Category Archives: Morgan Stanley

Sales involving alternative investment products sold to elderly investors has an unleashed an investigation by Massachusetts securities regulators into 15 brokerage firms. The firms include LPL Financial LLC, Morgan Stanley, Merrill Lynch, UBS Securities LLC, Fidelity Brokerage Services LLC, Charles Schwab & Co. Inc., Wells Fargo Advisors, TD Ameritrade Inc., ING Financial Partners Inc.,  Commonwealth Financial Network, MML Investor Services LLC, Investors Capital Corp., Signator Investors Inc., Meyers Associates LP, and WFG Investments Inc.

As reported yesterday, the Massachusetts securities division has sent subpoenas to the firms being targeted, asking for information on sales of the products to state residents who are 65 or over.  Among the non-traditional investments included on the list:  Oil and gas partnerships, private placements, structured products, hedge funds and tenant-in-common offerings.

Massachusetts is demanding information on any such products that have been sold over the past year, the investors who purchased them, the commissions generated, how the sales were reviewed, and all relevant compliance, training and marketing materials used for marketing and sales purposes.

The firms have until July 24 to respond.

This isn’t the first time that Massachusetts has come down hard on broker/dealers for alleged improper sales of certain alternative investments. In May, the state settled cases involving non-traded REITs with Ameriprise Financial Services; Commonwealth Financial Network; Lincoln Financial Advisors Corp., Royal Alliance Associates; and Securities America. The five firms agreed to pay a total of $6.1 million in restitution to investors, as well as fines totaling $975,000.

In February, Massachusetts reached a similar settlement with LPL Financial, which agreed to pay at least $2 million in restitution and $500,000 in fines related to sales of non-traded REIT investments.

The REIT investigations “heightened my concern that the senior marketplace is being targeted for the sales of these high-risk, esoteric products,” said Massachusetts Secretary of the Commonwealth William F. Galvin in a statement yesterday.

“While these products are not unsuitable in and of themselves, they are accidents waiting to happen when they are sold to inexperienced investors by untrained agents who push the products to score … large commissions.”

The past year has been a good one for big retail brokerages, but many brokers aren’t viewing the increased revenues as a sign to sit back and relax. Instead, some say they’re feeling pressure to keep those revenues up by touting investments with higher commissions and fees. And for investors, that could mean added risks.

As reported Feb. 25 by the Wall Street Journal, more of the larger retail brokerage firms now have an eye on promoting financial products that generate greater profit margins. According to a broker at UBS Wealth Management Americas in New York, there has been a big push to put client money in alternative investments, as well as the lending business.

“Alternative investments are some of the biggest profit generators for the firm,” he said in the WSJ story. Asset-based lines of credit – a relatively easy way to earn a few percent in interest – also are popular.

Part of this newfound encouragement is tied to the way in which UBS pays its brokers. As reported in the Wall Street Journal article, UBS recently fine-tuned its basic formula for paying brokers a percentage of the revenue they produce to include incentives for selling products such as mortgages and credit lines. The changes went into effect in 2013.

Similar formulas, or pay grids as they’re called, are used at Morgan Stanley Wealth Management and Merrill Lynch, which also reward bonuses to brokers with growing loan-based business.

According to the WSJ story, financial advisers at Merrill Lynch also feel the continued push to get more assets into value-based models – i.e. those that charge clients a fee for advice and a financial plan.

Non-traded REITs. Elder fraud. LPL Financial. Medical Capital Holdings. Tim Durham. Provident Royalties. Tenant-in-Common investments. Those were just a few of the investment topics to dominate the financial headlines in 2012.

In January, elderly investors found themselves caught up in scams involving Provident Royalties and Medical Capital Holdings. Both firms had previously been the subject of fraud charges by Securities and Exchange Commission (SEC) for scamming investors, many of whom were senior citizens, out of millions of dollars through bogus private placement deals.

