Investment Advisers Act of 1940 - Rule 206(4)-3
RESPONSE OF THE OFFICE OF CHIEF COUNSEL
Our Ref. No. 2005126915
We would not recommend enforcement action to the Commission under Section 206(4) of the Investment Advisers Act of 1940 ("Advisers Act") and Rule 206(4)-3 thereunder if any investment adviser that is required to be registered pursuant to Section 203 of the Advisers Act pays to Morgan Stanley & Co. Incorporated (the "Settling Firm"), a registered broker-dealer and investment adviser, or any of the Settling Firm's associated persons, as defined in Section 202(a)(17) of the Advisers Act, a cash fee, directly or indirectly, for the solicitation of advisory clients in accordance with Rule 206(4)-3,1 notwithstanding a judgment of injunction from the United States District Court for the District of Columbia (the "Final Judgment") that otherwise would preclude such an investment adviser from paying the Settling Firm a solicitation fee.2
Our position is based on the facts and representations in your letter dated January 25, 2005, particularly the Settling Firm's representations that:
This position applies only to the Final Judgment and not to any other basis for disqualification under Rule 206(4)-3 that may exist or arise with respect to the Settling Firm or any of its associated persons.
Sara P. Crovitz
The entry of the Final Judgment, absent the issuance of an order by the Commission pursuant to section 9(c) of the Company Act exempting the Settling Firm from section 9(a) of the Company Act, would prohibit the Settling Firm from, among other things, acting as an investment adviser to any registered investment company. You state that, pursuant to section 9(c) of the Company Act, the Settling Firm and certain affiliates submitted an application to the Commission requesting (i) an order of temporary exemption from section 9(a) of the Company Act and (ii) a permanent order exempting the Settling Firm and certain affiliates from the provisions of section 9(a) of the Company Act.
On February 4, 2005, the Commission issued an order granting the Settling Firm and certain affiliates a temporary exemption from section 9(a) of the Company Act pursuant to section 9(c) of the Company Act, with respect to the Final Judgment, until the date the Commission takes final action on the application for a permanent order. In re Morgan Stanley Co. Incorporated, et. al, SEC Rel. No. IC-26749 (Feb. 4, 2005) ("Release"). In the Release, the Commission also issued a notice of the application for a permanent order exempting the Settling Firm and certain affiliates from section 9(a) of the Company Act, indicating that an order granting the application would be issued unless the Commission orders a hearing. As a result, the Final Judgment does not bar or suspend the Settling Firm or any person currently associated with the Settling Firm from acting in any capacity under the federal securities laws.
January 25, 2005
VIA E-MAIL AND COURIER
Douglas J. Scheidt, Esq.
Associate Director and Chief Counsel
Division of Investment Management
U.S. Securities and Exchange Commission
450 Fifth Street, N.W., Mail Stop 0506
Washington, D.C. 20549
Dear Mr. Scheidt:
We submit this letter on behalf of our client, Morgan Stanley & Co. Incorporated ("Morgan Stanley"), in connection with a settlement agreement (the "Settlement") arising out of an investigation by the Securities and Exchange Commission (the "Commission") into alleged violations of Rule 101 of Regulation M under the Securities Exchange Act of 1934, as amended (the "Exchange Act").
Morgan Stanley, a broker-dealer registered under Section 15 of the Exchange Act and an investment adviser registered under Section 203 of the Investment Advisers Act of 1940, as amended (the "Advisers Act"), seeks the assurance of the staff of the Division of Investment Management ("Staff") that it would not recommend any enforcement action to the Commission under Section 206(4) of the Advisers Act, or Rule 206(4)-3 thereunder (the "Rule"), if an investment adviser pays Morgan Stanley, or any of its associated persons, a cash payment for the solicitation of advisory clients, notwithstanding the existence of the Final Judgment (as defined below) of a court of competent jurisdiction as described below. While the Final Judgment in question does not operate to prohibit or suspend Morgan Stanley or any of its associated persons from acting as or being associated with an investment adviser and does not relate to solicitation activities on behalf of investment advisers, it may affect the ability of Morgan Stanley and its associated persons to receive such payments. The Staff in many other instances has granted no-action relief under the Rule in similar circumstances.
