Morgan Stanley to pay US$249m in block trade fraud settlement

The US Securities and Exchange Commission (SEC) has charged investment banking giant Morgan Stanley and the former head of its equity syndicate desk Pawan Passi with an alleged multi-year fraud involving the disclosure of confidential information about the sale of large quantities of stock known as “block trades.”

According to the SEC’s determination, a block trade generally involves the sale of a large quantity of shares of an issuer’s stock, privately arranged and executed outside of the public markets.

The SEC also charged Morgan Stanley with allegedly failing to enforce its policies concerning the misuse of this information.

Morgan Stanley has agreed to settle the fraud charges for US$249 million and for not maintaining adequate information barriers related to its block trading activities.

“Sellers entrusted Morgan Stanley and Passi with material non-public information concerning upcoming block trades with the full expectation and understanding that they would keep it confidential,” said SEC chair Gary Gensler.

“Instead, Morgan Stanley and Passi abused that trust by leaking that same information and using it to position themselves ahead of those trades.”

“While their conduct may have earned them tens of millions of dollars on low-risk trades, it violated the federal securities laws. Thanks to the hard work of the SEC staff, they are being held accountable.”

Confidentiality breach

Director of the SEC’s enforcement division Gurbir Grewal said that, despite assuring sellers that their efforts to sell large blocks of stock would be kept confidential, Morgan Stanley and Mr Passi instead leaked the information to mitigate their own risk, win more block trade business and generate illicit profits.

“When market participants game the system for personal gain in this way, it erodes investor confidence and undermines market integrity,” Mr Grewel said.

“Today’s fraud charges underscore our commitment to holding wrongdoers accountable, no matter how complicated the fraud or sophisticated the perpetrators.”

Long-running issues

The SEC alleged that from at least June 2018 through August 2021, Mr Passi and a subordinate on Morgan Stanley’s equity syndicate desk disclosed non-public, potentially market-moving information concerning impending block trades to select buy-side investors despite the sellers’ confidentiality requests and Morgan Stanley’s own policies regarding the treatment of such information.

The SEC’s orders found that Morgan Stanley and Mr Passi disclosed the block trade information with the understanding that those buy-side investors would use the information to “pre-position” themselves by taking a significant short position in the stock that was the subject of the upcoming block trade.

According to the SEC orders, if Morgan Stanley eventually purchased the block trade the buy-side investors would then request and receive allocations from Morgan Stanley to cover their short positions.

This pre-positioning also reduced Morgan Stanley’s risk in purchasing block trades.

The SEC further alleged that Morgan Stanley failed to enforce information barriers to prevent information involving certain block trades being conveyed by the equity syndicate desk – which sits on the private side of Morgan Stanley – to a trading division on the public side of the firm.

As a result, the firm was unable to sufficiently scrutinise whether trades by that division, placed while the equity syndicate desk was in discussions with selling shareholders regarding potential block trades, were based on such confidential discussions.