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STATE OF
OFFICE OF SECURITIES
121 STATE HOUSE STATION
AUGUSTA, ME 04333
In the matter of MORGAN STANLEY
& CO. INCORPORATED , Respondent. |
) ) ) ) ) ) ) ) |
CONSENT ORDER No. 03-106 |
WHEREAS,
Morgan Stanley & Co. Incorporated (“Morgan
Stanley”) is a broker-dealer licensed in the state of
WHEREAS,
coordinated investigations into Morgan Stanley’s practices, procedures
and conduct respecting the preparation and issuance by Morgan Stanley’s U.S.
equity research analysts (“research analysts”) of research, analysis, ratings,
recommendations and communications concerning common stocks of publicly traded
companies covered by such analysts (“research coverage”), during the period
1999 through 2001, including without limitation, commencement and
discontinuance of research coverage, actual or potential conflicts of interests
affecting research coverage, research analysts or termination of research
analysts, and statements, opinions, representations or non-disclosure of
material facts in research coverage (the “investigations”) have been conducted by a multi-state task
force and a joint task force of the U.S. Securities and Exchange Commission,
the New York Stock Exchange, and the National Association of Securities Dealers
(collectively, the “regulators”);
WHEREAS,
Morgan Stanley has cooperated with regulators conducting the investigations by
responding to inquiries, providing documentary evidence and other materials,
and providing regulators with access to facts relating to the investigations;
WHEREAS,
Morgan Stanley has advised regulators of its agreement to resolve the
investigations;
WHEREAS,
Morgan Stanley agrees to implement certain changes with respect to its research
practices and stock allocation, and to make certain payments; and
WHEREAS,
Morgan Stanley elects to permanently waive any right to a hearing and appeal
under 32 M.R.S.A. §§ 10708-10709
with respect to this Consent Order (the “Order”);
NOW, THEREFORE, the Securities
Administrator of the State of Maine Office of Securities, as administrator of the Revised Maine Securities Act, 32
M.R.S.A. §§ 10101-10713, hereby enters
this Order:
I.
Morgan
Stanley admits the jurisdiction of the Office of Securities, neither admits nor
denies the Findings of Fact and Conclusions of Law contained in this Order, and
consents to the entry of this Order by the Securities Administrator.
1.
Morgan Stanley is, and was at all relevant
times, a
2.
The Office
of Securities has jurisdiction over this matter pursuant to the Revised
Maine Securities Act, 32 M.R.S.A. §§ 10101-10713.
3.
From at
least July 1999 through 2001, Morgan Stanley engaged in acts and practices that
created conflicts of interest for its research analysts with respect to
investment banking activities and considerations. Morgan Stanley failed to manage those
conflicts in an adequate or appropriate manner.
Some conflicts resulted from the fact that Morgan Stanley compensated
its research analysts, in part, based on the degree to which they helped
generate investment banking business for Morgan Stanley. Morgan Stanley also offered research coverage
by its analysts as a marketing tool to gain investment banking business. As a result, Morgan Stanley research analysts
were faced with a conflict of interest between helping generate investment
banking business for Morgan Stanley and their responsibilities to publish
objective research reports that, if unfavorable to actual or potential banking
clients, could prevent Morgan Stanley from winning that banking business.
4.
As lead
underwriter in various stock offerings, Morgan Stanley also
complied with the issuers’ directives to pay portions of the underwriting fees
to other broker-dealers that served as underwriters or syndicate members to
publish research reports on the issuer.
Morgan Stanley did not take steps to ensure that these broker-dealers
disclosed these payments in their research reports. Further, Morgan Stanley did not cause the
payments to be disclosed in the offering documents or elsewhere as being for
research.
5.
Morgan
Stanley also failed to reasonably supervise its analysts regarding the content
of their research reports.
I. 1. BACKGROUND
A. The Investment Banking Function at
Morgan Stanley
6. The investment banking division at Morgan
Stanley advised corporate clients and helped them execute various financial
transactions, including the issuance of stock and other securities. Morgan Stanley frequently served as the lead
underwriter in initial public offerings (“IPOs”) -- the first public issuance
of stock of a company that has not previously been publicly traded -- and
follow-on offerings of securities.
7. During the relevant period, investment
banking was an important source of revenues and profits for Morgan
Stanley. In 2000, investment banking
generated more than $4.8 billion in revenues, or approximately twenty-four
percent of Morgan Stanley’s total net revenues.
B. The Role of Research Analysts at
Morgan Stanley
8. Research analysts at Morgan Stanley covered a
broad range of industry sectors and published periodic reports on certain
companies within those sectors. Analysts
typically reviewed the performance of their covered companies, evaluated their
business prospects, and provided analysis and projections concerning whether
they presented good investment opportunities.