A number of broker/dealers that sold investments in either Provident or Medical Capital found themselves facing regulatory investigations, as well as arbitration claims by investors. In late January, the Financial Industry Regulatory Authority (FINRA) ordered CapWest Securities to pay $9.1 million in damages and legal fees stemming from sales of private investments in both Medical Capital and Provident Royalties. The $9.1 million award is thought to be one of the single largest arbitration awards based on sales of failed private placements.

In February, tenant-in-common (TIC) investments and DBSI were big news. A one-time leader in the TIC industry, DBSI was now the focus of a criminal probe. DBSI founder and CEO Doug Swenson also faced charges of tax evasion, money laundering, racketeering and securities fraud.

DBSI, which filed for bankruptcy protection in 2008, left many of its 10,000-plus investors minus their life savings, while others took devestating financial losses. James Zazzaili, the court-appointed examiner in DBSI’s bankruptcy, stated that DBSI executives ran “an elaborate shell game, one that included improper and fraudulent use of investor money to prop up the company, to spend on pet projects, and to enrich themselves.”

In March, investors in several non-traded real estate investment trusts (REITs) received an unwelcome wake-up call when their investments unexpectedly declined sharply in value. Pacific Cornerstone Core Properties REIT fell by than 70%; investors in the non-traded REIT learned of the news via a letter from the REIT’s chairman that shares of Cornerstone, once priced at $8, were now worth $2.25.

Other REITs that followed down similar paths Cornerstone in 2012 included the Behringer Harvard Short-Term Opportunity Fund I LP and the Behringer Harvard Opportunity REIT I.

In April, shoddy private placements deals and the lawsuits that later ensued were behind the shuttering of yet another broker/dealer. On April 13, after losing an arbitration claim in March for $1.5 million, Cambridge Legacy Securities LLC filed its withdrawal request with FINRA. Several days later, the company sought bankruptcy protection.

April also witnessed the less-than-desirable IPO of Inland Western REIT. The REIT, now called Retail Properties of America, went public at $8 a share on April 5. The $8 per share price fell well below the expected price of $10 to $12. But that $8 valuation was the result of a 10-to-1 reverse stock split and distribution plan that may have cost pre-IPO investors as much as 70% of their initial investment.

In May, non-traded REITs again reared their ugly head when a FINRA arbitration panel ruled in favor of an investor’s claim against David Lerner Associates and the company’s Apple REIT Nine. FINRA further stepped up its scrutiny of the non-traded REIT sector in May by launching inquiries into several broker/dealers and their sales of the products.

In June, the SEC put life insurers on notice by instructing them to improve their product disclosures, protect legacy variable annuity clients and ensure that swapped benefits were indeed suitable for certain clients.

Investment scams involving financial aid, health insurance and Ponzi schemes also saw significant increases across the country in June.

Check back for Part 2 of our 2012 Year in Review wrap-up!

Fallout from its management of Facebook’s initial public offering continues to haunt Morgan Stanley. Today, Massachusetts Secretary of the Commonwealth William Galvin fined the investment bank $5 million for violating securities laws governing how investment research can be distributed.

Galvin accused Morgan Stanley – the lead underwriter for Facebook’s initial public offering – of improperly influencing the IPO process.

As reported Dec. 17 by the New York Times, a consent order alleges that an unnamed senior investment banker at Morgan Stanley coached Facebook on how to share information with stock analysts covering the social media company, a potential violation of a landmark Wall Street settlement in 2003. Those actions put ordinary investors who did not have access to the research at a disadvantage.

In agreeing to the $5 million fine, Morgan Stanley did not admit to any wrongdoing.

Facebook’s initial public offering was one of the most highly anticipated stock launches of the past decade. The tide quickly turned, however, with the stock’s first day of trading plagued with problems. Shares of Facebook fell below its $38 offering price and continued to struggle in the months that followed. At one point, the stock was as low as $17.55. It’s currently trading at $26.70.

Meanwhile, in a press statement, Galvin called Morgan Stanley’s “improper influence” “yet another example of an unlevel playing field, whereMain Street investors are put at a significant disadvantage to Wall Street.”

