Morgan Stanley Brokers Pushed Loans to Win Dinners
Morgan Stanley is in trouble in Massachusetts for allegedly running a sales contest for some of its financial advisers in which the advisers could win valuable prizes by convincing clients to borrow against their brokerage accounts. Except that the prize money could only be spent on entertaining more clients:
Rather than respond to the needs of their clients, Financial Advisors began to push PLAs in order to win the BDA incentives awarded under the Sales Contest. Financial Advisors used the BDA money awarded to them to wine and dine clients, including the following items: Boston Celtics tickets, client drinks, one client meal in the amount of $653.40, and $1,000.00 in client gifts from one Financial Advisor.
Right away, we have come to an insurmountable imaginative divide between me and these financial advisers. These people thought that this was good. They wanted more money to entertain clients. "You know how we are about BDA money!!!," said one of them, with three exclamation points, so you know how he was about it. (He was in favor of it. "BDA" stands for "business development allowance," i.e., client-entertainment money; "PLA" stands for "Portfolio Loan Account.") Now, for myself, I can imagine few crueler punishments than being told to go spend a thousand bucks on taking clients out to dinner and a Celtics game, but that is one of many reasons that I'm not a retail financial adviser.
Anyway, the Morgan Stanley advisers seem to have done their best to sell lending products and earn client-entertainment allowances, out of all proportion to their economic value, so this program was a success for Morgan Stanley, albeit on a small scale (because it was run only in five offices in Massachusetts and Rhode Island). But the Massachusetts Securities Division didn't like it, and has brought an administrative complaint against Morgan Stanley. ("Jim Wiggins, a Morgan Stanley spokesman, said the company objects to the allegations and intends to defend itself 'vigorously,'" says Bloomberg News.)
As you'd expect, the written communications turned up by the MSD are a little embarrassing, but not in the usual way of financial scandals, where traders send each other ungrammatical chat messages joking about going to prison. The e-mails here are embarrassing only for their earnest embrace of sales clichés. "There is no reason we shouldn't be able to knock this out of the park," said a private banker to a financial adviser. Another private banker wanted to "ensure we are giving [Financial Advisors] every opportunity to move the needle." "Game on," said one financial adviser. "Let's try and finish the year strong!," said another, with what I can only assume was genuine if incomprehensible enthusiasm.
None of this suggests that the financial advisers thought they were doing anything wrong. Which is understandable. It's not even clear what the Massachusetts Securities Division thinks they were doing wrong. There's no actual law against sales contests. The complaint was brought under very generic statutory language allowing the state to punish investment advisers who have "engaged in any unethical or dishonest conduct or practices in the securities, commodities or insurance business." The complaint just assumes that the sales contest was "unethical or dishonest," because it caused financial advisers to be "focused on their banking and lending numbers, not on the needs of Morgan Stanley clients," and because "the incentives paid under the Sales Contest created a material conflict of interest for participating Financial Advisors." The problem is that the financial advisers were rewarded for drumming up more business, not for doing what was right by clients. As Massachusetts Secretary of the Commonwealth William Galvin put it:
“This complaint lays bare the culture at Morgan Stanley that bred the high-pressure effort to cross-sell banking products to its brokerage customers without regard for the fiduciary duty owed to the investor," Galvin said in a statement. "This contest was relatively local, but the aggressive push to cross-sell was company wide."
Sensitive readers may want to avert their eyes at this point, because we are going to get into some hard truths. Financial advisers are paid for bringing in business. That is obviously, always and everywhere true. Yes these particular financial advisers got some extra client dinners for bringing in a particular kind of business, but that was against a background where their paycheck was generally based on bringing in business. There was no particular secret about it. "Advisers are paid on the basis of fees and commissions they bring in each year, with higher producers keeping a higher percentage of revenue," reported the Wall Street Journal, in an article about Morgan Stanley's published tables of how much advisers would get paid for bringing in business. Attracting more assets, selling more products and charging more fees brings in more revenue for Morgan Stanley, and advisers get a cut of that.
This is of course a conflict of interest: Getting paid to sell things to customers encourages you to sell things to customers, even if you don't think, in your heart of hearts, that the customers need those things. But I will tell you another hard truth, which is: Everyone is paid for bringing in business. This is true of fiduciaries: Many lawyers bill by the hour, so they have financial incentives to bill more work to their clients. It is true of non-fiduciaries: Car salespeople get paid for selling cars, so they have financial incentives to push customers to buy cars. The way business works, in the most general possible way, is that you do business, and people pay you for doing the business, and you try to do more business, so more people will pay you more for doing the business.