Through 2001, Morgan Stanley’s equity research department had a system
calling for rating covered companies, from most to least positive, as “Strong
Buy,” “Outperform,” “Neutral,” or “Underperform.” Analyst reports were disseminated to Morgan
Stanley clients by mail and facsimile and by financial advisors. Certain research reports were made available
to retail clients who set up accounts on Morgan Stanley’s web site and,
similarly, institutional clients were able to access Morgan Stanley’s research
reports via accounts on Morgan Stanley’s web site. In addition, certain industry reports were
available on Morgan Stanley’s public web site.
Certain institutional clients of Morgan Stanley could also access
research reports through the First Call subscription service. The financial news media on occasion also
reported Morgan Stanley analysts’ ratings.
9. Morgan Stanley analysts also played an
important role in assessing potential investment banking transactions, in
particular IPOs. Morgan Stanley’s stated
objective was to “take public” as lead underwriter the leading companies in
their respective industry sectors and to have its research analysts serve as
gatekeepers to the IPO process by investigating whether companies were
appropriate IPO candidates. Research analysts who endorsed an IPO candidate typically
participated in the competition to obtain the investment banking business and,
if Morgan Stanley was selected as lead underwriter, helped market the IPO to
institutional investors, explained the IPO to the firm’s institutional and
retail sales forces, and then issued research on the company.
10. Senior analysts at Morgan Stanley published
individual research reports without pre-publication review by research
department supervisors. While reports
were reviewed for grammatical errors and for compliance with certain legal
requirements, there was no system for reviewing the recommendations or price
targets included in the reports of senior analysts prior to their publication.
I. 2. THE
RELATIONSHIP BETWEEN INVESTMENT BANKING AND RESEARCH
CREATED CONFLICTS OF INTEREST FOR MORGAN STANLEY RESEARCH ANALYSTS
11. Certain practices at Morgan
Stanley created or maintained conflicts of interest for the firm’s research
analysts with respect to investment banking considerations. These conflicts arose from the inherent
tension between the analysts’ involvement in helping to win investment banking
business for Morgan Stanley and their responsibilities to publish objective
research that, if negative as to prospective banking clients, could prevent the
firm from winning the banking business.
A. Morgan Stanley Marketed Research
Coverage, Including, at Times, Implicitly
Favorable Coverage,
in Competing for Investment Banking Business
12. Morgan Stanley typically competed with other
investment banks for selection as the lead underwriter, or “bookrunner,” for
securities offerings, including IPOs and follow-on offerings. Significant financial rewards were at stake
in these competitions. Sole or joint
bookrunners generally received the largest portion of underwriting fees, which
were typically divided among the participating investment banks. The bookrunner also established the
allocation of shares in an offering and typically retained the greatest number
of shares for itself. The typical IPO
generated millions of dollars in investment banking fees for the bookrunner.
13. The process of selecting the lead underwriter
typically culminated in a series of presentations by competing investment banks
called a “bakeoff,” in which investment banks competing for the business in a
particular offering met with the issuer to present their qualifications and
offer investment banking and other services.
As part of these presentations, investment banks often provided issuers
with a “pitchbook,” which typically described the investment bank’s credentials
and services. In selecting the lead
underwriters, issuers assessed a host of factors, including the strength and
quality of the bankers’ research coverage.
Issuers sought research coverage of their stocks, believing such
coverage would enhance the credibility of their businesses, potentially lead to
higher stock prices, and increase their exposure to the investing public.
14. Between 1999 and 2001, as part of the package
of services it offered to issuers to win investment banking business from
certain issuers, Morgan Stanley typically committed that its analysts would
initiate (or continue) research coverage of the issuer if Morgan Stanley won
the banking competition. In so doing,
Morgan Stanley used its analysts as a marketing tool to help secure banking
business. The promise of future research
coverage was often a critical selling point that enabled Morgan Stanley to
obtain millions of dollars in investment banking fees. Research coverage was part of a package of
services for which Morgan Stanley was compensated in those investment banking
deals.
15. Analysts played an important role in Morgan
Stanley’s pitches for banking business.
Along with investment bankers and others, analysts were typically
presented as part of the Morgan Stanley “team” that would consummate the
transaction. The pitchbooks typically
identified the analysts on the team and dedicated several pages to the
analysts’ experience, credentials, and specific role in the contemplated
transaction. Analysts drafted portions
of the pitchbook and almost always attended the presentations for IPO
business. The pitchbooks typically
compared Morgan Stanley analysts favorably to their counterparts at competing
firms, citing their rankings in analyst polls and other measures
16. Morgan Stanley typically identified its
analysts as a favorable factor that issuers should consider in selecting Morgan
Stanley for investment banking business.
