(November 21) – “Legal troubles continued to mount yesterday for Morgan Stanley Dean Witter & Company when securities regulators accused the investment bank’s brokerage unit of misleading thousands of investors into buying mutual funds that resulted in losses of $65 million,” writes Patrick McGeehan in today’s New York Times.

“In a rare case of litigation between a major Wall Street firm and the National Association of Securities Dealers, the securities industry’s self-regulatory organization, Dean Witter Reynolds is being accused of fraud for the way it sold three bond funds in 1992 and 1993. Dean Witter sold more than $2 billion of shares in the funds to more than 100,000 investors, many of them beyond retirement age and some of them elderly, the association’s regulatory arm said in a complaint filed yesterday.”

“Dean Witter told its brokers to promote the funds as safe but higher-yielding alternatives to certificates of deposit without adequately disclosing how much riskier the funds were, the complaint said. The funds, which trade on the New York Stock Exchange, promised to return an investor’s principal after 7 or 10 years, depending on the fund, and to pay dividends along the way significantly higher than those offered by government bonds.”

“To achieve those returns, the trusts invested as much as 40 percent of their assets in derivatives known as inverse floaters, whose value sank when interest rates jumped in 1993 and 1994. The funds, known as term trusts, lost more than 30 percent of their value, and their market value declined by more than $600 million, the complaint said.”

“That drop led managers of the funds to cut dividends, which prompted about 30,000 investors to sell their shares, most at significant losses, the complaint said. Those losses amounted to $65 million, it said.”

” ‘The problem here is that these are long- term investments and they were marketed to people as C.D. substitutes,’ said Barry R. Goldsmith, executive vice president of N.A.S.D. Regulation. ‘They were marketed as safe, pure alternatives to C.D.’s, suitable for virtually anybody.’ “

“In its complaint, the N.A.S.D. contended that Dean Witter sold the funds to ‘an extremely large number of elderly, conservative investors.’ About $380 million, or almost 20 percent of the money invested in the funds, came from people 70 or older, the complaint said. An additional $154 million came from investors in their 80’s and more than $22 million belonged to people in their 90’s, it said.”