Securities Regulation Daily Morgan Stanley Smith Barney to pay $5 million after charged with misleading about retail wrap fee programs
Tuesday, May 12, 2020

Morgan Stanley Smith Barney to pay $5 million after charged with misleading about retail wrap fee programs

By Rodney F. Tonkovic, J.D.

The firm will pay a $5 million penalty that will benefit investors.

Morgan Stanley Smith Barney has settled charges that it gave misleading information to clients participating in its retail wrap fee programs. According to the SEC, MSSB's marketing and client communications led clients in wrap fee program accounts to believe that the firm executed most of their trades and that they would not incur transaction-based charges. However, the trades were regularly directed to third-party broker-dealers for execution, resulting in the clients paying additional execution costs that were not visible to them and paying a wrap fee that included execution services that were not rendered by MSSB. To settle the charges, the firm agreed to a $5 million penalty that will be distributed to the harmed investors (In the Matter of Morgan Stanley Smith BarneyRelease No. 34-88856, May 12, 2020).

Wrap fees. At issue in this matter are wrap fee program accounts, in which a client pays an asset-based "wrap fee" covering investment advice and brokerage services. Morgan Stanley Smith Barney (MSSB) offered wrap fee accounts to clients via marketing materials stating that they would receive investment advice, trade execution and other services with a transparent fee structure that would streamlines and simplify client expenses.

According to the Commission, between October 2012 and June 2017, MSSB provided incomplete information concerning the trade execution services provided by MSSB and the transaction-based execution costs incurred by clients in wrap fee program accounts. Specifically, clients were led to believe that MSSB executed most of their trades and that the clients would not incur transaction-based charges. During the period at issue, however, MSSB knew that some of its managers routinely directed wrap fee clients' trades to third parties for execution. In some instances, this practice resulted in the clients paying transaction-based charges that were not visible to them (in addition to the wrap fee).

The Commission found that MSSB's clients were unable to fully assess the value of the services they received in exchange for the wrap fees. A reasonable client reviewing the marketing materials and his or her account documents could conclude that additional costs were possible, but not the usual course of business; but, for certain clients, this was not the case. "Investment advisers are obligated to fully inform their clients about the fees that clients will pay in exchange for services," said Melissa R. Hodgman, Associate Director in the SEC's Division of Enforcement. "The SEC’s order finds that Morgan Stanley Smith Barney failed to provide certain clients in its retail wrap fee programs accurate information about the costs they incurred for the services they received."

Violations. The Commission found that MSSB violated the antifraud provisions of Investment Advisers Act Sections 202(2) and the requirement to adopt written policies to prevent violations contained in Section 206(4) and Rule 206(4)-7. In addition to censure and a cease and desist order, MSSB agreed to pay a civil penalty in the amount of $5 million, which will be distributed to harmed investors. The Commission also issued an order under Securities Act Rule 405 granting Morgan Stanley and Morgan Stanley Finance LLC a waiver from being considered "ineligible issuers" as a result of the proceedings against Morgan Stanley Smith Barney.

The release is No. 34-88856.

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