprisingly, only the Boston Herald gave leading play to the $1 million fine that Galvin is seeking to impose on Morgan Stanley for its practices. The fine is reportedly a response to the misleading statements made by Morgan Stanley officials to Galvin's office. That misleading information is also the basis for the eight-page complaint Galvin's office filed yesterday.
The Washington Post failed to mention the possible fine, but it did report that Galvin will try to force Morgan Stanley to disclose to Massachusetts's investors any possible conflicts of interest regarding mutual fund sales or any extra fees or commissions associated with the funds.
The Boston Globe provides expert commentary from Louis Harvey, president of the Dalbar. Harvey points out that the fund industry now faces growing scrutiny because of the three-year bear market. He adds that it could be tough for Galvin to prove investors lost money because of the practice. "There's very little evidence that proprietary funds perform any worse than independent funds," Harvey told the paper.
Galvin himself believes that its "too early to say how much money investors may have lost," reports the Herald. He did say that his office's "first take is that it has not been as good for the consumer."
Battle of the Regulators
The subtext for much of the coverage is the brewing battle between state and federal regulators that began when Spitzer looked into the underwriting practices of Wall Street brokerages. The Herald pointed out Galvin's claim that the recent amendment to the House Financial Services Committee bill would "make it far more difficult for his office to conduct probes into national brokerages such as Morgan Stanley." The paper also points out that Galvin is a Democrat (as is Spitzer, according to the Journal) and that Representative Barney Frank (D-Massachusetts), the top Democrat on the House Financial Services Committee, also appeared at the press conference.
The Washington Post also reports that the amendment would "presumably" prevent Galvin from forcing changes in Morgan Stanley's disclosure practices. The Washington paper also sought out Peggy A. Peterson, spokesperson for the House Financial Services Committee. Peterson told the paper that the amendment would ensure only that state regulators "not be able to set national market policy." Peterson also told the paper that mutual fund regulation should be addressed at the federal level. "These issues affect all mutual fund investors, not just those in two states. Shouldn't all mutual fund investors be protected equally no matter what state they reside in?"
The paper also spoke to NASD spokesperson Nancy Condon, who told it that the NASD said has brought more than 200 enforcement actions dealing with mutual funds and variable annuities since January 2000 and plans to bring two new regulatory proposals involving mutual fund disclosure to its board of governors later this month.
The Journal reports that the bill would "block state regulators from forging independent pacts with securities firms that effectively would set rules for brokerage houses on capital and margin requirements, record keeping, financial reporting, disclosure or conflicts that depart from or extend federal securities laws."
The paper adds the juicy tidbit that the similarity of the current bill to that of one circulated on Capitol Hill last summer by Morgan Stanley. That earlier bill was "scuttled after an investor uproar," says the paper. It adds that Morgan Stanley denies any connection to this new version.
Meanwhile, the Boston Herald suggests that the bill would have less impact that Spitzer and Galvin claim. Its source is Michael DiResto, a spokesperson for Representative Baker (the bill's author). DiResto told the paper that the bill would ensure federal regulators are in the loop with policy-setting cases but that it wouldn't dramatically affect state regulators' powers.
While nearly all of the papers note that the SEC is already investigating mutual-fund sales practices, including those at Morgan Stanley. The Journal is the only paper to claim to have gotten its hands on a copy of the letter sent by the SEC to 10 leading brokerages on May 16. In the letter the SEC requested data on each mutual fund sold, commissions, sales charges, contracts between the firms and funds for services or goods and documentation of all sales contests or other incentives. The firms had until June 2 to respond, according to the paper.
The Journal also snagged an interview with SEC Chairman William Donaldson himself.
Donaldson told the paper that he was "surprised" to learn of the probe "because the SEC has been investigating these practices at Morgan Stanley for over four months and industrywide for over two months." The paper adds that neither Spitzer's nor Galvin's offices told the SEC of their own plans.
Donaldson also warned Spitzer and Galvin to tread carefully, saying he "would remind them that the SEC's role is not political advocacy but rather investor protection through enforcement and regulation conducted in an intensive, careful and fair manner."
The Journal also talked with former SEC Chairman Arthur Levitt (a Democrat) who told it that the Spitzer probes "are convincing evidence that there is a clear role for the states that complements ... federal efforts." Levitt adds that "there always has been a role for the constructive efforts of the states and federal governments working together. If they are tripping all over each other, that can be redundant and costly, but I think we've done it successfully in the past."
While Donaldson spoke to the Journal, the LA Times reported that it turned that paper down in its interview request by saying that "his agency would not publicly debate the merits of the bill." The LA Times instead quoted Spitzer.
"If you feel [the SEC's] vigilance left something lacking then you should view this bill as a travesty," Spitzer said. His comments about the battle over the bill amendment also received prominent play in the Boston Globe. "In dark of night, the securities industry is trying to take away crucial protection for investors,'' the paper noted Spitzer as saying. "They're trying to remove the cop from the beat."
The
Boston Herald quotes Spitzer's remarks a little differently ("In dark of night, the securities industry is trying to take away the cop from the beat who has been protecting the small investor") but captures the same essence.
The Globe characterized Spitzer's comments as a "blunt challenge" to Donaldson. He called on legislators to "stand up and loudly reject" the bill. "If you do not do that, I'll have to say you haven't learned the lessons of the last five years," the Globe quotes Spitzer as saying.
The Globe speculated that the press conference was part of a "one-two punch" designed to kick off "a larger campaign to thwart the proposed legislation."
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