Lack of Supervision
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Morgan Stanley and New York: Lack of Supervision
MORGAN STANLEY FAILED REASONABLY TO SUPERVISE ITS SENIOR RESEARCH ANALYSTS
A. Morgan Stanley Had No System for Reviewing the ratings Issued by Its Senior Analysts
51. Morgan Stanley failed reasonably to supervise its senior research analysts. The firm required only non-officer-level analysts to submit their initial ratings and proposed changes in ratings for review by the Stock Selection Committee. Senior analysts - principals and managing directors - were not subject to their requirements. (Exhibit 39 at MS0000155.) In addition, Morgan Stanley had no effective system in place for reviewing the ratings of its senior analysts against changed conditions.
52. Morgan Stanley's lack of effective review system allowed some principal and managing director analysts to maintain Outperform ratings unchanged on declining stocks without any review by management. For example, in 2000 and 2001, four senior analysts maintained Outperform ratings unchanged on 13 stocks as the prices of the stocks declined by over 74 percent. The names of the stocks, their percentage declines, and the number of months without a change in the Outperform rating are shown on the following chart:
Company * percent Price Drop While Rated Outperform * Months Without Change in Outperform Rating
Chemdex (Ventro) 96.2 8.5
Drugstore.com 95.4 30
Priceline.com 92.0 30
Ask Jeeves 90.9 16
Marimba 88.9 8.5
Homestore.com 88.7 10
Vignette 87.4 7.5
VeriSign 83.3 19.5
Akamai 82.8 10
Women.com 80.3 8.5
CNET 77.7 16.5
Inktomi 76.9 15
FreeMarkets 74.3 23
(Exhibit 40.)
53. Not until late 2001, after complaints from Institutional Sales persons made as part of the year-end evaluation process, did management state to one of the analysts: "Don't let your ratings get stale; change them ahead of expected price action." (Exhibit 41 at MS0083402.)
Morgan Stanley's Analyst Virtually never Used the Lowest Rating in the Firm's Stock Rating System
54. From 1995 to March 2002, Morgan Stanley publicly stated that it had a four-category rating system: Strong Buy; Outperform; Neutral; and Underperform. "Underperform" was defined as: "Given the current price, these securities are not expected to perform as well as other stocks in the universe covered by the analyst." (Exhibit 42.)
55. Although Morgan Stanley stated that it had a four-category system, its analysts virtually never used the "Underperform" rating and, in effect, used a three-category system. From 1999 through 2001, the firm published research on approximately 1,000 North American company stocks. No more than three of the 1033 stocks covered over the course of 1999 were given an Underperform rating; no more than five of the 1058 stocks covered over the course of 2000 received that rating; and no more than six of the 1030 stocks covered over the course of 2001 were rated Underperform.
56. Morgan Stanley management was aware that the analysts were not using the "Underperform" rating, but did not correct the problem until March 2002, when a new rating system was instituted. (Exhibit 43.)