Morgan Stanley Seeks to Change Basis for Award in a Stock Case

The New York Times

August 21, 2003

In the years after the stock market peaked, Morgan Stanley worked overtime to persuade regulators that its research was fair and free of investment-banking-related conflicts. But the strategy failed, and the firm agreed to pay $50 million in fines last April to settle regulatory accusations that it issued biased research.

Now the firm is working equally hard to convince arbitrators hearing cases brought by aggrieved investors that the research settlement it struck is not relevant and should not be considered. This strategy, too, has failed, at least in a ruling made public yesterday by a NASD arbitration panel.

The case was brought by Joseph Kenith, a retired engineer living in Florida who was a Morgan Stanley client from 1996 to 2001. Last May, the arbitrators hearing the case ruled that Morgan Stanley must pay $100,000 to Mr. Kenith. They found that the firm was liable because it had failed to supervise Mr. Kenith’s broker and because of the findings in the research settlement that the firm had signed with regulators.

Morgan Stanley immediately objected to the arbitrators’ inclusion of the research settlement as part of the basis of its award. The firm appealed to the panel to strike the reference to it in the award. Yesterday, the panelists declined to do so. Now the case is in federal court in the Southern District of Florida.

Morgan Stanley declined to comment on its efforts to get the arbitrators to rewrite the justification for their award.

Bret Gallaway, a spokesman, said, “There was no claim ever made against Morgan Stanley for liability pursuant to the research settlement.” The firm is not asking to modify the award, which it has already paid.

The Kenith case illustrates what a problem the research settlement is posing, not just to Morgan Stanley but all Wall Street firms. While the brokerage firms agreeing to the settlement neither admitted nor denied the regulators’ findings of tainted research, arbitrators appear to be using the settlement documents even when they hear cases that do not hinge on research.

When he filed suit against Morgan Stanley in 2001, Mr. Kenith, 74, sought $3.3 million from the firm. This amount represented the value of his account at the market’s peak, said Darren C. Blum, a lawyer in Plantation, Fla., who represented Mr. Kenith.

The $100,000 award may seem like small potatoes compared with the amount Mr. Kenith sought, but it is significant. Mr. Kenith did not lose money in his years with Morgan Stanley and, unlike many former clients who are suing their brokers, he was a sophisticated investor. Indeed, he wound up making about $500,000 investing with Morgan Stanley from 1996 to 2001, Mr. Blum said.

Mr. Kenith’s lawyer said that his client did rely on Morgan Stanley research, especially on Internet companies whose shares Morgan Stanley had underwritten. “The research came into play as this guy’s account was dropping like a rock and he was saying to his broker, ‘What should I do?’ ” Mr. Blum said. “And his broker’s response was, ‘Our firm still has outperform ratings on Priceline.com, Agile Software, eBay, Homestore.com. Therefore, I don’t recommend you sell out; rather you should buy more.’ “

But the research that the broker was relying on, Mr. Blum added, was tainted. And the arbitrators seemed to agree.

Morgan Stanley is not asking the court to reduce the award. But in asking the arbitrators to strike their reference to the research settlement, Morgan Stanley is pursuing an unusual tack. Arbitrators do not often modify their awards, or the reasons behind them.

And the firm will probably have a tough time persuading a judge to modify the reasons given by the arbitrators when they made their award. Arbitrators’ awards are typically challenged successful only when panelists have shown a manifest disregard for the law.

Its aggressive approach to the Kenith case is consistent with Morgan Stanley ‘s actions throughout the extensive investigations by regulators into Wall Street’s conflicts. After agreeing to the research settlement, the firm tried to differentiate itself from the other Wall Street firms investigated by regulators.

Its 2002 annual report stated that the firm had come through the investigations “relatively unscathed.” And last April, Philip J. Purcell stated publicly that there was nothing in the settlement that should disturb the firm’s clients.

That comment produced a strong rebuke from William H. Donaldson, the chairman of the Securities and Exchange Commission, who said the remark showed “a troubling lack of contrition.”