Morgan, Merrill Face Lawsuits Over Annuities
by Neil Weinberg, Forbes, Jan 21, 2005
NEW YORK - Morgan Stanley received secret payments and offered its brokers undisclosed incentives to sell variable annuities, according to a class action filed against the firm earlier today. Merrill Lynch is expected to face a class action later in the day making similar allegations.
The suit against Morgan Stanley was filed in the Southern District of California in San Diego in the name of William Dornan, a San Marcos, Calif. resident and former Morgan Stanley client, who made similar allegations in a December complaint filed with the National Association of Securities Dealers. His attorney, Ronald Marron, said he plans to file a class action charging Merrill Lynch with similar wrongdoing. Marron also has a complaint pending with the NASD in which Charles Schwab is accused of wrongful variable annuity sales practices and abuse of elderly clients.
A Morgan Stanley spokeswoman said the suit is without merit and that it believes its variable annuity sales practices are "appropriate and have been properly disclosed." The company also maintains a variable annuity client bill of rights outlining the complex products and designed to protect investors, she added. Merrill Lynch spokesman Mark Herr said the company had not seen the suit and declined comment.
Variable annuities are a form of life insurance that includes a lump-sum death benefit and tax-deferred investments, often mutual funds, which are supposed to provide income during a client's lifetime. They can be particularly lucrative for insurers because of high upfront commissions, plus ongoing "trailer" commissions and the underlying fees for the mutual funds included in them.
Dornan's class action alleges that at least since 1990 variable annuity underwriters and Morgan Stanley maintained "secret contingent fee sharing arrangements" in which a portion of commission revenue was paid to the brokerage firm as an incentive to sell the product. Morgan Stanley has also limited its variable annuity sales to underwriters who participated in fee-sharing deals, it adds. The suit further claims that Morgan Stanley brokers received bonuses based on sales volume.
Under its fee-sharing arrangements, Morgan Stanely has received 10% of first-year commissions back from underwriters as contained in an "override addendum" on variable annuity policies, according to information Marron says he received from Morgan Stanley during the discovery process for Dornan's NASD complaint. That is in addition to half the 7% first-year commission on such policies, he said. Morgan Stanley brokers further received volume bonuses entitling them to up to 15% of first-year commissions for booking over $100,000 in "eligible production" on variable life insurance products, Marron said. The attorney further charges that the prospectuses Morgan Stanley provided clients included "misreprentations and omissions" of its financial interests.
Revenue-sharing by underwriters and brokerage firms is legal if properly disclosed. However, the class action claims the arrangements enabled Morgan Stanley to "receive a higher amount of compensation from the annuity transaction than disclosed to the client in the annuitiy's prospectus and related materials."
"Morgan Stanley entered into secret revenue-sharing agreements with insurers," Marron said.
The class actions come amid rapidly mounting scrutiny of variable annuity sales practices by the NASD and others. Two days ago, Forbes first reported that Morgan Stanley had been served earlier with a subpoena by Massachusetts Secretary of the Commonwealth William Galvin seeking details of its variable annuity sales, including revenue-sharing arrangements, compensation, whether the products receive preferred sales treatment, commission schedules, prospectuses and documents for internal use only (see: "Morgan Stanley Subpoenaed Over Annuity Sales").
Galvin said he has subpoenaed other financial institutions over variable annuity sales but declined to name them. The Hartford, one of the underwriters whose variable annuities Morgan Stanley sells disclosed in November that it has received subpoenas from attorneys general in California and Florida.
The lawsuits come at a particularly sensitive time for Morgan Stanley and the brokerage industry which recently came through a separate pay-to-play scandal involving mutual funds. Only 14 months ago Morgan Stanley agreed to pay $50 million in a Securities and Exchange Commission settlement charging it with failing to disclose to its mutual fund clients that its brokers were receiving extra payments to sell certain products.