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MORGAN STANLEY & CO. * * * * * * * * * * * * * * * * * |
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CONSENT ORDER DOCKET NO. CO-10-7505-S |
I. PRELIMINARY STATEMENT
II. CONSENT TO WAIVER OF PROCEDURAL RIGHTS
WHEREAS, Morgan Stanley, through its execution of this Consent Order, voluntarily waives the following rights:
1. |
To be afforded notice and an opportunity for a hearing within the meaning of Sections 36b-15(f), 36b-27(a) and 36b-27(d)(2) of the Act and Section 4-177(a) of the General Statutes of Connecticut; |
2. |
To present evidence and argument and to otherwise avail itself of Sections 36b-15(f), 36b-27(a) and 36b-27(d)(2) of the Act and Section 4-177c(a) of the General Statutes of Connecticut; |
3. | To present its position in a hearing in which it is represented by counsel; |
4. | To have a written record of the hearing made and a written decision issued by a hearing officer; and |
5. | To seek judicial review of, or otherwise challenge or contest the matters described herein, including the validity of this Consent Order; |
NOW THEREFORE, the Commissioner, as administrator of the Act, hereby enters this Consent Order.
III. JURISDICTION AND CONSENT TO ENTRY OF CONSENT ORDER
Morgan Stanley admits the jurisdiction of the Commissioner, neither admits nor denies the Findings of Fact and Conclusions of Law contained in this Consent Order, and consents to the entry of this Consent Order by the Commissioner, for the sole purpose of settling this matter prior to a hearing. |
IV. FINDINGS OF FACT
Unethical Practices in the Offer and Sale of Auction Rate Securities
1. | Auction rate securities are financial instruments that include auction preferred shares of closed-end funds, municipal auction rate bonds, and various asset-backed auction rate bonds (collectively referred to herein as “ARS”). ARS are long-term instruments where the interest/dividend is reset weekly or monthly. |
2. |
Morgan Stanley participated in the marketing and sale of ARS. |
3. |
In certain instances, Morgan Stanley, through its salespeople, advised certain clients that ARS were safe, liquid investments, when in fact auction rate securities had significant liquidity risks associated with them. |
4. | Representatives of Morgan Stanley represented to certain customers of Morgan Stanley that ARS were short-term investments. In fact, because ARS are bonds with long-term maturities, their short-term liquidity was dependent on the successful operation of a bidding process known as a Dutch auction. Certain representatives of Morgan Stanley failed to disclose to certain customers with short-term liquidity needs that they might be unable to sell their ARS if the auction process failed. |
5. | In connection with the sale of ARS, certain Morgan Stanley salespeople told certain investors that ARS were “just like cash” and “liquid with seven days notice.” |
6. | Morgan Stanley marketed ARS to investors in a brochure entitled “Money Market Instruments.” In this brochure, ARS were listed under the subsection “Other Short-Term Instruments.” |
7. | Since it began participating in the auction rate securities market, Morgan Stanley submitted support bids - purchase orders for the entirety of an auction rate security issue for which it acted as the sole or lead broker. Support bids were Morgan Stanley proprietary orders that would be filled, in whole or in part, if there was otherwise insufficient demand in an auction. When Morgan Stanley purchased auction rate securities through support bids, auction rate securities were then owned by Morgan Stanley, and the holdings were recorded on Morgan Stanley’s balance sheet. For risk management purposes, Morgan Stanley imposed limits on the amounts of auction rate securities it could hold in inventory. |
8. |
Because many investors could not ascertain how much of an auction was filled through Morgan Stanley proprietary trades, they could not determine if auctions at Morgan Stanley were clearing because of normal marketplace demand, or because Morgan Stanley was making up for the lack of demand through support bids. Generally, investors were also not aware that the liquidity of the auction rate securities as to which Morgan Stanley was the managing broker-dealer depended on Morgan Stanley’s continued use of support bids. While Morgan Stanley could track its own inventory as a measure of the supply and demand for its auction rate securities, ordinary investors had no comparable ability to assess the operation of Morgan Stanley’s auctions. There was no way for such investors to monitor supply and demand in the market or to assess when broker-dealers might decide to stop supporting the market, thereby causing its collapse. |
9. | Starting in August 2007, the credit crisis and other deteriorating market conditions strained the auction rate securities market. Some institutional investors withdrew from the market, decreasing demand for auction rate securities. |
10. | The resulting market dislocation should have been evident to Morgan Stanley. Morgan Stanley’s support bids filled the increasing gap in the demand in its auctions for auction rate securities, sustaining the impression that the demand for auction rate securities had not decreased. As a result, Morgan Stanley’s auction rate securities inventory grew significantly, requiring Morgan Stanley to raise its risk management limits on its auction rate securities inventory. |