For example, in describing one reason Loudcloud, Inc., should name
Morgan Stanley as bookrunner for its 1999 IPO, the pitchbook referred to two
senior analysts as a “dream team” who would “articulate Loudcloud’s story to
investors in a way that no other investment bank can match.” Another pitchbook described two senior
analysts as “the most powerful combination in the extended enterprise space . .
. ever.”
17. In its pitches to obtain investment banking
business, Morgan Stanley typically promised future research coverage as among
the package of services it would provide.
For example, in a pitchbook provided to iBeam Broadcasting Corp. to
obtain its IPO business, Morgan Stanley said it would “provide ongoing research
coverage and aftermarket trading” and, in another instance, said “coverage
would be initiated immediately after the quiet period. Additional research reports will follow on a
regular basis thereafter.” Morgan
Stanley won the iBeam IPO business and received investment banking fees of
approximately $3.8 million. Another
pitchbook, in a chronology of how the IPO would unfold, stated: “Research coverage initiated on day 26,”
which was the day research coverage could be initiated by an underwriter
following an IPO. Morgan Stanley made
comparable commitments to other prospective banking clients. Another Morgan Stanley pitchbook, provided to
Transmeta Corp. in July 2000 in connection with its IPO, said “we view research
as an ongoing commitment,” and offered to “continue regular publication of
research reports.” Morgan Stanley won
the Transmeta IPO business and received investment banking fees of
approximately $9.5 million. In other
pitchbooks, Morgan Stanley emphasized its “aftermarket support” services, which
it expressly described as including future research coverage. For example, a pitchbook presented to
AT&T Latin America said Morgan Stanley “is committed to bolstering an IPO’s
performance in the aftermarket through extensive equity research and
active market-making.” (Emphasis
added.) Morgan Stanley pitchbooks often
identified the specific number of reports its analysts published on other
companies, giving implicit guidance on how many reports issuers could expect to
receive if they selected Morgan Stanley as lead banker.
18. Further, Morgan Stanley at times implicitly
suggested that analysts would provide favorable research coverage, pending
completion of due diligence, by noting analysts’ past favorable coverage and/or
emphasizing its enthusiastic support for the issuer. For example, when Morgan Stanley sought
investment banking business from Convergys Corp., the company already had been
covered for two years by a senior Morgan Stanley analyst who, as the pitchbook
mentioned four times, considered Convergys to have been the analyst’s “#1 stock
pick” over those years. (During that
time period, the stock price had appreciated 98%.) The May 2001 pitchbook then described the
analyst as the “voice of the issuing company,” who would work “in tandem” with
Convergys management to position its story to investors. In the following month, June 2001, the senior
analyst downgraded Convergys from Strong Buy to Outperform, still a favorable
rating, then later upgraded Convergys back to Strong
Buy in December 2001.
19. In other instances, Morgan Stanley pitchbooks
identified a particular analyst’s history of issuing Strong Buy or Outperform
ratings on other companies. Some
pitchbooks also identified instances in which other stocks covered by Morgan
Stanley analysts increased in price following their IPOs. For example, the Morgan Stanley pitchbook
provided to Transmeta Corp. in July 2000 emphasized how one analyst’s “support”
of eight semiconductor IPOs since 1997 had “resulted in unparalleled
performance in the public market,” and included a line graph showing a dramatic
increase in the stocks’ price from 1998 through March 2000.
20. In another instance, after Loudcloud
management informed Morgan Stanley in 1999 that research coverage was a key
factor in its selection of the bookrunner for its IPO, Morgan Stanley’s head of
worldwide investment banking informed the issuer in an e-mail that the firm had
“developed a successful model which combines the best of technology and telecom
research at Morgan Stanley to properly position Loudcloud in the capital
markets; specifically, enthusiastic sponsorship” by two research analysts who
covered Loudcloud’s sector. He added: “I
commit to putting the entire franchise behind Loudcloud to achieve the best
valuation and after market performance, as well as unmatched strategic advice
post-IPO.” Morgan Stanley won the
Loudcloud IPO business and received investment banking fees of approximately
$4.7 million.
21. In addition to pitchbooks, Morgan Stanley
occasionally provided draft or “mock” research reports to issuers to provide an
example of how analysts might describe the issuer to investors. The draft or mock reports described the
issuers in favorable terms without including ratings or price targets.
22. Morgan Stanley’s commitments to provide
research coverage were not limited to pitches for IPO business. Morgan Stanley obtained investment banking
business for follow-on offerings of companies that its analysts did not cover
in part by promising to initiate future coverage.
