Morgan Stanley Pays $15 Million to Settle SEC Civil Injunctive Action Alleging That It Failed to Timely Produce Documents During Two SEC Investigations

5/22/2006
Client Alert

On May 10, 2006, the SEC announced that it had filed a civil injunctive action against Morgan Stanley & Co. for allegedly failing to produce emails and electronic records in a timely manner during the course of two separate SEC investigations, and that Morgan Stanley had agreed to settle the matter.  The action arose from Morgan Stanley’s electronic document preservation and production practices during SEC investigations into the company’s practices in allocating IPO shares and into possible conflicts of interest between the company’s research analyst and investment banking divisions.  The civil injunctive action represents a significant departure from the SEC’s usual practice of filing an administrative action to address document preservation issues, and signals a more aggressive approach to document preservation and production in matters under investigation.

Background

Federal securities laws, including Section 17(b) of the Securities Exchange Act of 1934 (hereinafter "Exchange Act"), 15 U.S.C § 78(q)(b), and Exchange Act Rule 17a-4(j), 17 C.F.R. § 240.17a-4(j), require a company to make its records available to the SEC in a prompt and timely manner.  Under Exchange Act § 17(b), a broker-dealer is required to submit its records to the SEC as part of a routine or special examination.  In complying with this provision, Exchange Act Rule 17a-4(j) requires a broker-dealer "to furnish promptly" to the SEC those records that are required to be preserved and those records which are the subject of the SEC’s examination.[1]

The Complaint

The SEC asserted that Morgan Stanley violated Exchange Act § 17(b), 15 U.S.C § 78(q)(b) and Exchange Act Rule 17a-4(j), 17 C.F.R. § 240.17a-4(j) by failing to preserve and promptly produce electronic documents sought by the SEC in the context of its investigations. The SEC’s action focused on Morgan Stanley’s practices for retaining, reviewing, and producing emails in response to subpoenas and document requests issued between December 2000 and October 2004.[2]  In its complaint, the SEC alleged that Morgan Stanley repeatedly failed to retain, diligently search for, and produce responsive emails.  The company also misrepresented the status of its email preservation and production systems to the Commission on a number of occasions.  

According to the SEC’s complaint:

  • Morgan Stanley failed to timely produce emails because it failed to diligently search for "readily accessible" back-up tapes stored in their "customary" location, depriving the SEC of responsive documents during its investigation. 
    • In responding to SEC requests and subpoenas, Morgan Stanley failed to search for and locate back-up tapes containing tens of thousands of responsive emails from 1999, stored in Morgan Stanley’s offices and at its off-site storage providers.  Instead, Morgan Stanley told the Commission that back-up tapes from 1999 did not exist. 
    • When it discovered the tapes sometime during the period of May 2004–July 2005, Morgan Stanley did not correct its prior erroneous assertion but instead indicated that its production in the still-ongoing research analyst investigation was complete and certified as part of its settlement in the IPO investigation that it had searched for and provided all responsive emails. 
    • Morgan Stanley did not disclose the existence of the back-up tapes until the SEC, acting on an anonymous tip, began to investigate the company’s email retention and production activities. 
  • Morgan Stanley failed to timely produce emails because the company took several years to load extracted emails to its searchable database. 
    • Although Morgan Stanley created a searchable database to which archived emails from back-up tapes could be uploaded for review, it reported that the database was complete when, in fact, there was a large backlog of unloaded emails that remained to be processed. 
    • The SEC relied on the company’s assertions that all relevant and responsive emails from the requested time periods had been uploaded and that email productions were complete when it began taking testimony, unaware that responsive documents had not yet been added to the database.  
  • Morgan Stanley failed to produce possibly responsive emails by recycling back-up tapes which had not been uploaded into the searchable database, thus over-writing and erasing potentially relevant data. 
    • Morgan Stanley repeatedly assured the SEC—both orally and in writing—that it had ceased over-writing back-up tapes in 2001. 
    • The SEC learned in late 2004 that these assertions were untrue and that the company had been continuing to over-write tapes, even after receiving SEC subpoenas. 
    • Morgan Stanley’s practice of recycling back-up tapes destroyed at least 200,000 emails, including potentially responsive documents.  

The SEC alleged that Morgan Stanley’s repeated email production failures and misstatements delayed the SEC’s research analyst and IPO investigations and caused the SEC to expend significant resources to complete those cases.

The Settlement

To settle the action, Morgan Stanley consented to a final judgment that permanently enjoined it from violating Exchange Act § 17(b), 15 U.S.C § 78(q)(b) and Exchange Act Rule 17a-4(j), 17 C.F.R. § 240.17a-4(j) and agreed to pay a $15 million fine, $5 million of which was to be distributed to the NASD and the NYSE in separate related proceedings.  Morgan Stanley also agreed to implement email document preservation and production policies, procedures, and training, and will hire an independent consultant to review the company’s reforms.  Morgan Stanley did not admit or deny the allegations in the SEC’s complaint.

Implications

This matter highlights the SEC’s increasingly strong interest in timely and complete document productions.  Moreover, the fact that the Commission charged Morgan Stanley with violations of the "examination" provisions of Section 17 of the Exchange Act establishes it has the ability and the willingness to seek stiff sanctions not only in the context of failing to provide required records during the course of an enforcement investigation, but during a routine examination as well.  The Commission’s somewhat unusual decision to file a civil injunctive action—rather than an administrative action—against Morgan Stanley indicates that the SEC will vigorously pursue companies which fail to implement timely, efficient, and effective document preservation and production procedures.


 
Footnotes:

1: Section 17(b) of the Exchange Act and Rule 17a-4(j) thereafter by their terms relate to the SEC’s authority to conduct examinations of registered broker-dealers and the obligation of those broker-dealers to produce required records to the SEC’s examination staff.  The SEC in its complaint notes that those provisions can also be cited to require the production of records to its investigative or enforcement staff.

2: The SEC previously sanctioned Morgan Stanley for failing to preserve emails relating to a broker-dealer’s business for at least three years under the record retention provisions of Section 17(a) of the Exchange Act and Rule 17a-4(b)(4) thereunder, as explained in Exchange Act Release No. 38245 (Feb. 5, 1997).  See In the Matter of Deutsche Bank Securities, Inc., et al., Exchange Act Rel. No. 46987 (Dec. 3, 2002).

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