Structured investments have rendered a countless number of investors financially ruined – many of whom would never have been invested in the exotic products if not for the recommendations of their financial advisor.  The 2008 financial crisis cast a new light on the potential problems of structured products, from so-called principal-protected investments issued by Lehman Brothers to reverse convertible notes from Morgan Stanley. The result was the same: Investors lost big.

Jargon-laden literature, illiquidity, counter-party risk and lack of transparency all make structured products a complex and often unsuitable investment for the average investor. Despite these characterizations, many financial advisors continue to sell structured products because of the large mark-ups and commissions they bring – not because they are in the best interests of a client.

In the case of Morgan Stanley, a review by the Financial Industry Regulatory Authority (FINRA) into sales of the firm’s structured products – which included principal-protected investments, leveraged exposure, yield enhancement, and access investments – revealed that in many instances the true risks of the structured products were never disclosed to clients.

FINRA’s findings were officially documented in a Letter of Acceptance, Waiver and Consent (AWC) in which Morgan Stanley signed on Dec. 7, 2011, and agreed to pay a $600,000 fine to settle the violations outlined. Among the violations cited: Supervisory deficiencies, as well as unsuitable recommendations of structured products to retail customers.

In the AWC letter, FINRA states that Morgan Stanley failed to create “reasonable systems or procedures to notify supervisors whether structured product purchases complied with the firm’s internal guidelines.” Instead, Morgan Stanley placed the responsibility with branch supervisors.

“During the Review Period, Morgan Stanley had no reports or tools for sales supervisors or compliance personnel that were specific to structured products, or which highlighted and detected single concentrated structured product purchases. As a result, of the 224,000 structured product purchases between September 2006 and August 2008, more than 28,000 were in net amounts that exceeded 25% of the customer’s disclosed liquid net worth and more than 2,600 were effected by customers with slated net worth less than $100,000,” the AWC letter said.

A federal judge has decided that Morgan Stanley must face the music and defend itself in a lawsuit brought by 18 Singapore investors over failed structured products. Among the allegations, investors accuse Morgan Stanley of committing fraud in 2006 and 2007 when it sold them nearly $155 million of Pinnacle Notes structured products. The notes, which were linked to synthetic collateralized debt obligations (CDOs), lost almost 100% of their value amid the financial crisis.

Morgan Stanley tried to get the lawsuit dismissed, but District Judge Leonard Sand rejected its request.

“Defendants point to generalized warnings cautioning investors not to rely solely on the offering materials,” Judge Sand stated in this ruling. “But even a sophisticated investor armed with a bevy of accountants, financial advisors and lawyers could not have known that Morgan Stanley would select inherently risky underlying assets and short them.”

As reported Nov. 4 by Reuters, the October 2010 lawsuit is seeking class-action status. It is one of several lawsuits accusing banks of misleading investors into buying supposedly safe securities backed by risky debt, even as other investors or the banks themselves were actually shorting them.

In the Morgan Stanley case – Dandong et al. vs. Pinnacle Performance Ltd et al., U.S. District Court, Southern District of New York, No. 10-08086 – plaintiffs allege that the bank represented the Pinnacle Notes as “conservative” and that they would keep their principal safe.

Instead, Morgan Stanley allegedly invested their money into synthetic CDOs that were tied to risky companies. In addition, investors say they were kept in the dark to the fact that Morgan Stanley acted as a counterparty in the CDO deal whereby it collected one dollar for every dollar investors lost.

“Morgan Stanley designed the synthetic CDOs to fail,” the complaint said. “It placed itself on the side guaranteed to win (the “short” side) and placed plaintiffs and the class on the side guaranteed to lose (the “long” side).”

When it comes to financial adviser satisfaction, Morgan Stanley Smith Barney rates at the very bottom of six national broker/dealers, according to a J.D. Power and Associates Survey.

Among independent broker/dealers, the survey says Commonwealth Financial Network came out on top, while MetLife Broker Dealer Group ranked the lowest.

As reported Oct. 24 by Investment News, the 2010 U.S. Financial Advisor Satisfaction Study was based on responses from 2,863 advisers who hold a Series 7 license. The study was conducted in February and March, and again between July and September.