It is weird to be shocked by this. The Massachusetts Securities Division objects that this sales contest was a "high-pressure effort to cross-sell banking products." Coming just a few weeks after Wells Fargo's fake-accounts debacle, where employees reacted to high-pressure cross-selling demands by fraudulently creating millions of fake accounts, you can see how this would be a concern. Except that there's no evidence that Morgan Stanley's contest was actually high-pressure, certainly not compared to the apparent constant misery at Wells Fargo. No one at Morgan Stanley seems to have been fired, or threatened with firing, for not opening enough portfolio loan accounts. Instead, if they opened enough accounts, they got a small prize -- more client dinners -- that I would have thrown away as fast as you could give it to me, though I guess they were into it.
Morgan Stanley's internal-use materials recommended that Financial Advisors look for specific triggers as catalysts to offer clients securities-based lending products.
These triggers included "bridge loans for mortgage funding," "tax liabilities or obligations," "weddings, graduations, etc.," and frivolous spending in the form of "purchasing a luxury item like a car or yacht."
Some more hard truths:
- Sometimes people buy cars.
- Sometimes people borrow money to buy cars.
- Sometimes car salespeople encourage people to buy cars, and to borrow money to do so.
There is a widespread belief that the financial industry is the most unethical business around, that it is a cesspool of abuse and corruption, that "the business model of Wall Street is fraud." And, you know, sure. But it is strange to see how often Wall Street is unthinkingly held to a higher standard than other businesses. The conduct for which Jesse Litvak was prosecuted -- essentially, telling customers that he was barely making any money on the bond trades he did with them, when he was in fact making a lot of money -- would be unremarkable for a car salesman. "Cross-selling" has become a dirty word in banking, but everyone shrugs resignedly when car salesmen push the extended warranty. And here, the Massachusetts Securities Division seems to be claiming that it is illegal for Morgan Stanley to reward salespeople for making sales, and criticizes Morgan Stanley for suggesting that its customers spend their money on something as frivolous as a car. Imagine bringing a similar case against a BMW dealership.
What is going on? One basic issue is that people think that financial advisers should be advisers. To be fair, it is right there in the name. "Adviser" has a different connotation from "salesperson": Advisers just sound like they should be honest, disinterested fiduciaries for their clients. They're not supposed to win a set of steak knives for signing up more clients for loans. The industry hasn't always helped itself here, particularly in retail financial advice, where some advisers are fiduciaries, some aren't, and some sometimes are and sometimes aren't. "When handling a brokerage account," says Morgan Stanley to its customers, "your Financial Advisor must have a reasonable basis for believing that any recommendation is suitable for you, but will not have a fiduciary or investment advisory relationship with you." The financial adviser advising you on investments doesn't have an investment advisory relationship with you. It is a bit confusing!
If you expect financial advisers to be fiduciaries, or quasi-fiduciaries, then you will hold them to a higher standard than most salespeople. Of course fiduciaries too are ultimately paid more for doing more business, but in a genteel sort of way. There are no contests. There are no crass e-mails about moving the needle or knocking it out of the park. They are transparent about how they get paid, and how much. They just do what is best for their clients, and the money comes to them as an afterthought, and they avert their eyes from it in embarrassment. They are not, of course, in the business of money management for the money.
The problem isn't limited to retail financial advisers. We talked last week about a Goldman Sachs derivatives salesman who seduced the Libyan Investment Authority into doing some ill-advised trades with Goldman. The Libyans sued claiming "undue influence": They trusted him, is the essence of their complaint, and he turned out to be just another salesman. There was no fiduciary duty, exactly, and he never lied to them, but finance is complicated, and if you can't trust the guy selling you complex derivatives to sell you the right complex derivatives, then whom can you trust?
One broad story you could tell about post-crisis financial regulation is that banks believe deeply in the arms-length-counterparty, caveat-emptor sales model -- and no one else does. The things that constrain salespeople in other businesses don't work as well in finance: The stuff that banks sell is hard to understand, comparison-shopping is difficult, and reputational concerns don't seem to matter when everyone's reputation is terrible. Too many people at banks look to the outside world like they should be trusted advisers to clients, but think of themselves as salespeople to counterparties, and are paid and promoted and praised for selling products. Eventually that gap between perception and reality has to close, one way or another.