23. Morgan Stanley consistently honored its
commitments to provide research coverage, initiating or maintaining coverage
when it won the investment banking business.
24. In Morgan Stanley’s annual performance
evaluation process, some analysts and bankers noted their success in obtaining
banking fees by promising future research coverage. For example, in a
B. Investment Banking Concerns
Influenced Morgan Stanley’s Decisions
Whether to Initiate or
Continue Research Coverage
25. The decision to initiate or continue research
coverage of certain companies was influenced, at least in part, by whether
those companies were actual or prospective investment banking clients of Morgan
Stanley.
26. In one instance, in May 2001, the liaison
between the research and investment banking divisions was advised that a
poultry company, Pilgrim’s Pride, was seeking equity research coverage in
connection with a prospective high-yield offering. The liaison made clear that Morgan Stanley
should not commit to providing coverage until it received a certain amount of
investment banking fees from the company:
Be
careful with this one. Under no
circumstances should we commit unless we get the books and at least $3-5mm in
fees, with the money in the bank before we pick up coverage. We can tell them it will go in the queue and
we cannot promise them a rating. It
costs about $1 mm to pick up coverage of a stock and there are also
meaningful ongoing expenses to maintain.
27.
Morgan
Stanley analysts on occasion also declined to cover some companies that refused
to award investment banking business to Morgan Stanley. One senior analyst wrote in a 2000
self-evaluation that the analyst had declined Sabre Group’s requests for
research coverage for four years and that the analyst had “insisted that we
first be mandated on a large investment banking transaction.” Generally, analysts select which of the many
companies in a sector they will cover.
This senior analyst did not consider Sabre to be one the analyst needed
to cover, unless Morgan Stanley were to be mandated on
an investment banking transaction. When
Sabre provided Morgan Stanley with banking business in connection with its
spin-off from AMR Corp., the analyst initiated coverage of Sabre with an
Outperform rating in March 2000.
28.
Morgan
Stanley also declined to initiate coverage of Concord/EFS, Inc. Concord initially retained Morgan Stanley as
bookrunner for a 1999 secondary offering, but then hired a different bank as
bookrunner after Morgan Stanley declined Concord’s request that it commit to
initiating coverage with a “Strong Buy” rating.
Though
29.
Morgan
Stanley also initiated coverage of eBay, Inc., in part with the hope of
obtaining investment banking business.
After Morgan Stanley initially lost the IPO business for eBay in 1998, a
senior Morgan Stanley analyst met with eBay’s chief executive officer and
provided a draft research report on the company. After Morgan Stanley nevertheless lost the
IPO business, the analyst initiated coverage on eBay on its first day of
trading with an Outperform rating. The
analyst was the only one covering eBay, since firms in the underwriting
syndicate were prohibited from initiating coverage until after the 25-day
“quiet period” had expired. It is the
only time that the senior analyst initiated coverage of a company on its first
day of trading. Later, in 1999 and again
in 2001, eBay awarded two banking transactions to Morgan Stanley, with total
fees of approximately $1.2 million. In
the senior analyst’s self-evaluation for 2000, the analyst stated, as part of
the analyst’s “philosophy” for Morgan Stanley’s
“Internet banking efforts,” that “when we miss a winning IPO, we should
work like crazy (with tons of ideas) to secure a spot as M&A advisor
(USWeb/CKS) or book running manager on follow-on offerings (eBay).”
C. Morgan Stanley Research Analysts
Performed Investment Banking
Functions
30. Morgan Stanley research analysts performed a
number of investment banking-related functions.
They identified potential IPO and merger and acquisition transaction
candidates for the investment banking department, participated in soliciting
investment banking business for the firm, and participated in road shows and
other efforts to sell Morgan Stanley-underwritten IPOs and secondary offerings
to institutional investors. At times,
analysts also had discussions about business strategy with investment banking
clients directly, and one senior analyst was described as a relationship
manager with certain investment banking clients.
31. Morgan Stanley kept a record of each
analyst’s contribution to investment banking revenues. Each year, a “Revenue Share Analysis” was
prepared that listed every investment banking transaction in which each analyst
had participated, the revenues from each transaction, a rating on a scale of 1
to 5 (5 being “critical” to the deal) of the analyst’s contribution to the
transaction, and a calculation of the analyst’s “share” of the credit for the
revenues secured from the transaction.
The Revenue Share Analysis also recorded investment gains on Morgan
Stanley investments in companies covered by the analyst.
