(The news featured below is a selection from the news covered in the Federal Securities Report Letter, which is distributed to subscribers of the Federal Securities Law Reports.)

Brokerage Firm Settles Mutual Fund Disclosure Action

The SEC announced the institution and simultaneous settlement of an enforcement action against Morgan Stanley DW Inc. for failing to provide customers with information relating to their purchases of mutual fund shares. As part of the settlement, the firm will pay $50 million in disgorgement and penalties, all of which will be placed in a "fair fund" for distribution to customers.

The SEC's industry-wide investigation of mutual fund sales practices revealed two alleged firm-wide disclosure failures. The first related to a program in which a select group of mutual fund complexes allegedly paid the firm substantial fees for preferred marketing of their funds. According to the SEC, the firm paid increased commissions to its sales force to recommend the purchase of shares in these preferred funds.

The SEC claimed that the firm also failed to adequately disclose at the point of sale the higher fees associated with purchases in excess of $100,000 of Class B shares of certain of its proprietary mutual funds. In connection with its recommendation to customers to purchase certain Class B shares, the SEC claimed the firm did not adequately inform customers at the point of sale that large purchases of such shares were subject to higher fees. The firm also allegedly failed to explain to customers that those fees could have a negative impact on customers' investment returns.

The SEC claimed that this conduct violated Securities Act Section 17(a)(2) and Exchange Act Rule 10b-10. Section 17(a)(2) prohibits the making of materially misleading statements or omissions in the offer and sale of securities, while Rule 10b-10 requires broker dealers to disclose the source and amount of any remuneration received from third parties in connection with a securities transaction. The SEC also claimed that the conduct violated NASD Rule 2830(k), which prohibits NASD members from favoring the sale of mutual fund shares based on the receipt of brokerage commissions.

Stephen M. Cutler, director of the Commission's Division of Enforcement, said "that unbeknownst to the firm's customers, the firm received monetary incentives--in the form of 'shelf space' payments--to sell particular mutual funds to its customers." He emphasized that " when customers purchase mutual funds, they should understand the nature and extent of any conflicts of interest that may affect the transaction."

The firm has agreed to settle this matter, without admitting or denying the findings in the SEC order. As part of the settlement, the firm will pay $25 million in disgorgement and prejudgment interest. In addition, the firm will pay civil penalties totaling $25 million. The entire $50 million payment will be placed in a "fair fund" for distribution to customers who purchased "preferred " fund shares since January 1, 2000.

In addition, the firm has undertaken to 1) make required disclosures on the firm's Web site concerning the preferred fund program disclosures, 2) provide customers with a disclosure document concerning the preferred fund program and the differences in fees and expenses connected with the purchase of different mutual fund share classes, 3) convert customers' Class B shares purchased in lots of more than $100,000 to Class A shares, 4) retain an independent consultant to review the firm's disclosures, policies and procedures and 5) adopt the recommendations of the independent consultant.

Finally, the order censures the firm and orders it to cease-and-desist from committing or causing any violations of Section 17(a)(2) and Rule 10b-10. The NASD also announced a settled action against the firm for violations of NASD Rule 2830(k) arising from the preferred fund program and its predecessor.