It also helps explain why I am no longer an investment banker. Actually, when I was a banker, client entertainment was effectively a punishment: When I was busy doing deals, I had an excuse to turn down dinners with prospective clients, but when things were slow, I was constantly on planes to steakhouses. Brr.
From the complaint:
The Sales Contest generated new loan balances totaling nearly $24,000,000.00.
In a December 2, 2014 e-mail regarding the Sales Contest, the Complex Manager stated, "Phenomenal. Assuming a profit of 150 [basis points] on the 24mm--we have 360k in new revenue minus the BOA$ (1 time) and FA comp. very very profitable[.]"
The next day another banker e-mailed:
YTD we've paid out $15,000 in extra BDA incentive, but will probably end the year at about $23,000 paid out. So, in theory, the one-time $23k BDA investment should produce $515k in annual revenue.
I wouldn't worry too much about the discrepancies there.
Private bankers actually do the securities-based loans; financial advisers are the ones with the clients. So the private bankers want the financial advisers to send clients their way.
The complaint notes that Morgan Stanley had a policy prohibiting some sales contests:
Morgan Stanley has an internal policy titled "Prohibition Against Sales Contest," ("Prohibition") which was in effect during the entirety of the Sales Contest.
The Prohibition "completely prohibits participation in sales contests, unless the contest under consideration is a national sales contest."
But that is an internal policy, not a law. In any case Morgan Stanley has denied that this program was a sales contest -- "It would be inaccurate to refer to this as a sales contest," it told the New York Post in March -- though the internal definition of a sales contest is "an arrangement that offers associated persons or their supervisors additional compensation in the form of bonus payments, incentives, or non-cash compensation to promote the sale or achievement of a specified level of sales over a specified period of time," which does sort of sound like this.
Other lawyers are paid by the deal, so they have incentives to push their clients to do more deals. Investment banks tend to be paid by deal value, so they have incentives to push deals (and to push prices up). Et cetera.
The complaint has a section heading claiming that "Morgan Stanley Created a Culture of Competition, Pressured Financial Advisors to Cross-Sell, and Closely Tracked Results," but the evidence of pressure is pretty thin. It's stuff like this:
When one Springfield-based Financial Advisor participating in the Sales Contest was trailing his peers in banking and lending business, the Complex Manager stated in a May 9, 2014 e-mail, "Ouch, I know you are competitive [FA] so I am sending [the numbers showing FA trailing his peers]."
The Financial Advisor responded, "I'm pushing. Springfield will be at goal!"
That's supposed to be high-pressure? In a retail financial advisory business? The Complex Manager might as well have given him a hug and said "I know you are trying your best, don't worry about the PLA goals."
Also their assistants apparently got $50 in actual cash compensation for each PLA application that they processed. That too is sort of a soft incentive for the actual financial advisers.
Another objection is that the MSD doesn't seem to love the product itself (a secured line of credit against a client's securities portfolio at Morgan Stanley) that much:
Internal-use materials highlighted the benefits of securities-based lending, but downplayed the risks, which were included in the fine print and only partially disclosed.
The risks associated with securities-based loans are material.
For example, in the event that the value of a client's securities pledged as collateral decline significantly, Morgan Stanley may liquidate those securities if the client is unable to post additional collateral.
If a client is unable to repay the balance of their PLA, Morgan Stanley may liquidate securities without first notifying the client.
If a client prepays the balance of their PLA, Morgan Stanley may charge the client a prepayment penalty.
PLAs make it more difficult for clients to move their assets to a new firm if those assets are pledged as collateral at Morgan Stanley because the client is required to pay off any PLA balance prior to transferring their assets.
None of this strikes me as that serious an objection?
In this case, the complaint says:
At the direction of the Complex Manager and Metro West Private Bankers, Financial Advisors, often owing a fiduciary duty to their clients, were now in the business of recommending that their clients burden themselves with debt.
That "often" presumably means that sometimes financial advisers pushed loan products on brokerage customers (no fiduciary relationship) and sometimes pushed them on investment-advisory clients (fiduciary relationship). The sales contest doesn't seem to have distinguished between the two.
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