The Commission has engaged in settlement discussions with Morgan Stanley in connection with an investigation into alleged violations of Rule 101 of Regulation M ("Regulation M") under the Exchange Act. As a result of these discussions, the Commission filed a complaint (the "Complaint") against Morgan Stanley in the United States District Court for the District of Columbia (the "District Court") in a civil action to be captioned Securities and Exchange Commission v. Morgan Stanley & Co. Incorporated. The Complaint alleges that Morgan Stanley provided allocations of stock to institutional customers in hot initial public offerings it underwrote and that Morgan Stanley attempted to induce certain institutional customers to place orders for shares in the aftermarket of initial public offerings in violation of Rule 101 of Regulation M. Morgan Stanley has executed a consent (the "Consent") in which Morgan Stanley neither admits nor denies any of the allegations in the Complaint, except as to jurisdiction, but consents to the entry of a final judgment against Morgan Stanley by the District Court (the "Final Judgment"). The Final Judgment will, among other things, order, adjudge, and decree that Morgan Stanley, its officers, agents, servants, employees, attorneys, and all persons in active concert or participation with Morgan Stanley who receive actual notice of the Final Judgment by personal service or otherwise are permanently restrained and enjoined from violating Rule 101 of Regulation M. Additionally, the Final Judgment will order Morgan Stanley to pay a civil fine in the amount of $40 million.
The Rule prohibits an investment adviser from paying a cash fee to any solicitor that has been temporarily or permanently enjoined by an order, judgment or decree of a court of competent jurisdiction from engaging in or continuing any conduct or practice in connection with the purchase or sale of any security. Entry of the Final Judgment could cause Morgan Stanley to be disqualified under the Rule, and accordingly, absent no-action relief, Morgan Stanley may be unable to receive cash payments for the solicitation of advisory clients.1
In the release adopting the Rule, the Commission stated that it "would entertain, and be prepared to grant in appropriate circumstances, requests for permission to engage as a solicitor a person subject to a statutory bar."2 We respectfully submit that the circumstances present in this case are precisely the sort that warrant a grant of no-action relief.
The Rule's proposing and adopting releases explain the Commission's purpose in including the disqualification provisions in the Rule. The purpose was to prevent an investment adviser from hiring as a solicitor a person whom the adviser was not permitted to hire as an employee, thus doing indirectly what the adviser could not do directly. In the proposing release, the Commission stated that:
[b]ecause it would be inappropriate for an investment adviser to be permitted to employ indirectly, as a solicitor, someone whom it might not be able to hire as an employee, the Rule prohibits payment of a referral fee to someone who . . . has engaged in any of the conduct set forth in Section 203(e) of the [Advisers] Act . . . and therefore could be the subject of a Commission order barring or suspending the right of such person to be associated with an investment adviser.3
The Final Judgment does not bar, suspend, or limit Morgan Stanley or any person currently associated with Morgan Stanley from acting in any capacity under the federal securities laws.4 Morgan Stanley has not been sanctioned for conduct relating to its activities as an investment adviser or its solicitation of advisory clients.5 Accordingly, consistent with the Commission's reasoning, there does not appear to be any reason to prohibit an adviser from paying Morgan Stanley or its associated persons for engaging in solicitation activities under the Rule.
The Staff previously has granted numerous requests for no-action relief from the disqualification provisions of the Rule to individuals and entities found by the Commission to have violated a wide range of federal securities laws and rules thereunder or permanently enjoined by courts of competent jurisdiction from engaging in or continuing any conduct or practice in connection with the purchase or sale of any security.6
In connection with this request, Morgan Stanley undertakes:
1. to conduct any cash solicitation arrangement entered into with any investment adviser required to be registered under Section 203 of the Advisers Act in compliance with the terms of Rule 206(4)-3 except for the investment adviser's payment of cash solicitation fees to Morgan Stanley which is subject to the Final Judgment;
2. to comply with the terms of the Final Judgment, including, but not limited to, the payment of disgorgement, pre-judgment interest, civil or administrative penalties and fines; and
3. that for ten years from the date of the entry of the Final Judgment, Morgan Stanley or any investment adviser with which it has a solicitation arrangement subject to Rule 206(4)-3 will disclose the Final Judgment in a written document that is delivered to each person whom Morgan Stanley solicits (a) not less than 48 hours before the person enters into a written or oral investment advisory contract with the investment adviser or (b) at the time the person enters into such a contract, if the person has the right to terminate such contract without penalty within 5 business days after entering into the contract.
We respectfully request the Staff to advise us that it will not recommend enforcement action to the Commission if an investment adviser that is required to be registered with the Commission pays Morgan Stanley, or any of its associated persons, a cash payment for the solicitation of advisory clients, notwithstanding the Final Judgment.
Please do not hesitate to call the undersigned at (312) 861-2107 or Scott A. Moehrke at (312) 861-2199 regarding this request.
David S. Royal
James Cusick, Esq.
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