The SEC said that a failure of oversight over Morgan Stanley Smith Barney’s (MSSB’s) financial advisers led to millions of dollars of client funds being stolen over several years, and it has charged MSSB a $15m penalty to settle charges.

MSSB was charged with failing to reasonably supervise Michael Carter, Chingyuan “Gary” Chang, Douglas McKelvey, and Jesus Rodriguez, who collectively misappropriated almost $10m in client funds through unauthorized wire transfers and automated clearing house payments (ACH), the SEC alleged.

Such transfers included ones to pay for personal credit card bills and other personal expenses, the SEC said. The first alleged incident occurred back in 20707 and ended in late 2022.

Supervision and surveillance tech failures

The SEC order states that MSSB did not have a policy or procedure to screen externally initiated ACH payment instructions to detect instances in which one of its financial advisers assigned to the account bore the same name as the beneficiary listed in the ACH payment instructions. As a result, the firm didn’t detect hundreds of unauthorized ACH transfers between May 2015 and July 2022 from its customers’ or clients’ accounts.

In 2015, the SEC said MSSB implemented a third-party fraud detection software system that MSSB mistakenly believed would, among other things, monitor for such activity. The system had not in fact been designed to detect when such patterns of wire activity had occurred. Moreover, Morgan Stanley Smith Barney did not perform testing to validate the use of the system for that purpose at any time over the course of the next five years, the SEC said.

“Safeguarding investor assets is a fundamental duty of every financial services firm,” Sanjay Wadhwa, acting director of the SEC’s Division of Enforcement, said in a statement.

“Today’s resolution also takes into account the firm’s several self-reports to, and substantial cooperation with, the Commission staff and its remedial efforts, including compensating the financial advisers’ victims and retaining a compliance consultant to conduct a comprehensive review of the relevant policies and procedures.”

Rule violations and undertakings

By failing to adopt and/or implement written policies and procedures reasonably designed to prevent misappropriation by its advisers, MSSB violated SEC Rule 206(4)-7 (the Compliance Program Rule), the SEC said.

And its alleged, inadequate supervisory policies, procedures, and systems for implementation that led to its failure to prevent and detect violations of the antifraud provisions of the Exchange Act and Advisers Act led to violations of Section 15(b)(4)(E) of the Exchange Act and/or Section 203(e)(6) of the Advisers Act – the rules governing the registration and regulation of broker-dealers and investment advisers, respectively.

As part of its cease-and-desist order, the MSSB agreed to have a compliance consultant review all forms of third-party cash disbursements from customer client accounts and the policies, procedures and internal controls for detecting and preventing conversion of customer funds by a supervised person.

MSSB’s statement about the settlement

“These were isolated events, each of which occurred several years ago. We take these incidents very seriously and have since enhanced our control framework, working in conjunction with an outside expert,” a Morgan Stanley spokesperson said in a statement.

“We pride ourselves on putting clients first, and in each instance, when we learned of the wrongdoing, we conducted an internal investigation, terminated the wrongdoers, reported them to the proper authorities and worked with affected clients to compensate them for any harm.”

Morgan Stanley formed a venture with Citigroup’s Smith Barney in 2009 and then purchased the Smith Barney business in 2013.