THE BLOG
08/11/2010 03:07 pm ET | Updated May 25, 2011

The Big Oops! Morgan Stanley's Research Failures

In a Press Release titled: FINRA Fines Morgan Stanley $800,000 for Deficient Conflict of Interest Disclosures in Equity Research Reports and Public Appearances by Research Analysts Firm Also Violated 2003 Research Analyst Settlement at, the Financial Industry Regulatory Authority (FINRA), Wall Street's largest self-regulatory organization, announced on August 10, 2010, that it has censured and fined Morgan Stanley & Co., Inc. $800,000 for failing to make public disclosures required by FINRA's rules governing research analyst conflicts of interest. The firm also failed to comply with a key provision of the 2003 Research Analyst Settlement by failing to disclose the availability of independent research in customer account statements. In addition to the censure and fine, Morgan Stanley must review a sample of its research reports and certify to FINRA that they comply with FINRA's research analyst conflict-of-interest rules. These reviews and certifications must take place every six months for two years.

Four Years of Non-Disclosure. Thousands of Incidents.

FINRA found that from April 2006 to June 2010, Morgan Stanley issued equity research reports that failed to disclose accurate information about the relationships Morgan Stanley, or its analysts, had with companies covered in its research reports. Overall, these inaccuracies resulted in approximately

  • 6,836 deficient disclosures

  • in about 6,632 equity research reports and
  • 84 public appearances by research analysts.
  • Among the deficient disclosures were:

    • Securities holdings of an analyst, or a member of the analyst's household, in a subject company;

  • Morgan Stanley's receipt of investment banking and non-investment banking revenue from subject companies;
  • Morgan Stanley's role as a manager, or co-manager, of a public offering of securities for subject companies;
  • Morgan Stanley's role as a market maker for certain subject companies' securities; and
  • Price charts for securities covered in equity research reports and the valuation method used to support published price targets.
  • Moreover, Morgan Stanley did not disclose in approximately 127,600 monthly account statements sent to customers from August 2007 to February 2008 that it had available independent, third-party research. The requirement to provide customers with this notification was part of the Securities and Exchange Commission's final agreement with Morgan Stanley as part of the 2003 Research Analyst Settlement and was incorporated into a separate agreement with FINRA.

    FINRA Gives Credit for Self-Review and Self-Reporting -- gee, that's nice

    In determining the appropriate sanctions in this matter, FINRA considered Morgan Stanley's self-review and self-reporting of some of its disclosure violations and remedial steps taken by the firm, as well as a prior FINRA settlement that found the firm violated FINRA's research analyst disclosure rules. In settling this matter, Morgan Stanley neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

    Bill Singer's Comment:

    For those of you who still desperately cling to the belief that allowing Wall Street to self regulate itself works, perhaps this case may yet change your mind.

    Consider that for a four-year period from April 2006 to June 2010, Morgan Stanley issued over 6,000 research reports with deficiences -- yet, amazingly, no regulator seemed to have had a clue about these violations. If I were being a truly obnoxious, sarcastic bastard, I might suggest that the regulators failed to timely detect Morgan Stanley's violations because Wall Street's cops were all hot on the trail of both Madoff and Stanford. But I"m not that crude a pundit. Course not. I mean, you know, it's not like Bernie and Sir Alan were up to their shenanigans for over a decade, right under the formidable noses of so many regulators.

    In April 2003, the U.S. Securities and Exchange Commission (SEC), the New York Stock Exchange (NYSE), the National Association of State Securities Administrators (NASAA), and the New York State Attorney General announced the final terms of the Global Settlement of Conflicts of Interest Between Research and Investment Banking (Global Settlement), which resulted from joint regulatory investigations into conflicts of interest between investment banking and securities research at brokerage firms.

    As a result of that high profile and much ballyhooed investigation, ten of the nation's top investment firms agreed to pay $1.4 billion:

    • $387.5 million of it in restitution to be returned to harmed investors through a process overseen by the SEC, and
    • $487.5 million in penalties.
    • Funds were also earmarked for investor education and to help pay for independent research for investors.

    And let us not forget that the regulators required that the settling firms also agreed to reforms in the way they do business to help prevent these conflicts in the future. Not only were the financial penalties supposed to send the proverbial message and get the big boys' attention, but they were also made to promise, no fingers crossed, cross my heart and hope to die, that they would change their wayward ways.

    FINRA is more than happy to toot its own horn when trumpeting its own settlements with the firms involved in the 2003 Global Settlement. Morgan Stanley's settlement with FINRA's predecessor, the NASD, resulted in the imposition of a Censure, $25 million fine, $25 million disgorgement, and $75 million earmarked for the "procurement of Independent Research." Add it up -- that's $125 million dollars. If nothing else, since 2003, someone at FINRA should have been paying attention to Morgan Stanley's compliance with the terms of the settlement. Hell, given all the bucks paid by the brokerage firm, at the very least FINRA could have hired one full time employee to do nothing but monitor Morgan Stanley!

    Then there is this odd tidbit from the August FINRA settlement. From August 2007 through February 2008, a period of six months, Morgan Stanley did not disclose in approximately 127,600 monthly account statements sent to customers that it had available independent, third-party research. That specific requirement to provide customers with this notification was part of the 2003 Research Analyst Settlement and was incorporated into a separate agreement with FINRA. Think about that. For six months statements went out that failed to disclose the availability of independent, third-party research -- a disclosure that was among the alleged keystone achievements of the 2003 settlement.

    Maybe I'm just dense but did anyone at the SEC or FINRA even bother to monitor Morgan Stanley's monthly statements for this mandated disclosure -- you know, like for even one month during the six in question? After all, hundreds of millions of dollars later, many promises later, years later, Morgan Stanley agreed to print a disclosure on its statements that indicated the availability of the independent research. Apparently, that disclosure didn't make it on to the statements. Sort of an easy omission to spot, no? And the excuse from Wall Street's cops is what? They were too busy on other more important things?

    We didn't see it. Is that the sorry state to which Wall Street's regulators have fallen? Of course, if you're not looking, you can't see anything.

    Moreover, given that FINRA is crediting "Morgan Stanley's self-review and self reporting of some of its disclosure violations. . ." you have to wonder whether any regulator would have uncovered this long-term, massive disclosure failure by Morgan Stanley but for the firm's own efforts to come clean.

    I guess that NASD/FINRA settlement didn't really get it done. Not for all the publicized million dollar fines and the self-aggrandizing regulatory publicity. After all, it was only three years after the 2003 Global Settlement that Morgan Stanley returned to its former errant ways. And for good measure, it appears that Morgan Stanley kept it up for more than four years. So much for self-regulation sending a meaningful message to its larger member firms.

    Of course, if this matter had involved, say, a smaller FINRA member firm, I'm sure that some heads would have rolled and folks would have been suspended, if not barred. But, things are as they are. The high and mighty on Wall Street get to write out fat checks and say "sorry." Line forms to the rear, get behind Goldman Sachs, then Morgan Stanley. No cutting in.

    READ THE FULL-TEXT NASD APRIL 2003 MORGAN STANLEY ACCEPTANCE, WAIVER AND CONSENT (AWC) SETTLEMENT at http://www.finra.org/web/groups/industry/@ip/@enf/@da/documents/industry/p007676.pdf

    READ THE FULL-TEXT FINRA AUGUST 2010 MORGAN STANLEY ACCEPTANCE, WAIVER AND CONSENT (AWC) SETTLEMENT http://www.finra.org/web/groups/industry/@ip/@enf/@ad/documents/industry/p121898.pdf