Morgan Stanley Fined by FINRA for Failing to Supervise a Registered Representative
There are some investments that because of their upfront sales charges are only advantageous to investors if they are held for a long-term. On August 12, 2020, the U.S. Financial Industry Regulatory Authority (FINRA) entered into a settlement with Morgan Stanley Smith Barney LLC, for failing to reasonably supervise one of their registered representatives who recommended short-term trades of corporate bonds and preferred securities in the accounts of ten customers from January 2012 through December 2017.1 Those customers suffered losses of more than $900,000. 2
Hundreds of times during the time period stated, the registered representative, identified only as KG, recommended that customers buy, and then promptly sell, corporate bonds or preferred securities. FINRA Rule 2111 requires registered representatives to have a “reasonable basis to believe that a recommended securities transaction or investment strategy is suitable for the customer, based on information obtained through the reasonable diligence of the firm or associated person to ascertain the customer’s investment profile.”3 FINRA Rule 3110 and its predecessor, NASD Rule 3010, require “that each member firm take reasonable steps to ensure that the activities of each associated person comply with applicable securities laws and regulations, investigate red flags of potential misconduct, and take appropriate action when misconduct has occurred.”4
When KG recommended the short-term trades of corporate bonds and preferred securities, Morgan Stanley’s automated alert system identified 100 separate issues. The alert system flags trading activity and accounts that warrant further review by a supervisor, including alerts that identify accounts in which the trading exceeds certain turnover and cost-to-equity ratios.5 A Morgan Stanley representative did discuss the alerts with KG and even contacted affected customers to confirm whether they were satisfied with KG and his recommendations.
In September 2014, over two years after some of the short-term trades were executed, the Central Compliance Department at Morgan Stanley reviewed KG’s securities recommendations. They concluded that his recommendations were “generating high costs/commissions and the products/investment strategies were costing the clients more money than they were making the clients.”6 Even after that review was conducted and conclusions drawn, FINRA alleges that Morgan Stanley didn’t take sufficient actions to address the issue, as those 10 affected customer accounts continued to generate alerts for potentially excessive turnover and cost-to-equity ratios. It wasn’t until January 2016 that Morgan Stanley instructed KG to stop short-term trading in corporate bonds and preferred securities in all of his customer accounts. Even with those instructions, KG still executed a small number of short-term trades in some customer accounts between June 2016 and December 2017.
In the settlement with FINRA, Morgan Stanley neither admitted nor denied FINRA’s findings. They agreed to a censure and to pay a $175,000 fine and restitution to those affected customers in the amount of $774,574.08 plus interest.7
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1,3,4, 6 Financial Industry Regulatory Authority Letter of Acceptance, Waiver and Consent No. 2019063917801
2 FINRA fines Morgan Stanley for failure to reasonably supervise representative
5,7 Morgan Stanley Accepts $175.000 Fine from FINRA to Settle Charges, by Celeste Skinner, 8/13/2020