Morgan Stanley Settles ETF Investment Case -- Update

By Dave Michaels 

Morgan Stanley admitted Tuesday that it failed to properly oversee sales of complex exchange-traded funds to investors, agreeing to pay $8 million to settle a probe by the Securities and Exchange Commission.

The case marks the second time in five years that regulators have accused Morgan Stanley of inappropriate sales of inverse ETFs, products that move in the opposite direction of a market they track and that can be used to hedge other investments. In the latest case, Morgan Stanley in many cases didn't follow its procedures for selling the products, including getting a signed statement from clients attesting that they understood the risks, the SEC said.

A Morgan Stanley spokeswoman said the bank is "pleased to have resolved this matter" and declined to answer additional questions.

The SEC's move shows how regulators have ramped up their oversight of ETFs, funds that trade on exchanges like stocks and have proliferated in recent years as sponsors offer evermore complex and specialized strategies. Former SEC Chairman Mary Jo White said last year that the agency would further scrutinize ETFs, including how they are pitched by brokers and financial advisers.

Regulators and sponsors of leveraged and inverse ETFs warn they should be used as short-term investments because, due to the effects of compounding, their performance over longer periods will likely diverge from the index they are supposed to follow.

Morgan Stanley's wealth-management unit sold inverse ETFs from 2010 to 2015, the SEC said, and in many cases solicited clients using "retirement accounts with long-term horizons." Some clients held the funds for "months or years" and lost money on the investments, the SEC said in a settlement order.

In 2012, Morgan Stanley agreed to pay a $1.75 million fine to settle an investigation by the Financial Industry Regulatory Authority that accused its brokerage unit of similar misconduct. Finra, the brokerage industry's self-regulator, said Morgan Stanley sold inverse ETFs in 2008 and 2009 to investors who had conservative investment goals or risk appetites.

Even after that settlement, Morgan Stanley failed to sufficiently upgrade its oversight of financial advisers who sold inverse ETFs, the SEC's documents say. The firm couldn't find the required client statements for 44% of the accounts that purchased inverse ETFs from 2010 to 2015, the SEC said in its order. In those cases, according to the SEC, Morgan Stanley managers also failed to conduct appropriate risk checks to verify the investor didn't stake too much on the position or misunderstand the product.

Morgan Stanley also failed to heed warnings flagged by SEC examiners and its own internal auditors who raised questions about how the firm monitored sales of inverse ETFs, the SEC said. Morgan Stanley told the SEC examiners that its compliance systems didn't need to be improved, the SEC's documents said.

Write to Dave Michaels at [e-mail]

(END) Dow Jones Newswires

February 14, 2017 17:46 ET (22:46 GMT)

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