Morgan Stanley Smith Barney (Morgan Stanley) has agreed to pay roughly $13 million to settle allegations it lacked the proper supervisory system to spot and prevent unsuitable short-term trading in certain client investments.
The Financial Industry Regulatory Authority (Finra) alleges that from January 2012 through June 2015, hundreds of Morgan Stanley representatives executed short-term unit investment trust (UIT) rollovers in thousands of customer accounts. In settling, the firm agreed to pay a $3.25 million fine and roughly $9.79 million in restitution. The firm did not admit or deny Finra’s findings.
As a result of the case, Finra launched a targeted exam in September 2016 looking at brokerages’ practices around UIT rollovers, officials say in a related filing.
A UIT is an SEC-registered investment company that offers shares or units in a portfolio of securities in a public offering. Generally, a UIT’s portfolio is not actively traded and follows a buy-and-hold strategy. A UIT terminates on a specified maturity date, often after 15 or 24 months, at which point the underlying securities are sold and the resulting proceeds are paid to the investors.
UITs impose a variety of sales charges and most UIT sponsors may charge a creation and development fee. Finra officials note, therefore, that a registered rep who repeatedly recommends the sale of a customer’s UIT position before the maturity date and rolls that investment into a new UIT would cause the customer to incur increased sale charges over time. The long-term nature of UITs, their structure and upfront costs mean short-term trading of UITs may be improper and raises suitability concerns, Finra officials write in the related regulatory filing.
During the period at issue, however, Morgan Stanley executed more than $33.4 billion in UIT transactions – generating more than $650 million in sales credits and commissions, including more than $5.2 billion in UIT transactions involving ‘early rollovers,’ defined by the firm as UITs rolled over more than 100 days before maturity, according to Finra.
The firm failed to establish and maintain a supervisory system and written supervisory procedures reasonably designed to detect and prevent unsuitable short-term trading of UITs, according to Finra.
The self-regulatory organization (SRO) alleges that Morgan Stanley failed to adequately supervise reps’ sales of UITs in a number of ways. For example, Finra says the firm’s compliance procedures noted that ‘UITs are intended to be long-term investments’ but offered insufficient guidance to supervisors regarding how they should monitor and review UIT transactions to detect unsuitable short-term trading, including short-term rollovers. The SRO also alleges that, during the period at issue, Morgan Stanley conducted no specific UIT training for registered reps.
In addition, Finra says Morgan Stanley had an inadequate system to detect potentially unsuitable short-term UIT rollovers. During the relevant time period, the firm’s order entry system alerted supervisors to short-term UIT ‘switches,’ which the firm’s procedures defined as the purchase of a UIT within 60 days of the sale of either an open-end mutual fund or UIT. When such a switch was identified, Finra says, the rep had to provide a justification for the switch, and a supervisor had to review and approve the transaction before it was executed.
But the SRO alleges that Morgan Stanley during this period excluded UIT rollovers from the definition of a switch in its policies and procedures – meaning that if a rep selected ‘rollover’ as the justification for a UIT switch in the firm’s order entry system, it was not routed to supervisors for review and approval before execution.
In June 2015, the firm modified its policies and procedures to include UIT rollovers in the switch definition, making UIT rollovers executed more than 100 days before maturity subject to the supervisory review and approval process, according to Finra.
Officials write that, in resolving the matter, Finra recognizes Morgan Stanley’s co-operation in having:
- Initiated, before regulatory intervention, a company-wide investigation to identify the scope of potentially unsuitable short-term UIT rollovers, including interviewing more than 65 company personnel and retaining an outside consultant to conduct a statistical analysis of UIT rollovers at the firm
- Identified customers harmed by potentially unsuitable short-term UIT rollovers and established a plan to remediate them
- Provided ‘substantial assistance’ to the SRO’s investigation.
A Morgan Stanley spokesperson says: ‘The firm is pleased to have resolved this matter and to have been recognized by Finra for its extensive co-operation.’
Ben Maiden
Ben Maiden is the editor-at-large of Governance Intelligence, an IR Media publication, having joined the company in December 2016. He is based in New York. Ben was previously managing editor of Compliance Reporter, covering regulatory and compliance...