32. One senior analyst’s involvement in
investment banking activities was such that several investment bankers at the
firm regarded the analyst as tantamount to an investment banker. One banker wrote that the analyst was the
most committed and focused banker with whom he had ever worked. Another wrote that the analyst was a
“commercial animal” who would do anything appropriate
to win underwriting mandates. The
analyst’s supervisor wrote in 1999 that the analyst’s focus was primarily on
banking and that, notwithstanding the growing demand for the analyst’s time on
investment banking matters, the analyst needed to devote more attention to
institutional investors and the firm’s institutional sales force.
33. The analyst’s own self-evaluation prominently
mentioned the analyst’s assistance to investment banking in selecting and
generating investment banking business and large fees, stating: “Bottom line, my highest and best use is
to help MSDW win the best Internet IPO mandates (and to ensure that we have
the appropriate analysts and bankers to serve the companies well). . . ”
(emphasis in original). It also
prominently listed the deals and revenues from the analyst’s investment-banking
connected efforts:
Internet Investment Banking, a Record Year with $205MM+ YTD Revenue,
[20+] Pending Financings, Co-Coverage (Leverage) in 85% of Cases, 6 of 6 Tech
IBD Revenue Generating Clients, Internet Category was #1 Revenue Generator in
Tech IBD ($505MM YTD Tech Revenue). . . (Emphasis in
original.)
OK,
the numbers (see Attachment A): Forty investment banking transactions ($143MM
in fees) . . .
It’s
notable that 96% of the $205MM in revenue was derived from clients new to the
firm since 1995! Exceptions were America Online, Compaq, Hearst and
Sotheby’s. And I have been very
involved in this business. (Emphasis
added.)
D. Investment Banking Was an Important
Factor in Determining Research
Analysts’ Compensation
34. From 1999 through 2001, participation in
investment banking activities was a factor in determining the total compensation
awarded to some Morgan Stanley research analysts. These analysts thus faced a conflict of
interest between helping win investment banking business for Morgan Stanley and
publishing negative research that could prevent Morgan Stanley from winning that
banking business.
35. The annual salaries paid to senior Morgan
Stanley analysts and other senior Morgan Stanley personnel typically were
comparatively small components of their total annual compensation. The majority of their total annual
compensation was paid in the form of a bonus.
In 2000, one senior analyst received a year-end bonus that was 90 times
greater than the analyst’s base salary.
36. The total compensation paid to analysts was
based in part on Morgan Stanley’s total revenues for a particular year,
including the investment banking fees that Morgan Stanley received. Thus, the success or failure of the
investment banking division determined, in part, the total amount of funds
available to pay employee compensation in any given year, including analyst
compensation.
1. Analysts Rated Their Contributions to Investment Banking
37. The level of contribution to investment
banking transactions was an important factor in the annual evaluations of
Morgan Stanley’s analysts and compensation decisions.
38. As part of the annual performance evaluation
process, analysts were asked to submit self-evaluations that, among other
things, discussed their contributions to Morgan Stanley. Analysts often included in their
self-evaluations a discussion of their involvement in investment banking,
including a description of specific transactions, the fees generated, and the
role the analyst played in each deal.
For example, one-quarter of the 1999 self-evaluation of one analyst was
dedicated to the analyst’s role in investment banking activities, and
identified forty transactions that year that had generated a total of $143
million in fees.
39. As part of the evaluation process, the
analysts also provided a rating of their contributions to specific banking
transactions. Analysts were instructed
to complete a Transaction Summary Worksheet (“TSW”) in which they graded their
roles in specific deals on a scale of 1-5.
Instructions provided to each analyst described the rating system as
follows:
5 = critical to deal
4
= important to development and execution
3
= solid contribution
2
= limited contribution
1
= contribution limited to providing research coverage
40. Analysts were also instructed to comment on
important aspects of any transaction, including, for example, whether the
“promise of coverage was critical to winning” the mandate. The instructions informed analysts that
supplying the information called for in the TSWs was an “important part” of
their annual evaluation process.
2. Investment Bankers Evaluated Analysts’ Performance
41.
Morgan Stanley
also solicited and received the investment bankers’ assessment of the analysts’
performance on the same transactions.
Morgan Stanley’s liaison between the research and investment banking
divisions compiled and summarized the bankers’ evaluations of the analysts’
role in each deal and then prepared a final TSW listing for each transaction
that provided a joint evaluation of the analysts’ contributions to each deal.
42.
Finally,
as part of Morgan Stanley’s “360 degree” review process, in which employees confidentially
reviewed one another, investment bankers submitted written opinions of analysts
with whom they worked.
43.
