FINRA Also Bars Broker, Charges Second Broker, Suspends Supervisor
Washington, D.C. — The Financial Industry Regulatory Authority (FINRA) announced today that it has fined Morgan Stanley & Co. $3 million — and ordered it to pay more than $4.2 million in restitution to 90 Rochester, NY-area retirees — to resolve charges that its supervisory system failed to detect and prevent brokers from persuading Eastman Kodak Company and Xerox Corporation employees to take early retirement based upon unrealistic promises of consistently high investment returns and by espousing unsuitable investment strategies.
FINRA found that Morgan Stanley failed to reasonably supervise the activities of Michael J. Kazacos and David M. Isabella, two former registered representatives in its Rochester branch office. FINRA has permanently barred Kazacos from the securities industry for committing numerous violations of FINRA rules in connection with his solicitation and handling of IRA rollover/retirement accounts, such as making unrealistic predictions that customers would earn investment returns of 10 percent each year.
In a formal disciplinary complaint filed today, FINRA charged Isabella with having engaged in similar misconduct. The matter will be adjudicated before a three-member FINRA Hearing Panel. FINRA also found that Ira S. Miller, the manager of Morgan Stanley's Rochester branch, failed to reasonably supervise both representatives. Miller was fined $50,000, suspended from acting in a principal capacity for one year and ordered to re-qualify as a principal before serving in such capacity in the future.
FINRA found that as a result of the misconduct at least 184 customers suffered financial hardships, including market losses, a reduction in principal and the inability to sustain expected withdrawal rates. In many cases, the customer's initial investment was eroded by market declines and the customer's monthly withdrawals were not funded by income but were really distributions of principal. Some customers were forced to return to work at a greatly reduced income in order to meet their basic living expenses. FINRA has ordered Morgan Stanley to pay restitution to 90 former customers of Kazacos or Isabella who sustained losses. The firm has previously settled with 101 other customers of those brokers.
"Protecting investors who have retired or are considering retirement has been one of FINRA's top priorities," said Susan L. Merrill, Executive Vice President and Chief of Enforcement. "Brokerage firms and brokers who serve investors considering retirement must ensure that their customers are given suitable investment recommendations based upon reasonable assumptions of market performance and are given thorough disclosure of investment risks. The supervisory failures of Morgan Stanley and its management led to losses suffered by customers at a vulnerable time in their lives — retirement — which could have been avoided."
Specifically, FINRA found that, from 1998 through 2003, Kazacos persuaded retirees and potential retirees to invest their retirement assets with him by representing that these investors would earn 10 percent returns each year and would be able to satisfy their income needs by withdrawing annually a similar percentage for living expenses without reducing their principal. Kazacos' statements encouraged several individuals to move their retirement accounts to Morgan Stanley, with some deciding to retire sooner than they otherwise might have.
FINRA found that Kazacos told customers in their 50s that, even though they had not reached the minimum age for taking withdrawals from their qualified retirement accounts (59-and-a-half), they could begin taking systematic distributions from their accounts, without penalty, by relying upon Section 72(t) of the Internal Revenue Code. FINRA also found that Kazacos failed to inform these customers of the risks associated with his recommended investment strategies.
FINRA further found that, once Kazacos began servicing the retirement accounts — which were often the only source of income for the retirees — he implemented unsuitable investment strategies that exposed the accounts to greater risk, particularly in a declining market, and reduced the principal in many accounts. He invested many of the customers in mutual funds, with an unsuitably high concentration in equity funds. Kazacos also recommended unsuitable variable annuity transactions.
As to Isabella, a former Xerox employee, FINRA charged that from 2000 through 2003, he solicited many of that company's retirees and potential retirees to invest with him at Morgan Stanley. Isabella allegedly represented to prospective customers that, if they invested their retirement money with him, they would earn approximately 10 percent returns or more each year and be able to satisfy their income needs by withdrawing a consistent amount of money each year without reducing their principal.
In addition to the violations above, FINRA charged Isabella with falsifying records concerning the financial situations and goals of his customers. FINRA also alleged that, in exchange for various gifts to certain Xerox employees, Isabella improperly obtained confidential employment records regarding, among other things, the retirement status of prospective customers employed by Xerox. He utilized this confidential information to attract new customers. FINRA further alleged that, in communicating with prospective customers, Isabella used a professional designation — Retirement Planning Specialist — that he did not actually possess. Finally, FINRA charged Isabella with providing false testimony during its investigation.
FINRA found that Morgan Stanley failed to enforce a reasonable supervisory system to ensure that Kazacos and Isabella provided customers with appropriate risk disclosures concerning their retirement accounts. During the relevant time period, Kazacos and Isabella generated approximately $15.4 million in gross commissions. The firm knew or should have known that these representatives were actively marketing their early retirement programs to retirees and potential retirees. Nevertheless, the firm failed to take reasonable steps to ensure, among other things, that customers received proper risk disclosures and that Kazacos and Isabella did not promise or promote unrealistic investment returns. FINRA further found that Morgan Stanley also failed to ensure that the securities and accounts that those representatives recommended for the retirees, such as variable annuities and fee-based managed accounts, were properly reviewed for suitability and other concerns.
FINRA also found that Miller failed to take appropriate action to reasonably supervise Kazacos and Isabella to prevent their unsuitable investment recommendations and failures to disclose risks to many customers.
In settling these matters, Morgan Stanley, Kazacos and Miller neither admitted nor denied the findings, but consented to the entry of FINRA's findings.
Under FINRA rules, a firm or individual named in a complaint, such as Isabella, can file a response and request a hearing before a FINRA disciplinary panel. Possible remedies include a fine, censure, suspension, or bar from the securities industry, disgorgement of gains associated with the violations, and payment of restitution. The issuance of a disciplinary complaint represents the initiation of a formal proceeding by FINRA in which findings as to the allegations in the complaint have not been made and does not represent a decision as to any of the allegations contained in the complaint. Because the complaint against Isabella is unadjudicated, interested persons may wish to contact the respondent before drawing any conclusions regarding the allegations in the complaint.
Investors can obtain more information about, and the disciplinary record of, any FINRA-registered broker or brokerage firm by using FINRA's BrokerCheck. FINRA makes BrokerCheck available at no charge. In 2008, members of the public used this service to conduct 11.6 million reviews of broker or firm records. Investors can access BrokerCheck at www.finra.org/brokercheck or by calling (800) 289-9999.
FINRA, the Financial Industry Regulatory Authority, is the largest independent regulator for all securities firms doing business in the United States. FINRA is dedicated to investor protection and market integrity through comprehensive regulation. FINRA touches virtually every aspect of the securities business — from registering and educating all industry participants to examining securities firms; writing and enforcing rules and the federal securities laws; informing and educating the investing public; providing trade reporting and other industry utilities; and administering the largest dispute resolution forum for investors and firms.
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