Morgan Stanley Has Paid Fines for Two Decades for Abusing Customers with In-House Products, Now It Plans to Stuff Bitcoin Futures into Its Mutual Funds and Retiree Annuities
By Pam Martens and Russ Martens: May 14, 2021 ~
James Gorman, Chairman and CEO, Morgan Stanley
Morgan Stanley has more than 15,000 financial advisors calling clients each day with investment recommendations that are frequently engineered inside the firm. (These are known as in-house or proprietary products.) For the past two decades, we have been reading about regulatory fines against Morgan Stanley for abusing its customers in these home-grown offerings.
In November 2000, Morgan Stanley’s Dean Witter unit was charged by the National Association of Securities Dealers’ regulatory arm with selling over $2 billion of Term Trusts to more than 100,000 customers using an internal marketing campaign that characterized the investments as safe and low-risk. The NASD Regulation complaint said that Dean Witter targeted “certificate of deposit holders and other conservative investors, many of whom were elderly with moderate, fixed incomes…” The risky Term Trusts at one point had lost over 30 percent of their value and had to reduce their dividends by nearly a third.
The NASD Regulation complaint noted that “Dean Witter’s marketing effort for the Term Trusts also included high-pressure sales efforts at the regional and branch levels, include the use of sales contests and sales quotas.”
In 2003, Morgan Stanley was fined $50 million by the Securities and Exchange Commission for improper mutual fund sales practices. The SEC said the firm had set up a “Partners Program” in which a “select group of mutual fund complexes paid Morgan Stanley substantial fees for preferred marketing of their funds.” The firm further incentivized its brokers to recommend the purchase of the “preferred” funds by paying them increased compensation. The SEC said Morgan Stanley also failed to disclose the higher fees imposed on Class B shares of its proprietary funds versus sales of Class A shares.
In November 2019, the SEC again charged and fined Morgan Stanley for selling its customers more expensive share classes of mutual funds when less expensive share classes were available. The SEC noted that Morgan Stanley’s recommendations of more expensive share classes negatively impacted the overall return on the customers’ investments. According to the SEC, the activity had occurred for more than seven years, from at least July 2009 through December 2016.
One would think that Morgan Stanley might now be cautious and try to avoid further wrath from regulators over its mutual fund practices. Just the opposite appears to be the case. As we pointed out earlier this week, Bitcoin has been thoroughly discredited by some of the smartest people in the investment community. The only thing more risky than buying Bitcoin with cash is buying Bitcoin with leveraged futures contracts. And that’s just what Morgan Stanley told the SEC in recent filings that it plans to do.
Yes, Morgan Stanley plans to stuff Bitcoin futures contracts into a host of its own mutual funds. If that’s not troubling enough, Cayman Island subsidiaries also come into play with these Bitcoin futures contracts . Per the April 30, 2021 prospectus from Morgan Stanley:
“Special Risks Related to the Cayman Islands Subsidiary. Each of the Advantage Portfolio, Asia Opportunity Portfolio, Counterpoint Global Portfolio, Developing Opportunity Portfolio, Global Insight Portfolio, Global Opportunity Portfolio, Global Permanence Portfolio, Growth Portfolio, Inception Portfolio, International Advantage Portfolio, International Opportunity Portfolio and Permanence Portfolio may, consistent with its principal investment strategies, invest up to 25% of its total assets in a wholly-owned subsidiary of the Fund organized as a company under the laws of the Cayman Islands. Each Subsidiary may invest in GBTC [Grayscale Bitcoin Trust], cash-settled bitcoin futures and other investments…
“While each Subsidiary may be considered similar to investment companies, it is not registered under the 1940 Act and, unless otherwise noted in the Prospectus and this SAI, is not subject to all of the investor protections of the 1940 Act and other U.S. regulations. Changes in the laws of the United States and/or the Cayman Islands could result in the inability of a Fund and/or the Subsidiary to operate as described in the applicable Prospectus and this SAI and could eliminate or severely limit the Fund’s ability to invest in the Subsidiary which may adversely affect the Fund and its shareholders.”
Morgan Stanley includes numerous risks concerning its Bitcoin strategy, including the following:
“Exchanges on which bitcoin is traded (which are the source of the price(s) used to determine the cash settlement amount for a Fund’s bitcoin futures) have experienced, and may in the future experience, technical and operational issues, making bitcoin prices unavailable at times. In addition, the cash market in bitcoin has been the target of fraud and manipulation, which could affect the pricing of bitcoin futures contracts.
