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Regulation and Compliance > Federal Regulation > SEC

Morgan Stanley to Pay $8M Over Inverse ETFs

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The Securities and Exchange Commission said Tuesday that Morgan Stanley will pay $8 million to settle charges related to inverse ETF investments the firm recommended to advisory clients.

According to the SEC, Morgan Stanley “did not adequately implement its policies and procedures to ensure that clients understood the risks involved with purchasing inverse ETFs.”

The regulator says that Morgan Stanley, which has over 15,700 financial advisors, did not obtain signed disclosure notices from several hundred clients. The notice explains that single inverse ETFs “were typically unsuitable for investors planning to hold them longer than one trading session unless used as part of a trading or hedging strategy.”

Instead, the wirehouse solicited clients to purchase single inverse ETFs in retirement and other accounts, according to the regulator; plus, the ETFs were held on a long-term basis, and many of the clients experienced losses.

Inverse ETFs, also called “short” funds, seek to deliver the opposite of the performance of the index or benchmark they track via the use of swaps, futures contracts and other derivatives. They are reset daily, and their performance over longer periods of time “can differ significantly from the performance (or inverse of the performance) of their underlying index or benchmark during the same period of time,” the SEC explains.

Furthermore, this effect can be magnified when equity and other markets are volatile. In addition, these products can be less tax-efficient than traditional ETFs given the daily reset, the regulator points out.

Morgan Stanley said in a statement that it is “pleased to have resolved this matter.”

Earlier Matters

In January, Morgan Stanley agreed to pay the SEC $13 million to settle charges that it overbilled investment advisory clients due to coding and other billing system errors. In addition, the firm violated a custody rule pertaining to annual surprise examinations, according the regulatory group.

The SEC found that Morgan Stanley overcharged some 149,000 advisory clients “because it failed to adopt and implement compliance policies and procedures reasonably designed to ensure that clients were billed accurately according to the terms of their advisory agreements.”

Plus, the wirehouse did not validate billing rates against client contracts, fee billing histories and other documents.

The SEC says Morgan Stanley received more than $16 million in excess fees from the billing errors, which took place from 2002 to 2016.

In December, the wirehouse agreed to pay the SEC $7.5 million to settle charges it used trades involving institutional clients’ cash to lower its borrowing costs. These activities, which took place from March 2013 to May 2015, violated the SEC’s Customer Protection Rule.

— Check out Morgan Stanley Grabs $4.6M Merrill Team on ThinkAdvisor.


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