Investment
bankers thus played a role in the annual evaluation of research analysts by
providing substantive information that was considered in the year-end
evaluation process and input into the determination of the analysts’
compensation for that year. The
investment bankers’ role in the evaluation process created a conflict of
interest for analysts, who hoped for positive evaluations from investment
bankers at the same time that they were charged with issuing objective research
reports that, if negative, could have impeded Morgan Stanley’s ability to win
future investment banking business from the covered companies.
3. Investment
Banking Was the Factor Accorded the Greatest
Weight by Management in Reviewing
Management’s Initial
Determination of Proposed Analysts’
Compensation
44. In 1999 and 2000, analyst compensation was
set primarily by a managing director in the equity research division. The managing director made an initial
determination of proposed compensation for all analysts and ranked the analysts
based on that determination. The
managing director then ranked the analysts based on their composite scores in
nine categories. The managing director
then compared the two rankings before forwarding the compensation
recommendations to superiors.
45. The nine categories used to rank the analysts
included the amount of investment banking revenues attributed to analysts based
on their involvement in transactions (relative weight of 33%) and eight other
categories related to core research activities, including: (1) poll rankings
from the Institutional Investor and other sources (19%); (2) poll
ranking from institutional equity division sales (12%); (3) firm activities and
ability to be a team player (11%); (4) the “hit ratio” in vote gathering from
institutional clients (7%); (5) rank in vote gathering from institutional
clients (7%); (6) stock picking (active portfolio vs. passive portfolio) (6%);
(7) stock picking (active portfolio vs. index portfolio) (3%); and (8) poll
ranking from retail sales (2%). Thus,
the managing director assigned a one-third weight to investment banking
revenues -- the highest weight given to any single category.
46. The impact that an analyst’s contribution to
investment banking revenues could have on the determination of the analyst’s
compensation is shown by the compensation of one Morgan Stanley senior analyst
in 1999 and 2000. In 1999, the analyst
who received the highest compensation among Morgan Stanley research analysts
had a composite score that ranked only 11th overall, but ranked
first in investment banking revenues.
47. In 2000, the same analyst continued to rank
first in investment banking revenues:
the total investment banking revenues that the analyst helped Morgan
Stanley obtain more than doubled. In
most other categories, however, the analyst’s performance declined from 1999,
and the analyst’s composite score dropped to 19th overall. In 2000, the analyst ranked only 70th out of
111 analysts in stock picking, and the analyst’s self-evaluation conceded that
2000 had been the analyst’s worst stock-picking year in fifteen years. Nevertheless, this analyst’s total salary and
bonus for 2000 increased by approximately $8.7 million as compared to 1999,
again ranking first among all Morgan Stanley analysts.
I. 3. MORGAN STANLEY DID NOT
DISCLOSE THAT IT PAID
$2.7 MILLION OF UNDERWRITING FEES AT ISSUERS’ DIRECTION TO
OTHER INVESTMENT BANKS TO
PROVIDE RESEARCH COVERAGE
48. In at least twelve stock offerings in which
it was selected as lead underwriter from 1999 through 2001, Morgan Stanley paid
$2.7 million of the underwriting fees to approximately twenty-five investment
banks. Internal Morgan Stanley documents
described these payments as “research guarantees” or “guaranteed economics for
research.” Other internal Morgan Stanley
documents noted instances in which the bank receiving the payment “will
write.” Morgan Stanley made these
payments from the offering proceeds at the direction of the issuers.
49. These “research guarantee” payments included
more than $670,000 paid to three investment banks in connection with an
offering by Veritas Software Corp. in December 1999; more than $816,000 paid to
seven banks in connection with an Agile Software Corp. offering in December
1999; and more than $440,000 paid to five banks in connection with an offering
by Atmel Corp. in February 2000. The
individual disbursements ranged from two payments of just over $6,000 each to
three payments of more than $225,000 each.
50. The issuers’ registration statements and
other offering documents identified the other banks as part of the underwriting
syndicates and as receiving payments, but did not specifically disclose the
payments as being for research. Morgan
Stanley did not take steps to ensure that these banks disclosed these payments
in their research reports. Morgan
Stanley also did not cause the payments to be disclosed in offering documents
or elsewhere as having been for research.
I. 4. MORGAN STANLEY FAILED REASONABLY TO
SUPERVISE ITS SENIOR
RESEARCH ANALYSTS
A. Morgan
Stanley Had No System for Reviewing
the Ratings Issued by Its
Senior Analysts
51. Morgan Stanley failed reasonably to supervise
its senior research analysts. The firm
required only non-officer-level analysts to submit their initial ratings and
proposed changes in ratings for review by the Stock Selection Committee. Senior analysts -- principals and managing
directors -- were not subject to this requirement. In addition, Morgan Stanley had no effective
system in place for reviewing the ratings of its senior analysts against
changed conditions.
