Morgan Stanley Clamps Down on Sales of Some Fund Classes

By Arden Dale

NEW YORK -- Morgan Stanley (MWD) is taking stricter measures to block its brokers from beefing up commissions through controversial mutual fund sales.

Morgan Stanley told brokers in an internal memo that it has tightened caps on the dollar amount of Class B and C fund shares they can sell starting on May 2.

"The view of regulators and industry practices concerning the sale of mutual fund share classes continue to evolve," the firm said in the memo."The Firm's policies also continue to evolve." Morgan told its clients about the new policy in a mailing during March, according to Andrea Slattery, a spokeswoman for the firm.

The new policy narrows the dollar amount of Class B shares that brokers can sell an individual from $100,000 over a 45-day period to under $25,000 over a 90-day period. It tightens the amount of allowable Class C shares from $1 million to under $250,000 over a 90-day period.

Morgan has had a policy restricting large purchases of Class B and C shares by its customers since Oct. 1, 2001. Mutual funds offer different share classes for the same fund, charging investors different amounts to buy them. Class A shares often require an upfront sales charge based on the size of the investment. Class B shares, on the other hand, usually come with an annual charge and a fee for cashing out. Class C shares shun sales charges for buying or selling, but carry higher costs in general than the other classes.

Mutual funds have been clamping down on sales of Class B and Class C shares in the face of a growing number of lawsuits involving abusive fund share sales, according to Mercer Bullard, a University of Mississippi law professor and founder of Fund Democracy, an investor advocacy group.

The National Association of Securities Dealers has also been putting pressure on the industry to clean up practices. Last month, NASD fined Citigroup Global Markets Inc., American Express Financial Advisors and Chase Investment Services a total of $21.25 million for recommending inappropriate share classes. The agency anticipates bringing more enforcement actions over Class B shares, according to NASD spokesman Herb Perone.

"Every firm is thinking about this issue," said Bullard. "Morgan Stanley is definitely not the only company that is putting caps in place. A lot them haven't had any caps at all."

Morgan Stanley has been involved in high-profile skirmishes over inappropriate sales of certain share classes. In January 2004, a U.S.District Court judge dismissed a class-action suit filed in Tennessee against the firm on its marketing of Class B fund shares.

The firm also settled Securities and Exchange Commission charges last year and paid a $50 million fine after the SEC accused it of a failing to tell clients that they would often pay more to purchase Class B shares in Morgan Stanley than if they bought Class A shares.

Concerns about abusive share class sales focus on the issue of how long investors hold the shares. In general, Class A shares tend to be more appropriate for large, longer-term investments held for over six or seven years. Class C shares are more appropriate for short-term mutual fund investors.

As a general matter, Class B shares are very rarely the best option for an investor, especially when the size of the investment entitles him to a discount on the front end-load of the fund, according to Bullard.

Morgan told brokers in the memo, dated April 4, that they should "carefully consider" how long an investor plans to a hold a fund when deciding which share class is most favorable. They should also look closely at the size of the investment, the expenses of each share class, and whether the client qualifies for sales charge discounts fact, Morgan said.

The firm referred brokers to a mutual fund expense calculator on the NASD Web site for help in determining which class of shares is most suitable for a client.

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