Washington, D.C., Nov. 16, 2011 — The Securities and Exchange Commission today charged Morgan Stanley Investment Management (MSIM) with violating securities laws in a fee arrangement that repeatedly charged a fund and its investors for advisory services they weren’t actually receiving from a third party.
The SEC’s Enforcement Division Asset Management Unit has been focused on fee arrangements with registered funds. The SEC’s investigation found that MSIM — the primary investment adviser to The Malaysia Fund — represented to investors and the fund’s board of directors that it contracted a Malaysian-based sub-adviser to provide advice, research and assistance to MSIM for the benefit of the fund, which invests in equity securities of Malaysian companies. The sub-adviser did not provide these purported advisory services, yet the fund’s board annually renewed the contract based on MSIM’s representations for more than a decade at a total cost of $1.845 million to investors.
MSIM agreed to pay more than $3.3 million to settle the SEC’s charges.
The SEC’s Asset Management Unit has an initiative inquiring into the investment advisory contract renewal process and fee arrangements in the fund industry.
“We want to take the advisory fee setting process out of the shadows by scrutinizing the role of investment advisers and fund board members in vetting fee arrangements with registered funds,” said Robert Khuzami, Director of the SEC’s Division of Enforcement.
According to the SEC’s order instituting the settled administrative proceedings, The Malaysia Fund’s board of directors evaluated and approved the sub-adviser fees each year from 1996 to 2007 based on MSIM’s representations during what’s known as the “15(c) process.” Section 15(c) of the Investment Company Act requires an investment adviser to provide a fund’s board with information that is reasonably necessary to evaluate the terms of any contract whereby a person undertakes regularly to serve as an investment adviser of a registered investment company.
“MSIM failed in its duty to provide the fund’s board members with the information they needed to fulfill their significant responsibility of reviewing and approving the sub-adviser’s contract,” said Bruce Karpati, Co-Chief of the SEC Enforcement Division’s Asset Management Unit. “MSIM’s failure undermined the integrity of the board’s oversight process.”
According to the SEC’s order, MSIM arranged The Malaysia Fund’s sub-advisory agreement with a subsidiary of AM Bank Group, one of the largest banking groups in Malaysia. Despite the research and advisory agreement stating that the AM Bank Group subsidiary (AMMB) would provide MSIM with “investment advice, research and assistance, as [MSIM] shall from time to time reasonably request,” the SEC found that AMMB merely provided two monthly reports based on publicly available information that MSIM neither requested nor used in its management of the fund. Furthermore, MSIM’s oversight and involvement with AMMB during the relevant time period were wholly inadequate. MSIM had no written procedures specifically governing its oversight of sub-advisers, and did not have a procedure in place for reviewing work done by AMMB.