52. Morgan Stanley’s lack of an effective review
system allowed some principal and managing director analysts to maintain
Outperform ratings unchanged on declining stocks without any review by
management. For example, in 2000 and
2001, four senior analysts maintained Outperform ratings unchanged on 13 stocks
as the prices of the stocks declined by over 74 percent. The names of the stocks, their percentage
declines, and the number of months without a change in the Outperform rating
are shown on the following chart:
Percent Price
Drop While Months Without Change in
Company Rated Outperform Outperform
Rating
Chemdex (Ventro) 96.2 8.5
Drugstore.com 95.4 30
Priceline.com 92.0 30
Ask Jeeves 90.9 16
Marimba 88.9 8.5
Homestore.com 88.7 10
Vignette 87.1 7.5
VeriSign 83.3 19.5
Akamai 82.8 10
Women.com 80.3 8.5
CNET 77.7 16.5
Inktomi 76.9 15
FreeMarkets 74.3 23
53. Not until late 2001, after complaints from
Institutional Sales persons made as part of the year-end evaluation process,
did management state to one of the analysts: “Don’t let your ratings get stale;
change them ahead of expected price action.”
B. Morgan Stanley’s Analysts Virtually Never Used the Lowest
Rating in the
Firm’s Stock Rating System
54. From 1995 to March 2002, Morgan Stanley
publicly stated that it had a four-category rating system: Strong Buy; Outperform; Neutral; and
Underperform. “Underperform” was defined as follows: “Given the current price, these securities
are not expected to perform as well as other stocks in the universe covered by
the analyst.” Although Morgan Stanley
stated that it had a four-category system, its analysts virtually never used
the “Underperform” rating and, in effect, used a three-category system. From 1999 through 2001, the firm published
research on approximately 1,000 North American company stocks. No more than three of the 1033 stocks covered
over the course of 1999 were given an Underperform rating; no more than five of
the 1058 stocks covered over the course of 2000 received that rating; and no
more than six of the 1030 stocks covered over the course of 2001 were rated
Underperform.
55. Morgan Stanley management was aware that
analysts were not using the “Underperform” rating, but did not correct the
problem until March 2002, when a new rating system was instituted.
II.
CONCLUSIONS
OF LAW
1. The Office of Securities has jurisdiction over this matter pursuant to the Revised Maine Securities Act, 32 M.R.S.A. §§ 10101-10713.
2. The Securities Administrator finds that Morgan Stanley violated 32 M.R.S.A. §§ 10313(1)(G) and 10313(1)(J) in that:
a) The relationship between investment
banking and research created conflicts of interest for Morgan Stanley research
analysts;
b) Morgan Stanley did not disclose that it
paid $2.7 million of underwriting fees at issuers’ direction to other
investment banks to provide research coverage; and
c) Morgan Stanley failed reasonably to
supervise its senior research analysts.
3. The Securities Administrator finds the following relief appropriate and in the public interest.
On the basis of the Findings of Fact, Conclusions
of Law, and Morgan Stanley’s consent to the entry of this Order, for the sole
purpose of settling this matter, prior to a hearing and without admitting or
denying any of the Findings of Fact or Conclusions of Law,
IT IS HEREBY ORDERED:
1. This Order concludes the investigation by the
Office of Securities and any other
action that the Office of Securities could commence under applicable Maine law
on behalf of the Securities Administrator as it relates to Morgan Stanley
relating to the subject of the investigations, provided however, that excluded
from and not covered by this paragraph 1 are any claims by the Office of
Securities arising from or relating to the “Order” provisions herein.
2. Morgan Stanley will CEASE AND DESIST from
violating sections 10313(1)(G) and 10313(1)(J) of the Revised Maine
Securities Act, 32 M.R.S.A. §§ 10101-10713,
in connection with the research practices referenced in this Order and will comply with the undertakings of Addendum A,
incorporated herein by reference.
3. As
a result of the Findings of Fact and Conclusions of Law contained in this
Order, Morgan Stanley shall pay a total amount of $125,000,000.00. This total amount shall be paid as specified
in the SEC Final Judgment as follows:
a.
$25,000,000 to the states (50 states, plus the
b. $25,000,000 as disgorgement of commissions, fees and other monies as specified in the SEC Final Judgment;
c. $75,000,000, to be used for the procurement
of independent research, as described in the SEC Final Judgment;
4. If payment is not made by Morgan Stanley or
if Morgan Stanley defaults in any of its obligations set forth in this Order,
the Office of Securities may vacate this Order, at its sole discretion, upon 10
days notice to Morgan Stanley and without opportunity for administrative hearing.
