SEC Settlement with Major Investment Firm Results in $5M Fund Benefitting Harmed Wrap Fee Program Investors

Investment firm, Morgan Stanley Smith Barney, LLC (MSSB), recently settled charges brought by the U.S. Securities and Exchange Commission (SEC) that the company misled retail investment clients about trade execution services and transaction costs related to its retail wrap fee programs.

Without admitting or denying the SEC findings, MSSB agreed to a Cease-and-Desist Order and remedial sanctions which included payment of a $5 million penalty. The penalty funds will be distributed to harmed investors.

MSSB was one of the largest sponsors of wrap fee programs in the nation from at least October 2012 until June 2017, the period in which the SEC alleged that MSSB was negligent in providing complete and accurate information regarding trade execution services and transaction-based execution costs incurred by certain retail clients in the wrap fee program.1 A wrap fee is a comprehensive charge, generally a percentage of the assets under management, levied on a client by an investment professional for providing a bundle of services such as investment advice, investment research and brokerage services.2

One advantage of a wrap fee is that it is less complicated for the client as they are only charged one set fee and another advantage is that a wrap fee discourages brokers from making trades to generate higher commissions.

The SEC asserted that from at least October 2012 to June 2017 MSSB led retail clients in the wrap program to believe that MSSB executed most client trades and that the clients did not incur transaction-based charges. In fact, MSSB marketed its wrap fee accounts as offering clients professional investment advice, trade execution, and other services within a “transparent” fee structure.3

The SEC alleges that MSSB knew that some wrap managers directed most, and sometimes all, client trades to third-party broker-dealers for execution. Clients were then levied transaction-based charges but these charges were not revealed to them. Some MSSB clients were not aware that they were actually regularly paying execution costs in addition to the MSSB wrap fee charges. Clients were also not aware that, contrary to what they had been told, MSSB did not routinely, if ever, execute their transactions.

The SEC maintained that MSSB did not have an adequate system to detect when wrap managers directed trades to MSSB affiliated broker-dealers resulting in client’s incurring transaction-based charges — a violation of MSSB’s own affiliate trading policies.

Morgan Stanley oversaw $2.4 trillion of client assets, including $1.13 trillion from fee-based clients, as of March 31, according to a regulatory filiing.4 “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 .5 “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.”

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1 United States Securities and Exchange Commission Order in the Matter of Morgan Stanley Smith Barney, 5/12/2020

2 Wrap Fee, by Julia Kagan, www.investopiedia, 1/3/2018

3, 5 SEC Charges Morgan Stanley Smith Barney with Providing Misleading Information to Retail Clients, 5/12/2020

4 Morgan Stanley Pays $5M Fine to Settle SEC Charges it Misled Investing Clients, by Jonathan Stempel, 5/12/2020