Improper Fee Suit Hits Morgan Stanley

Jack Humphrey, Regulatory journalist
November 17, 2011 /

The Securities and Exchange Commission has charged Morgan Stanley Investment Management (MSIM) with violating securities laws in a fee arrangement that repeatedly charged a fund and its investors for advisory services they weren’t actually receiving from a third party.

The SEC’s case was handled by Chad Alan Earnst, Christine Lynch, and Jessica Weiner, members of the Asset Management Unit in the Miami Regional Office, and Tonya Tullis, staff accountant. Karen Stevenson, Susan Schneider, and Dennis Delaney from the SEC’s Washington D.C. office conducted the related examinations.

The SEC’s Enforcement Division Asset Management Unit has been focused on fee arrangements with registered funds. The SEC’s investigation found that MSIM — the primary investment adviser to The Malaysia Fund — represented to investors and the fund’s board of directors that it contracted a Malaysian-based sub-adviser to provide advice, research and assistance to MSIM for the benefit of the fund, which invests in equity securities of Malaysian companies.

The sub-adviser did not provide these purported advisory services, yet the fund’s board annually renewed the contract based on MSIM’s representations for more than a decade at a total cost of $1.845 million to investors.

MSIM agreed to pay more than $3.3 million to settle the SEC’s charges. It also agreed to repay the fund $1.845 million for the sub-adviser’s fees and pay a $1.5 million penalty.

The SEC’s Asset Management Unit has an initiative inquiring into the investment advisory contract renewal process and fee arrangements in the fund industry.

According to the SEC’s order instituting the settled administrative proceedings, The Malaysia Fund’s board of directors evaluated and approved the sub-adviser fees each year from 1996 to 2007 based on MSIM’s representations during what’s known as the “15(c) process.”

Under securities law, investment advisers are required to provide a fund’s board with information that is reasonably necessary to evaluate the terms of any contract whereby a person undertakes regularly to serve as an investment adviser of a registered investment company.

According to the SEC’s order, MSIM arranged The Malaysia Fund’s sub-advisory agreement with a subsidiary of AM Bank Group, one of the largest banking groups in Malaysia.

Despite the research and advisory agreement stating that the AM Bank Group subsidiary (AMMB) would provide MSIM with “investment advice, research and assistance, as [MSIM] shall from time to time reasonably request,” the SEC found that AMMB merely provided two monthly reports based on publicly available information that MSIM neither requested nor used in its management of the fund.

Furthermore, MSIM’s oversight and involvement with AMMB during the relevant time period were wholly inadequate. MSIM had no written procedures specifically governing its oversight of sub-advisers, and did not have a procedure in place for reviewing work done by AMMB.

According to the SEC’s order, MSIM also was responsible for preparing and filing the fund’s annual and semi-annual reports to shareholders. The fund’s filings stated that for an advisory fee, AMMB provided MSIM with “investment advice, research and assistance.”

Since AMMB was not providing any advisory services, MSIM prepared and filed false information in the annual and semi-annual reports.

According to the SEC’s order, the fund’s sub-adviser contract with AMMB was terminated in early 2008 after the SEC’s examination staff inquired into the fund’s relationship with the sub-adviser.

The SEC’s investigation is continuing.

 

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