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U.S. Securities and Exchange Commission

Securities and Exchange Commission

Litigation Release No. 18117 / April 28, 2003

Securities and Exchange Commission v. Morgan Stanley & Co. Incorporated, 03 CV 2948 (WHP) (S.D.N.Y.)


The Securities and Exchange Commission announced today that it has settled charges against Morgan Stanley & Co. Incorporated, a New York-based brokerage firm and investment bank, arising from an investigation of research analyst conflicts of interest. This settlement, and settlements with nine other brokerage firms, are part of the global settlement the firms have reached with the Commission, NASD, Inc., the New York Stock Exchange, Inc. ("NYSE"), the New York Attorney General, and other state regulators. As part of the settlement, Morgan Stanley has agreed to pay $25 million as disgorgement and an additional $25 million in penalties. One-half of the total of these payments - $25 million - will be paid in connection with the SEC action and related proceedings by the NASD and NYSE and will be placed into a distribution fund for the benefit of customers of the firm. The remainder will be paid to resolve related proceedings by state regulators. In the SEC action, Morgan Stanley has agreed to a federal court order that will enjoin the firm from future violations of NASD and NYSE rules and require the firm to make changes in the operations of its equity research and investment banking departments. In addition, Morgan Stanley will pay, over five years, $75 million to provide the firm's clients with independent research.

In connection with this matter, the Commission today filed a Complaint against Morgan Stanley in the U.S. District Court for the Southern District of New York, alleging violations of NASD and NYSE rules. According to the Commission's Complaint, from at least July 1999 through June 2001, research analysts at Morgan Stanley were subject to inappropriate influence by investment banking at the firm. The Complaint also alleges that Morgan Stanley made payments to other firms for those firms to publish research on Morgan Stanley's underwriting clients without ensuring that such payments were disclosed and failed to maintain appropriate supervision over its research and investment banking operations.

Specifically, the Commission's Complaint alleges that:

  • Morgan Stanley compensated its research analysts, in part, based on the degree to which they helped generate investment banking business for the firm. As part of the annual performance evaluation process, Morgan Stanley analysts were asked to submit self-evaluations that often included a discussion of their involvement in investment banking, including a description of specific transactions and the fees generated. One analyst's self-evaluation prominently mentioned the analyst's assistance to investment banking, 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.)

  • Morgan Stanley also offered research coverage by its analysts as a marketing tool to gain investment banking business. Pitchbooks used by Morgan Stanley to solicit investment banking business routinely described the research analysts who would cover the company and, at times, implicitly suggested that analysts would provide favorable research coverage of the prospective client. For example, some pitchbooks identified a particular analyst's history of issuing Strong Buy or Outperform ratings on other companies, or identified instances in which other stocks covered by Morgan Stanley analysts increased in price following their initial public offerings. One such pitchbook emphasized how one analyst's "support" of eight semiconductor IPOs had "resulted in unparalleled performance in the public market," and included a graph showing a dramatic increase in the stocks' prices.

      In a November 3, 1999 e-mail, an investment banker listed several banking transactions that he said Morgan Stanley had won because it committed that a particular highly-rated analyst would initiate research coverage. Specifically, the banker wrote that Morgan Stanley had won two transactions totaling $13.4 million in fees from Veritas Software Corp. "just for promising that [the senior analyst] would pick up coverage after the deals."

  • In at least twelve stock offerings in which it was selected as lead underwriter from 1999 through 2001, Morgan Stanley paid at the direction of its investment banking clients approximately $2.7 million of the underwriting fees to approximately twenty-five other investment banks as "research guarantees" or "guaranteed economics for research." Morgan Stanley failed to ensure that these payments were disclosed.

  • Morgan Stanley failed to establish and maintain adequate procedures to protect research analysts from conflicts of interest, and failed to adequately supervise the work of senior analysts, the content of their reports, and the reasonableness of their ratings. Morgan Stanley's lack of an effective review system allowed certain 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 thirteen stocks as the prices of the stocks declined by over 74 percent.

Morgan Stanley has agreed to settle the Commission's action and has consented, without admitting or denying the allegations of the Complaint, to the entry of a final judgment that, if approved by the court, permanently enjoins Morgan Stanley from violations of NASD and NYSE rules governing just and equitable principles of trade (NASD Rule 2110; NYSE Rules 401 and 476), advertising (NASD Rule 2210; NYSE Rule 472), and supervisory procedures (NASD Rule 3010; NYSE Rule 342). The final judgment also orders the firm to make the payments described above, and provides for the appointment of a fund administrator who, subject to court approval, will formulate and administer a plan of distribution for those monies placed into the distribution fund.

In addition, the final judgment orders Morgan Stanley to implement structural reforms and provide enhanced disclosure to investors, including a broad range of changes relating to the operations of its equity research and investment banking operations. Morgan Stanley has agreed to sever the links between research and investment banking, such that: research and investment banking are physically separated with completely separate reporting lines; analysts' compensation cannot be based directly or indirectly upon investment banking revenues; investment bankers may no longer evaluate analysts; investment bankers will have no role in determining what companies are covered by the analysts; and research analysts will be prohibited from participating in efforts to solicit investment banking business, including pitches and roadshows. In addition, Morgan Stanley must disclose on the first page of each research report whether the firm does or seeks to do investment banking business with that issuer, and when Morgan Stanley decides to terminate coverage of an issuer, Morgan Stanley must issue a final research report discussing the reasons for the termination. Each quarter, Morgan Stanley also will publish on its website a chart showing its analysts' performance, including each analyst's name, ratings, price targets, and earnings per share forecasts for each covered company, as well as an explanation of the firm's rating system.

Morgan Stanley also has agreed as part of this settlement to retain, at its own expense, an Independent Monitor to conduct a review to provide reasonable assurance that the firm is complying with the structural reforms. This review will be conducted eighteen months after the date of the entry of the Final Judgment and the Independent Monitor will submit a written report of his or her findings to the SEC, NASD, and NYSE within six months after the review begins. Five years after the entry of the final judgment, Morgan Stanley must certify to the SEC and other regulators that it has complied in all material respects with the requirements and prohibitions of the structural reforms.

* * *

The Commission acknowledges the assistance of NASD, the New York Stock Exchange, the New York Attorney General, and other state regulators in the investigation of this matter.

SEC Complaint in this matter
SEC Final Judgment in this matter
Final Judgment Appendix A
Final Judgment Appendix B



Modified: 04/28/2003