FINRA Castigates Prodigious Morgan Stanley Smith Barney for Supervisory Failures

The use of language can be a powerful thing especially in the business world where concise communication is fundamental. With the steadily increasing liabilities associated with conducting business, it requires hyper-vigilance in saying what you mean, meaning what you say, and following the rules. In the field of investments, there can be a lot of paperwork generated in the interest of full disclosure, and the way to transact business is clearly defined and closely monitored by regulatory agencies. This is to ensure that the interests of investors are protected and that all parties involved in the investment industry are following the same practices. It is the responsibility of each broker, advisor, and investment firm to understand the language set forth in the rules that govern the industry and to strictly abide by them. When they don’t, sooner or later, it is likely one regulatory agency or another will be slapping them with fines, penalties, and/or even criminal charges.

Such was the case with Morgan Stanley Smith Barney last week. The Financial Industry Regulatory Authority (FINRA) fined the mega-firm $5 million for failing to accurately supervise many of its brokers who were using the terms “indication of interest” and “conditional offer to buy” interchangeably. For a powerhouse brokerage firm that has been around for more than 75 years and has more than $1.65 trillion in client assets that it manages, they should have known better.

According to a recent FINRA press release, from February 16, 2012 until May 1, 2013 Morgan Stanley Smith Barney enticed investors to purchase shares in 83 initial public offerings (IPOs). Unfortunately, the company fell short in establishing appropriate policies, procedures, and training guidelines for its sales staff to help them delineate the difference between the two terms when offering the IPO shares to perspective clients.

An indication of interest (IOI) can be offered before the registration date of an IPO because it is not a binding commitment, as it is illegal to sell a security before it is fully registered. The IOI will only become irrevocable if the purchase is approved by the client after the completion of the IPO registration. A conditional offer to buy, however, becomes effective as a purchase after the registration of the IPO and upon acceptance by the firm unless the client takes action to revoke it. The problem for Morgan Stanley Smith Barney arose when in February, 2012 the company instituted a policy that began allowing its staff to use these terms synonymously. Consequently, sales of the shares were being processed without getting reaffirmation from their clients.

FINRA’s stance is that since the firm failed to provide the appropriate training to its financial advisors, it is conceivable that neither the sales staff nor the clients were aware of what kind of commitment they were making. The regulatory agency also found that the firm did not ensure that its policies were being adhered to and failed to institute procedures to make sure that conditional offers were being conducting in a manner consistent with federal securities laws and FINRA regulations. FINRA did state that on May 1, 2013, Stanley Smith Barney clarified its policy to advisors, and they have begun reaffirming all customer orders after the final pricing terms became available.

Approximately 68,000 investors purchased shares in the firm’s biggest offering, however, a FINRA spokesperson stated that there isn’t any evidence to indicate that any of the firm’s clients were negatively effected by these supervisory insufficiencies.

FINRA executive, Brad Bennett, said, “Customers must understand when they are entering a contract to buy shares in an IPO. This starts with the firm’s duty to establish clear procedural guidelines for soliciting conditional offers to buy and to educate its sales force regarding this type of solicitation. There must not be ambiguity regarding the customer’s obligations given the significant legal differences between an indication of interest and a conditional offer to buy.”

Although Morgan Stanley Smith Barney neither admitted nor denied the charges, the firm did consent to the entry of FINRA’s findings.

If you feel that you have been negatively impacted as a result of Morgan Stanley Smith Barney’s supervisory failures, please call us at the Blum Law Group for a free consultation at 877-STOCK-LAW.

Sources: FINRA.org; Investmentnews.com; Wikipedia.com; Investopedia.com