Morgan Stanley Fined $7M for Broker Rollover Misconduct

The Financial Industry Regulatory Authority (FINRA) said it fined Morgan Stanley&Co. for failing to prevent brokers from violating FINRA rules for IRA rollovers/retirement accounts.

Morgan Stanley was fined $3 million and was ordered to pay more than $4.2 million in restitution to resolve charges that its supervisory system failed to prevent brokers from violating FINRA rules on handling of IRA rollover/retirement accounts.

FINRA found that Morgan Stanley failed to reasonably supervise the activities of Michael Kazacos and David Isabella, two former registered representatives in its Rochester, New York branch office. FINRA said the advisers persuaded Eastman Kodak Company and Xerox Corporation employees to take early retirement based upon unrealistic promises of consistently high investment returns and by espousing unsuitable investment strategies. The restitution will go to 90 Rochester -area retirees, FINRA said.

FINRA has permanently barred Kazacos from the securities industry for committing numerous violations of FINRA rules in connection with his solicitation and handling of IRA rollover/retirement accounts, such as making unrealistic predictions that customers would earn investment returns of 10% each year, according to a FINRA news release.

In a formal disciplinary complaint filed Wednesday, FINRA charged Isabella with engaging in similar misconduct, and the matter will be adjudicated before a three-member FINRA Hearing Panel. FINRA also found that Ira Miller, the manager of Morgan Stanley’s Rochester branch, failed to reasonably supervise both representatives. He was fined $50,000, suspended from acting in a principal capacity for one year, and ordered to re-qualify as a principal before serving in such capacity in the future.

FINRA said at least 184 customers suffered financial hardships, including market losses, a reduction in principal, and the inability to sustain expected withdrawal rates. In many cases, according to the announcement, the customer’s initial investment was eroded by market declines and the customer’s monthly withdrawals were not funded by income but were really distributions of principal.

Some customers were forced to return to work at a greatly reduced income in order to meet their basic living expenses. Morgan Stanley has previously settled with 101 other customers of the two brokers.

Broker Misconduct

In a press release, FINRA said that from 1998 through 2003, Kazacos persuaded retirees and potential retirees to invest their retirement assets with him by representing that these investors would earn 10% returns each year and would be able to satisfy their income needs by withdrawing annually a similar percentage for living expenses without reducing their principal. Kazacos’ statements encouraged several individuals to move their retirement accounts to Morgan Stanley, with some deciding to retire sooner than they otherwise might have.

FINRA found that Kazacos told customers in their 50s that, even though they had not reached the minimum age for taking withdrawals from their qualified retirement accounts (59 세), they could begin taking systematic distributions from their accounts, without penalty, by relying upon Section 72(t) of the Internal Revenue Code. FINRA also found that Kazacos failed to inform these customers of the risks associated with his recommended investment strategies.

Once Kazacos began servicing the retirement accounts—which were often the only source of income for the retirees—he implemented unsuitable investment strategies that exposed the accounts to greater risk, particularly in a declining market, and reduced the principal in many accounts, according to the release. He invested many of the customers in mutual funds, with an unsuitably high concentration in equity funds. Kazacos also recommended unsuitable variable annuity transactions.

FINRA said Isabella, a former Xerox employee, from 2000 through 2003, solicited many of that company’s retirees and potential retirees to invest with him at Morgan Stanley. He allegedly represented to prospective customers that, if they invested their retirement money with him, they would earn approximately 10% returns or more each year and be able to satisfy their income needs by withdrawing a consistent amount of money each year without reducing their principal.

In addition, FINRA charged Isabella with falsifying records concerning the financial situations and goals of his customers. FINRA also alleged that, in exchange for various gifts to certain Xerox employees, Isabella improperly obtained confidential employment records regarding, among other things, the retirement status of prospective customers employed by Xerox. He utilized this confidential information to attract new customers.

In communicating with prospective customers, Isabella used a professional designation — Retirement Planning Specialist — that he did not actually possess. FINRA also charged Isabella with providing false testimony during its investigation.

FINRA found that Morgan Stanley failed to enforce a reasonable supervisory system to ensure that Kazacos and Isabella provided customers with appropriate risk disclosures concerning their retirement accounts. During the relevant time period, Kazacos and Isabella generated approximately $15.4 million in gross commissions. The firm knew or should have known that these representatives were actively marketing their early retirement programs to retirees and potential retirees, FINRA said.

In addition, the regulator said Morgan Stanley failed to ensure that the securities and accounts that those representatives recommended for the retirees, such as variable annuities and fee-based managed accounts, were properly reviewed for suitability and other concerns.

In settling the allegations, Morgan Stanley, Kazacos and Ira S. Miller, Kazacos’ former manager, neither admitted nor denied the findings, but consented to their entry.