Investment firm Morgan Stanley is facing an arbitration claim by the city of Burlington, Vermont, which alleges breaches of fiduciary duty and fraud involving something known as a wrap account. According to the claim, Morgan Stanley’s actions resulted in damages of more than $21 million for the Burlington Employees’ Retirement System – losses that were mainly due to hidden fees and commissions associated with the wrap account Morgan Stanley recommended.
As reported Feb. 11 by Investment News, the city alleges that the fraud occurred from 1981 through 2006 and that the Morgan Stanley employees in charge of its account engaged in a “pay-to-play” scheme. According to the claim, Morgan Stanley selected only managers who funneled a portion of their management fees to the brokerage firm.
In addition, the claim alleges that Morgan Stanley was charging per-trade commissions despite an initial contract that promised free trading. The allegedly excessive fees and mark-ups dramatically reduced the city pension fund’s returns, contributing to the $21 million in losses.
A Feb. 9 article in Forbes (Wrap Account Rip-Off?) highlights the potential drawbacks of wrap accounts. A wrap account is essentially an investment account in which clients are charged a flat percentage of their assets (usually between 1% and 3%) in return for unlimited trading.
Wraps have become an increasingly popular sales product on Wall Street – so popular, in fact, that brokerage firms now have roughly $1.5 trillion in assets under management in them, according to the Forbes article.
Critics, however, say wrap accounts have plenty of pitfalls and may be just as bad – if not worse – as commission-based accounts.
Burlington is asking a Financial Industry Regulatory Authority (FINRA) arbitration panel to order Morgan Stanley to pay the city, its board and the plan actual damages incurred as a result of Morgan Stanley’s alleged misconduct. The claim also is requesting punitive damages.
Morgan Stanley denies all the allegations.