11. | From the Fall of 2007 through February of 2008, demand for auction rate securities continued to erode and Morgan Stanley’s auction rate securities inventory reached unprecedented levels. Morgan Stanley eventually became aware of the increasing strains in the auction rate securities market, and recognized the potential for widespread market failure. Morgan Stanley never disclosed these increasing risks of owning or purchasing auction rate securities to its customers. |
12. |
In February 2008, Morgan Stanley and other firms stopped supporting the auctions. Without the benefit of support bids, the auction rate securities market collapsed, leaving investors who had been led to believe that these securities were cash alterative investments appropriate for managing short-term cash needs, holding long-term or perpetual securities that could not be sold at par value until and if the auctions cleared again. |
Failure to Supervise
13. |
Although ARS are complex products, Morgan Stanley did not provide its sales or marketing staff with the training necessary to adequately explain these products or the mechanics of the auction process to their customers. |
14. |
Morgan Stanley did not adequately train all of its brokers and financial advisers regarding the potential illiquidity of ARS, including the fact that Morgan Stanley might stop supporting the market. |
V. CONCLUSIONS OF LAW
15. | The Commissioner has jurisdiction over this matter pursuant to the Act. |
16. |
The Commissioner finds that Morgan Stanley failed to supervise its employees and engaged in dishonest or unethical practices in the securities business, that this conduct violates Sections 36b-4(b) of the Act and Section 36b-31-6f(b) of the Regulations, and forms the basis for a proceeding under Section 36b-15(a) of the Act. |
17. |
The Commissioner finds that this Consent Order and the following relief are appropriate, in the public interest, and consistent with the purposes fairly intended by the policies and provisions of the Act. |
VI. CONDITIONS PRECEDENT TO ENTRY OF CONSENT ORDER
Definitions For purposes of these Conditions Precedent and this Consent Order, the following terms shall have the meanings specified:
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Requirement to Repurchase ARS from Retail ARS Investors
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Relief for Investors Who Sold Below Par
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Claims for Consequential Damages
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Institutional Investors
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Relief for Municipal Issuers
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Review of Customer Accounts
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VII. CONSENT ORDER
On the basis of the Findings of Fact, Conclusions of Law, and Morgan Stanley’s consent to the entry of this Consent Order,
IT IS HEREBY ORDERED THAT:
1. |
This Consent Order concludes the investigation by the Division and any other action that the Commissioner could commence under the Act on behalf of Connecticut as it relates to Morgan Stanley’s marketing and sale of auction rate securities to Morgan Stanley’s Retail ARS Investors as defined herein. Specifically excluded from and not covered by this paragraph are any claims by the Commissioner arising from or relating to the Consent Order provisions herein contained; |
2. |
This Consent Order is entered into solely for the purpose of resolving the investigation into Morgan Stanley’s marketing and sale of auction rate securities to Morgan Stanley Retail ARS Investors, and is not intended to be used for any other purpose; |
3. |
Morgan Stanley shall CEASE AND DESIST from violating the Act or any regulation or order under the Act, and shall comply with the Act, its regulations and any order under the Act; |
4. |
Within ten (10) days after the entry of this Consent Order by the Commissioner, Morgan Stanley shall pay to the “Treasurer, State of Connecticut”, by electronic funds transfer or wire transfer, the sum of Nine Hundred Nine Thousand Ninety Four and 71/100 Dollars ($909,094.71) as a fine. If Morgan Stanley fails to make the payment described in this paragraph, the Commissioner may, at the Commissioner’s sole discretion, pursue any legal remedies, including but not limited to initiating an action to enforce this Consent Order, revoking Morgan Stanley’s registration under the Act or vacating this Consent Order; |
5. |
In the event another state securities regulator determines not to accept Morgan Stanley’s settlement offer, the total amount of the payment to the State of Connecticut shall not be affected, and shall remain at Nine Hundred Nine Thousand Ninety Four and 71/100 Dollars ($909,094.71); |
6. |