“In addition, bitcoin and bitcoin futures have generally exhibited significant price volatility relative to traditional asset classes. Bitcoin futures may also experience significant price volatility as a result of the market fraud and manipulation noted above.”
Assuming that there are investors in America that want exposure to potential “market fraud and manipulation,” we’re pretty sure that group of investors does not include retirees seeking safety through annuities.
And yet, we found this stunning prospectus from Morgan Stanley that was filed with the SEC on March 31 and updated on April 30 of this year. It pertains to the mutual funds offered by the Morgan Stanley Variable Insurance Fund, which it explains as follows:
“The Portfolios are not available for direct investment. Shares of the Portfolio are offered exclusively to certain life insurance companies in connection with particular variable life insurance and/or variable annuity contracts they issue. The insurance companies invest in shares of the Portfolios in accordance with instructions received from owners of variable life insurance or annuity contracts.
“Variable annuities are long-term investments designed for retirement purposes.”
Got that? Retirement purposes.
The prospectus includes the following among numerous risks involved with bitcoin:
“Bitcoin futures expose a Fund to all of the risks related to bitcoin discussed below and also expose the Fund to risks specific to bitcoin futures. Regulatory changes or actions may alter the nature of an investment in bitcoin futures or restrict the use of bitcoin or the operations of the bitcoin network or exchanges on which bitcoin trades in a manner that adversely affects the price of bitcoin futures, which could adversely impact a Fund and necessitate the payment of large daily variation margin payments to settle the Fund’s losses.”
Underscoring just how volatile Bitcoin is, consider this headline from CNBC on March 13 of last year: “Bitcoin loses half of its value in two-day plunge.” Do folks nearing retirement really want something in their investment portfolio that has already demonstrated the ability to lose half its value in the span of 48 hours?
On Tuesday, the SEC sent a tepid warning to Morgan Stanley and other Wall Street firms planning to stuff bitcoin futures into their mutual funds. The statement came from the SEC’s Division of Investment Management (IM) and included this:
“IM staff understands that some mutual funds are investing or seek to invest in Bitcoin futures and that these funds believe they can do so consistent with the substantive requirements of the Investment Company Act and its rules and other federal securities laws. IM staff, in coordination with staff from the Division of Examinations, will closely monitor and assess such mutual funds’ and investment advisers’ ongoing compliance with the Investment Company Act and the rules thereunder and the other federal securities laws. Investor protection and assessing the ongoing compliance of these funds is a top priority for the staff.
“In addition, IM staff, in coordination with staff from the Division of Economic and Risk Analysis and Division of Examinations, will closely monitor the impact of mutual funds’ investments in Bitcoin futures on investor protection, capital formation, and the fairness and efficiency of markets.”
For how the SEC is rapidly evolving into the LifeLock commercial, where it simply “monitors” a situation rather preventing financial crimes against the public, see our previous reporting here.
It should also be noted that Morgan Stanley is the least appropriate firm to be engaging in a high stakes game with its reputation. During the last financial crisis, the firm was in such dire straits that the Federal Reserve had to loan it a cumulative total of $2.04 trillion in emergency bailout funds. (Yes, trillion.) See page 131 of the GAO’s Audit of the Fed’s secret loans here.
A Bitcoin futures contract is a derivative and Morgan Stanley, in particular, does not have a good history with derivatives. Part of Morgan Stanley’s stresses during the last financial crisis on Wall Street came from one of its traders, Howie Hubler, losing $9 billion of the firm’s capital betting on subprime debt. Michael Lewis, in his book The Big Short, describes Hubler as a star bond trader at Morgan Stanley, making $25 million in one year prior to the collapse of the subprime mortgage market. Hubler was one of those who made early bets that the lower-rated subprime bonds would fail. Hubler used credit default swaps (derivatives) to make his bets. But because he had to pay out premiums on these bets until the collapse came, he placed $16 billion in other bets on higher-rated portions of the subprime market, according to Lewis. When those bets failed, Morgan Stanley lost at least $9 billion.
It’s time for the Biden administration to appoint real watchdogs to police, rather than “monitor,” Wall Street.
