Investment banking giant Morgan Stanley has agreed to pay more than US$249 million to settle block trading fraud charges and for information barrier failures.
The US Securities and Exchange Commission (SEC) alleges the firm and the former head of its equity syndicate desk, Pawan Passi, are guilty of a multi-year fraud involving the disclosure of confidential information about the sale of block trades, generating more than a hundred million dollars in profits. Passi himself has been hit with a $250,000 fine.
Between June 2018 and August 2021, Morgan Stanley and Passi allegedly disclosed block trade information with the understanding that buy-side investors would use the information to take a “significant” short position in the stock that was the subject of the upcoming block trade.
If Morgan Stanley eventually purchased the block trade, the buy-side investors would then request and receive allocations from the block trade from Morgan Stanley to cover their short positions. This pre-positioning reduced Morgan Stanley’s risk in purchasing block trades. An SEC spokesperson declined to comment beyond the public filings on whether these buy-side beneficiaries would also be prosecuted.
SEC chair Gary Gensler said: “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.”
“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,” Gensler added.
The SEC also alleged that Morgan Stanley failed to enforce information barriers, preventing material non-public information from being transmitted from the equity syndicate desk to a trading division. 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.
SteelEye CEO Matt Smith noted that the Morgan Stanley fine underscores how any block trade is extremely sensitive to information leakage to a third party. “The trouble is that block trades not yet publicly disclosed are considered material non-public information, which is why the SEC view the sharing of such information as market manipulation since the recipient can potentially ‘front run’ the block trade to trade favourably on their own account.”
“With the spread of insider information much harder to control for block trades, proper supervision of information flow prior to any block trading activity is crucial and this needs to be linked to any corresponding market shifts,” Smith said.
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