The National Association of Securities Dealers said Tuesday it has fined an arm of the investment firm Morgan Stanley $1.5 million and ordered the firm to pay more than $4.6 million in restitution for failing to adequately supervise its fee-based brokerage business.
More than 3,500 Morgan Stanley DW Inc. customers will be receiving restitution, the NASD said.
Fee-based brokerage accounts are an alternative to traditional commission-based accounts. In a fee-based account, a customer is charged an annual fee that is either fixed or a percentage of the assets in the account, rather than a commission for each transaction as in a traditional brokerage account.
"Fee-based accounts can be appropriate for a wide range of customers," said NASD Vice Chairman Mary L. Schapiro. "But firms have an obligation to their customers to periodically reassess whether a fee-based account, like that offered by Morgan Stanley, remains appropriate. Firms must have systems and procedures in place that adequately evaluate the continued appropriateness of these accounts for their customers."
The firm neither admitted nor denied the charges, but consented to the entry of NASD's findings.
The Securities and Exchange Commission issued a report in 1995 — known as the Tully Report — noting that fee-based accounts are appropriate for investors who are building assets in their accounts, and may be appropriate for investors with moderate trading activity. However, it also noted that because of the imposed annual fee, small and low-trading-activity accounts would pay higher costs as a fee-based account than as a commission-based account.
The following year, Morgan Stanley began offering its customers a fee-based brokerage account program, now known as "Morgan Stanley Choice." NASD found that Morgan Stanley recognized and instructed its brokers, consistent with its report, that Choice accounts were not appropriate for certain categories of investors, including buy-and-hold customers and certain accounts that fall below $50,000.
The firm typically required a minimum of $50,000 in eligible assets to open a Choice account and charged an annual fee based on the total amount and type of eligible assets held in the account.
NASD found that between 2001 and 2003, all Choice accounts or Choice account groups, regardless of size, paid a minimum annual fee of $1,000. By the end of 2001, the firm had 129,630 Choice accounts, holding $19.8 billion in assets. Morgan Stanley had 176,274 Choice accounts holding $30.6 billion in assets by the end of 2003.
NASD said its investigation showed that from January 2001 through December 2003, Morgan Stanley failed to establish and maintain a supervisory system reasonably designed to review and monitor its fee-based brokerage business to determine whether Choice accounts remained appropriate for its customers.
The NASD said that as a result of the firm's deficient system and procedures, Morgan Stanley allowed 3,549 of its customers to continue using Choice accounts without adequately reassessing whether the accounts remained appropriate for them.
These customers, who either conducted no trades in their Choice accounts for at least two consecutive years or had Choice accounts whose assets averaged below $25,000 for at least one full year, or both, will be receiving restitution under the settlement announced today.
The NASD said this case is part of its continuing focus on fee-based brokerage accounts. In April, NASD fined Raymond James & Associates Inc. $750,000 and ordered the firm to pay $138,000 in restitution for fee-based account violations.