Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Wednesday, November 16, 2011

Morgan Stanley Settles SEC Allegations that Adviser Charged Fees for Non-Existent Services

The SEC 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.  According to the SEC, 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.

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

“We want to take the advisory fee setting process out of the shadows by scrutinizing the role of investment advisers and fund board members in vetting fee arrangements with registered funds,” said Robert Khuzami, Director of the SEC’s Division of Enforcement.

The SEC’s order finds that MSIM willfully violated Sections 15(c) and 34(b) of the Investment Company Act and Sections 206(2) and (4) of the Investment Advisers Act of 1940, and Rule 206(4)-7 thereunder. Without admitting or denying the SEC’s findings, MSIM agreed to a censure and to cease and desist from committing or causing any violations and any future violations of those provisions. MSIM agreed to repay the fund $1.845 million for the sub-adviser’s fees and pay a $1.5 million penalty. MSIM also agreed to implement policies and procedures specifically governing the Section 15(c) process and its oversight of service providers.

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Here are some pointed Questions Judge Rakoff might ask the SEC before approving the Morgan Stanley settlement.

1. You say the board of directors approved these contracts each year yet you have not charged the board with any violation of the Investment Company Act? Don’t the directors, whom the Supreme Court has said are the watchdogs for investors, have a duty to obtain information about a fund’s service provider before they approve a contract with that provider? If so, do you believe the board acted responsibly at all times? If they have not acted responsibly, why have no directors even been censured?

2. You state that “In early 2008, after Commission examination staff inquired into the Fund’s relationship with the sub-adviser, the sub-adviser’s services were terminated.” Why did the board not seek at that time to have the fund reimbursed for all of the past fees paid by the Fund to the sub-advisor?

3. You do not indicate whether MSIM received any quid pro quo from the sub-advisor for recommending that the board approve these unnecessary contracts. The Court thinks this is a question that deserves an answer since there is no apparent motive for the advisor to have made such a recommendation.

Posted by: Dissident | Nov 18, 2011 7:51:05 AM

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