$2 Million Fine Exposes Conflicts of Interest Between Morgan Stanley Dean Witter and Its Customers

ecently the National Association of Securities Dealers (NASD) censured and fined Morgan Stanley Dean Witter (MSDW) $2 million for conducting mutual fund and variable annuity sales contests. The details of the prohibited conduct, which are revealed in the Letter of Acceptance, Waiver and Consent available on the NASD's website ( http://www.nasdr.com/news/pr2003/release_03_039.html) are further examples of Wall Street brokerage firms placing their own financial interests ahead of their customers' best interests.

Summary

Between 1999 and 2002, MSDW conducted at least 29 prohibited sales contests on national, regional and local (branch office) levels. The purpose was to encourage the sale of MSDW's own, proprietary mutual funds and certain variable annuity products. Valued at $1 million, the sales contest rewards offered or provided by MSDW included all-expense paid trips to resorts, basketball playoff tickets and concert tickets, as well as offered (but cancelled) vacations to Hawaii and the Caribbean.

These contests violated NASD rules because the contests impermissibly encouraged the sale of specific MSDW proprietary products distributed or offered by the firm, including:

Van Kampen mutual funds
Morgan Stanley Small-Mid Special Value Fund
Morgan Stanley American Opportunities Fund
Portfolio Architect
Financial Outlook and
Northbrook, Hartford, Travelers Variable Annuities

The Underlying Pressure to Sell Proprietary Products

NASD's investigation found that national managers pressured regional managers, who in turn pressured branch managers, to meet proprietary mutual fund sales goals. In one email regarding the MSDW Small-Mid Special Value Fund, a regional manager, "in strong terms" told branch managers that they were required to help achieve sales targets. During many of the sales contests, according to NASD findings, MSDW provided managers and brokers with updates, often daily, of each of their standings with respect to the sales contests at issue.

In fact, the conflict of interest extended beyond offering sales contests. NASD found that MSDW inappropriately encouraged the sale of its proprietary products overall. Specifically, MSDW national managers pressured regional managers, who in turn pressured branch managers, to increase the ratio of proprietary mutual fund sales versus non-proprietary mutual fund sales. One region ran a violative sales contest in 2002 called "Move Your Dial", which provided illegitimate incentives to increase the ratio of MSDW proprietary mutual fund sales.

Financial Incentives Provided to Managers

MSDW paid regional managers and branch managers a 'significant part of their compensation" as bonuses, consisting of "Management Incentive Compensation" and "Challenge Goal" bonuses. The NASD found that these bonuses were based in part on the regional and branch managers' ability to promote sales of proprietary mutual funds and meet their proprietary fund sales goals, as set by MSDW.

Additionally, branch manager compensation was tied directly to the profitability of their branches. Even apart from sales contests, branch managers stood to "earn" more compensation by selling MSDW proprietary funds to customers. The conflict of interest worked this way. Branches would retain a significantly greater percentage of their revenue on sales of proprietary mutual funds than sales of non-proprietary mutual funds. Managers also were rewarded with "leadership" conferences at domestic and international resorts based, in part, on their ability to meet their proprietary mutual fund sales goals.

Secret Nature of Prohibited Activities

The NASD found that, "MSDW apparently attempted to shield this focus on proprietary mutual funds from the public as much as possible to avoid public relations ramifications." The NASD based this finding on the fact that it discovered email messages by a regional manager directing branch managers and other employees to refrain from putting in writing the details regarding sales contests, as well as the fact that former MSDW branch managers corroborated the policy in their testimony before the NASD.

The Punishment

The NASD imposed a fine of $2 million, which is rather light in view of the systematic customer abuse perpetrated over a lengthy, three-year period.

However, investors may have recourse to compensate them for their losses associated with MSDW's wrongdoing. For example, state securities laws allow for the rescission of investments (or damages) when a material fact (for example, a conflict of interest) has been omitted or misrepresented. These and other claims may be filed in securities arbitration.

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James J. Eccleston is a securities attorney, representing customers as well as brokers and brokerage firms nationwide in arbitration, litigation and regulatory matters. He maintains an informative website at www.FinancialCounsel.com. He is an equity partner with Shaheen, Novoselsky, Staat, Filipowski & Eccleston, and can be reached at 312-621-4400.