In a curious case of absent oversight, Morgan Stanley Investment Management has been fined $1.5 million by the Securities and Exchange Commission (SEC) for improperly charging a fund it manages for investment advisory services that were never performed.
Morgan Stanley Investment Management is a wholly owned subsidiary of Morgan Stanley. From 1996 to 2007, it charged The Malaysia Fund Inc. about $1.845 million pursuant to a research and advisory agreement with AMMB Consultant Sendirian Berhad. Under the agreement, AMMB was supposed to provide advice, research, and assistance to Morgan Stanley for the benefit of the fund, according to a Nov. 16 cease and desist order from the SEC that serves to settle the charges.
All AMMB did was send Morgan Stanley two reports per year on the state of the Malaysian market comprising information that could have been gathered by anyone with an Internet connection. Nonetheless, for more than 10 years, Morgan Stanley kept passing the AMMB charges onto the fund, despite having agreed to monitor AMMB’s performance, the SEC order said
As a condition of the settlement, Morgan Stanley was censured and will reimburse the fund the $1.845 million it shelled out for AMMB, less a credit of $543,000 that has already been paid back.
Morgan Stanley also agreed to cease and desist from committing or causing any violations and any future violations of Sections 15(c) and 34(b) of the Investment Company Act, and Sections 206(2) and 206(4) of the Advisers Act and various rules thereunder, the order said.
The cease and desist order also directs Morgan Stanley to implement and policies and procedures within 45 days to improve its Section 15(c) processes and its oversight of advisers and sub-advisers, principal underwriters, administrators, and transfer agents. Section 15(c) concerns the renewal of services contracts and the gathering of information to ensure accurate evaluations of such contracts.
The policies and procedures include requiring Morgan Stanley personnel with direct knowledge of a service agreement to review and verify the services performed, obtain an annual certification from the service provider that the services were performed, and provide accurate descriptions of the service providers and their services to its clients, the order said.
This latter measure includes ensuring that personnel with knowledge of a given agreement and the services it covers will review descriptions of the services providers contained in a registration statement, application, report, account, record, or other document filed or transmitted pursuant to the Investment Company Act, as well as any financial statements and marketing materials.
Morgan Stanley was also directed to certify to the SEC that it has implemented these policies and procedures within 60 days of their completion.
The Malaysia Fund Inc. is a closed-end investment company launched and managed by Morgan Stanley in 1987 to invest in the equity securities of Malaysian companies. As of June 30, 2011, the fund reported net assets of $93.8 million. Morgan Stanley is the fund’s the primary investment adviser.
The two signed a written advisory agreement in 1987 for investment management services, including investment trading and maintenance of the books and records. The fund pays Morgan Stanley an annual fee of 0.90 percent of the fund’s first $50 million of average weekly net assets, with the percentage decreasing incrementally to 0.50 percent of the fund’s average weekly net assets in excess of $100 million. Morgan Stanley is also the fund’s administrator, for which it receives additional fees.
AMMB, of Kuala Lumpur, Malaysia, is a wholly owned subsidiary of AM Bank Group, one of the largest banking groups in Malaysia. It was an investment adviser registered with the SEC from 1987 until February 2008, when it withdrew its registration.
As part of the agreement between the fund, Morgan Stanley and AMMB, Morgan Stanley was supposed to assist AMMB in making the relationship as productive as possible. It was also supposed to give guidance to AMMB on working procedures -- and most to the point -- monitor AMMB’s performance of services, the order said.
The funds board of directors approved AMMB’s fees each year based on Morgan Stanley’s representations, the SEC order said. As a result, it paid $1.845 million to the sub-adviser between 1996 and the end of 2007 for advisory services it did not receive. In early 2008, after the SEC began to look into the fund’s relationship with AMMB, its services were terminated.
Per the service agreement that the fund paid out on for so long, AMMB collected fees at an annual rate of 0.25 percent for the first $50 million of average weekly net assets, 0.15 percent for the next $50 million and 0.10 percent of assets in excess of $100 million.
Every year the contract lasted, AMMB sent a report to Morgan Stanley that falsely claimed it was providing specific research, intelligence, and advice to Morgan Stanley. The purpose of the report, according to the SEC order, was to provide the fund’s board of directors with the information it needed to evaluate the terms of the sub-adviser agreement.
In each of these reports, AMMB said that it provided the following services to Morgan Stanley on behalf of the fund: research on Malaysian companies to identify and recommend stocks for investment; statistical reports to help with investment decisions; market intelligence on local corporate developments; and advice on changes in economic and political conditions in Malaysia. The report also listed personnel and included AMMB’s unaudited financial statements, the order said.
Despite the fact that very little of the information listed above was ever imparted to Morgan Stanley, the investment management company submitted these reports to the fund’s board as it considered renewal of the AMMB advisory agreement.
Morgan Stanley also submitted two compliance reports to the fund and its shareholders that indicated AMMB was providing the advisory services, when actually these services were limited to two minor monthly reports, which Morgan Stanley’s portfolio management team did not even use.
Section 15(c) of the Investment Company Act requires an investment adviser to furnish such information as may reasonably be necessary for its client to evaluate the terms of any contract whereby any person or entity agrees to act as investment adviser.
The SEC’s order stated that Morgan Stanley did not provide The Malaysia Fund’s board with information reasonably necessary for the board to evaluate the nature, quality, and cost of AMMB’s services. Morgan Stanley represented to the board and the funds investors that AMMB was providing advisory services for the benefit of the fund when it was doing no such thing.
Full text: http://www.sec.gov/litigation/admin/2011/ia-3315.pdf