Key areas covered in the survey included adviser satisfaction, firm performance, technology and work environment.

This is the first time that the survey has ranked independent broker/dealers.

Last week, Morgan Stanley was sued by a group of Singapore investors who accused the company of rigging a bond sale related to collateralized debt obligations in order to wipe out their $155 million investment. The notes were issued by Pinnacle Performance Ltd, a Cayman Islands-registered outfit that Morgan Stanley had allegedly marketed as “conservative,” with the goal to protect investors’ principal.

Instead, the investors say Morgan Stanley invested their funds into synthetic CDOs, with the bank itself serving as the counterparty on the underlying swap agreements. The investors allege that the arrangement was structured so that Morgan Stanley would collect one dollar for each dollar they lost.

Citigroup and Morgan Stanley appear to be taking a lead from Goldman Sachs when it comes to collateralized debt obligations (CDOs). As reported in a May 21 article by Bloomberg, Citigroup is the focus of several inquiries for allegedly selling a series of mortgage-linked securities – known as the Jackson Segregated Portfolio – to investors without disclosing the fact that Morgan Stanley helped shape the investments while also betting they would fail.

According to the Bloomberg article, marketing documents for the products – which were underwritten by Citigroup in 2006 – failed to provide information on the entity responsible for selecting the underlying mortgage bonds. Sources close to the deal contend that the entity was a Morgan Stanley unit. Six of the seven series of Jackson bonds later defaulted, costing investors more than $150 million of losses, according to Bloomberg data.

So far, Citigroup hasn’t been publicly accused of any violations tied to the Jackson deals.

In a similar situation last month, the Securities and Exchange Commission (SEC) accused Goldman Sachs of misleading investors by failing to disclose that the hedge fund, Paulson & Company, had a role in picking securities it then bet against.

As in the Goldman Sachs case, the Jackson Segregated investments involved a synthetic CDO. Derivatives linked to mortgage bonds were pooled together, packaged into new bonds and then sold investors. On the other end of the Jackson derivatives was a “short” investor. Profits were made when the underlying bonds failed.

“To get the deals done, most underwriters of synthetic CDOs initially took the short positions, sometimes with a plan to sell them off later. When Citigroup set up Jackson, it arranged with Morgan Stanley to take over the short positions once the deal closed . . . Citigroup allowed the firm to help select the bonds linked to the derivatives because Morgan Stanley would have a stake in the performance of the securities,” the Bloomberg article reports

Investments deals involving CDOs have come back to haunt Morgan Stanley. Federal prosecutors apparently are investigating whether the investment bank intentionally misled investors about various synthetic collateralized debt obligations that it helped design and sometimes bet against. The story was first reported by the Wall Street Journal on May 11.

According to the story, Morgan Stanley marketed and sold the CDOs in question to investors and then subsequently placed bets that their value would fall. Among other things, investigators want to know whether the bank disclosed certain facts to investors, as well as its role in the deals themselves.

In April, the Securities and Exchange Commission (SEC) charged another investment firm – Goldman Sachs – with fraud in connection to sales of synthetic CDOs.

According to the SEC’s complaint, Goldman Sachs failed to tell investors certain details regarding the financial products, including the fact that a major hedge fund not only selected the securities held by the CDO but also bet against them to fail.

Meanwhile, the probe into Morgan Stanley’s CDO is at a preliminary stage.

Francisco P. Esparza, a broker whose employment history include stints with J.P. Turner & Company, LPL Financial, UBS, Citicorp Investment Services and Morgan Stanley, has been fined $10,000 and suspended from association with any member of the Financial Industry Regulatory Authority (FINRA) for 15 business days.

FINRA’s actions were related to findings that allege Esparza made unsuitable recommendations to customers to buy closed-end funds without fully understanding the pricing of the products or the risks associated with the investments.

FINRA noted its actions against Esparza in its March 2010 Disciplinary Report.

Esparza, who didn’t deny or admit to the findings, nonetheless consented to the regulator’s sanctions. According to FINRA, Esparza’s recommendations accounted for customer losses totaling approximately $73,290.