Morgan Stanley has not helped itself with regulators. This afternoon two state regulators -- Massachusetts's William Galvin and New York's Eliot Spitzer -- said that they have the broker-dealer in their sights. At issue is whether Morgan Stanley incented its brokers to sell proprietary funds with beefed-up commissions. The investigation is likely to spill over into the practices of other fund firms.

Galvin, the secretary of the Commonwealth, said that he started looking into the matter in March after a Boston-based broker tipped-off regulators. The tipster said that the brokerage was pressuring brokers to sell its captive funds by offering special incentives.

Morgan Stanley officials responded to the probe by issuing a written denial to Galvin on May 8. Last week, though, a Morgan Stanley "compensation expert" sang a different tale while under oath. That expert confirmed to state regulators that brokers and branch managers did indeed receive financial incentives to pitch Morgan Stanley funds. That switch of stories has started the regulators on the chase.

"Usually when you see one ant at a picnic, you'll find a lot more, and I think this is a similar case," Galvin told the media at a press conference today. "Where you see a practice that is so endemic to a company as this apparently was with Morgan Stanley, it is certainly not a secret in the industry."

Galvin also accused Morgan Stanley of making a "false filing" in its May 8 letter and accused it of putting profits ahead of its fiduciary duty to clients.

Eliot Spitzer, New York's attorney general, will take part in the investigation into industry practices begun by Galvin. By letting Spitzer in on the probe, the regulators will be able to potentially wield the Martin Act cudgel against brokerage firms it targets.

Morgan Stanley was not the only target of today's press conference. The two regulators also wanted to send a message to Congress, which is threatening to strip state regulators of their power of Wall Street. Indeed, Spitzer accused Congress of "trying to remove the cop from the beat."

"I hope the leadership in Washington and Wall Street back away from this idea," he added.  

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