To the extent that Morgan Stanley agrees to any subsequent settlement with any NASAA jurisdiction arising out of the above-referenced coordinated investigations pertaining to Morgan Stanley’s marketing and Sale of Eligible ARS to Retail ARS Investors as described herein, which includes a term or terms analogous to the terms herein which are more favorable to Retail ARS Investors in such NASAA jurisdiction than those terms identified herein, the subsequent more favorable settlement term or terms shall, upon the Commissioner’s request, be incorporated by reference into this Consent Order and become equally applicable to Connecticut Retail ARS Investors; |
7. | Nothing herein shall preclude Connecticut, its departments, agencies, boards, commissions, authorities, political subdivisions and corporations, other than the Commissioner and only to the extent set forth in paragraph 1 above, (collectively, “State Entities”) and the officers, agents or employees of State Entities from asserting any claims, causes of action, or applications for compensatory, nominal and/or punitive damages, administrative, civil, criminal, or injunctive relief against Morgan Stanley in connection with auction rate securities practices at Morgan Stanley; |
8. | This Consent Order shall not disqualify Morgan Stanley or any of its affiliates or current or former employees from any business that they otherwise are qualified or licensed to perform under applicable state law, and this Consent Order is not intended to form the basis for any disqualification; |
9. | This Consent Order shall not operate to disqualify Morgan Stanley, its affiliates or current or former employees, from relying, to the extent applicable, upon the registration exemptions or registration safe harbor provisions contained in the federal securities laws, the rules and regulations thereunder, the rules and regulations of self regulatory organizations or any states’ or U.S. Territories’ securities laws. In addition, this Consent Order is not intended to form the basis for any such disqualification, nor is it intended to form the basis of a statutory disqualification under Section 3(a)(39) of the Securities Exchange Act of 1934; |
10. | For any person or entity not a party to this Consent Order, this Consent Order does not limit or create any private rights or remedies against Morgan Stanley, nor does it limit or create liability of Morgan Stanley, or limit or create defenses of Morgan Stanley; |
11. | This Consent Order and any dispute related thereto shall be governed and construed in accordance with the laws of the State of Connecticut without regard to any choice of law principles; and |
12. | This Consent Order shall be binding upon Morgan Stanley and its successors and assigns as well as the successors and assigns of relevant affiliates with respect to all conduct subject to the provisions herein and all future obligations, responsibilities, undertakings, commitments, limitations, restrictions, events and conditions. |
NOW THEREFORE, the Commissioner enters the following:
1. | The Findings of Fact, Conclusions of Law and Consent Order set forth above, be and are hereby entered; |
2. | Entry of this Consent Order by the Commissioner is without prejudice to the right of the Commissioner to take enforcement action against Morgan Stanley based upon a violation of this Consent Order or the matters underlying its entry, if the Commissioner determines that compliance with the terms herein is not being observed or if any representations made by Morgan Stanley and reflected herein are subsequently discovered to be untrue; and |
3. | This Consent Order shall become final when entered. |
So ordered at Hartford, Connecticut | _______/s/_________ | |
this 7th day of July 2010. | Howard F. Pitkin | |
Banking Commissioner |
CONSENT TO ENTRY OF ORDER
I, Eric Grossman, state on behalf of Morgan Stanley & Co. Incorporated, that I have read the foregoing Consent Order; that I know and fully understand its contents; that I am authorized to execute this Consent Order on behalf of Morgan Stanley & Co. Incorporated; that Morgan Stanley & Co. Incorporated agrees freely and without threat or coercion of any kind to comply with the terms and conditions stated herein; and that Morgan Stanley & Co. Incorporated voluntarily consents to the entry of this Consent Order, expressly waiving any right to a hearing on the matters described herein. Morgan Stanley & Co. Incorporated further agrees that it shall not claim, assert, or apply for a tax deduction or tax credit with regard to any state, federal or local tax for any administrative monetary penalty that Morgan Stanley & Co. Incorporated shall pay pursuant to the foregoing Consent Order.
Morgan Stanley & Co. Incorporated | |
By: | ______/s/__________________ |
Eric Grossman | |
General Counsel of the Americas |
County of: New York
On this the 2nd day of July, 2010, before me, the undersigned officer, personally appeared Eric Grossman, who acknowledged himself to be the General Counsel of the Americas of Morgan Stanley & Co. Incorporated, a corporation, and that he, as such General Counsel of the Americas, being authorized to do so, executed the foregoing instrument for the purposes therein contained, by signing the name of the corporation by himself as General Counsel of the Americas.
In witness whereof I hereunto set my hand.
_____/s/_____________________
Notary Public
Date Commission Expires: 7/9/11