5. Morgan Stanley agrees that it shall not seek
or accept, directly or indirectly, reimbursement or indemnification, including
but not limited to payment made pursuant to any insurance policy, with regard
to all penalty amounts that Morgan Stanley shall pay pursuant to this Order or
section II of the SEC Final Judgment, regardless of whether such penalty
amounts or any part thereof are added to the Distribution Fund Account referred
to in the SEC Final Judgment or otherwise used for the benefit of investors. Morgan Stanley further agrees that it shall
not claim, assert, or apply for a tax deduction or tax credit with regard to
any state, federal or local tax for any penalty amounts that Morgan Stanley
shall pay pursuant to this Order or section II of the SEC Final Judgment,
regardless of whether such penalty amounts or any part thereof are added to the
Distribution Fund Account referred to in the SEC Final Judgment or otherwise
used for the benefit of investors. Morgan
Stanley understands and acknowledges that these provisions are not intended to
imply that the Office of Securities would agree that any other amounts Morgan
Stanley shall pay pursuant to the SEC Final Judgment may be reimbursed or
indemnified (whether pursuant to an insurance policy or otherwise) under
applicable law or may be the basis for any tax deduction or tax credit with
regard to any state, federal or local tax.
6. This Order is not intended by the Office of
Securities to subject any Covered Person to any disqualifications under the
laws of any state, the District of Columbia or Puerto Rico (collectively,
“State”), including, without limitation, any disqualifications from relying
upon the State registration exemptions or State safe harbor provisions. "Covered Person" means Morgan
Stanley, or any of its officers, directors, affiliates, current or former
employees, or other persons that would otherwise be disqualified as a result of
the Orders (as defined below).
7. The SEC Final Judgment, the NYSE Stipulation
and Consent, the NASD Letter of Acceptance, Waiver and Consent, this Order and
the order of any other State in related proceedings against Morgan Stanley
(collectively, the “Orders”) shall not disqualify any Covered Person from any
business that they otherwise are qualified, licensed or permitted to perform
under the applicable law of Maine and any disqualifications from relying upon
this state’s registration exemptions or safe harbor provisions that arise from
the Orders are hereby waived.
8. The Orders shall not disqualify any Covered Person from any business that they otherwise are qualified, licensed or permitted to perform under applicable state law.
9. For any person or entity not a party to this Order, this Order does not limit or create any private rights or remedies against Morgan Stanley including, without limitation, the use of any e-mails or other documents of Morgan Stanley or of others regarding research practices, or limit or create liability of Morgan Stanley, or limit or create defenses of Morgan Stanley to any claims.
10. Nothing herein shall preclude the State of
Maine, its departments, agencies, boards, commissions, authorities, political
subdivisions and corporations, other than the Office of Securities and only to
the extent set forth in paragraph 1 above, (collectively, “State Entities”) and
the officers, agents or employees of State Entities from asserting any claims,
causes of action, or applications for compensatory, nominal and/or punitive
damages, administrative, civil, criminal, or injunctive relief against Morgan
Stanley in connection with certain research practices at Morgan Stanley.
Dated this 2nd day of September, 2003.
By: s/Christine A. Bruenn
Christine A. Bruenn, Securities Administrator
State of
CONSENT TO ENTRY OF ADMINISTRATIVE ORDER BY
MORGAN STANLEY & CO. INCORPORATED
Morgan Stanley &
Co. Incorporated hereby acknowledges that it has been served with a copy of
this Administrative Order, has read the foregoing Order, is aware of its right
to a hearing and appeal in this matter, and has waived the same.
Morgan Stanley &
Co. Incorporated admits the jurisdiction of the Office of Securities,
neither admits nor denies the Findings of Fact and Conclusions of Law contained
in this Order, and consents to entry of this Order by the Securities
Administrator as settlement of the issues contained in this Order.
Morgan Stanley &
Co. Incorporated states that no promise of any kind or nature whatsoever was
made to it to induce it to enter into this Order and that it has entered into
this Order voluntarily.
James P. Cusick represents that he/she is Managing Director
of Morgan Stanley & Co. Incorporated and that, as such, has been authorized
by Morgan Stanley & Co. Incorporated to enter into this Order for and on
behalf of Morgan Stanley & Co. Incorporated.
Dated this 27th
day of August, 2003.
Morgan
Stanley & Co. Incorporated
By: s/James P. Cusick
Title: Managing Director
SUBSCRIBED AND SWORN TO
before me this _____ day of __________________, 200_.
____________________________________________
Notary
Public
My Commission expires:
____________________