Morgan Stanley’s pitch to sellers looking to unload big blocks of stock was that their block-trading unit was the best at preventing leaks that could drive share prices down.
But federal prosecutors and the Securities and Exchange Commission now say it was all a lie, and that from 2018 through 2021 the bank would quietly divulge news of the impending block trades to hedge funds as a way of lessening its own risk. The result was that sellers would lose millions of dollars on the deal, investigators said.
In simultaneous announcements Friday, the Department of Justice and the SEC charged Morgan Stanley MS, -0.89% and the head of its equity syndicate desk, Pawan Passi, with fraud, and levied fines against the bank totaling $249 million. Passi was hit with a $250,000 fine from the SEC, and is barred from working in any supervisory or associate roles, or serving as a broker in the sale of penny stocks. He had been placed on leave from Morgan Stanley when prosecutors opened their probe and was later dismissed.
The U.S. attorney’s office in Manhattan said it had entered into non-prosecution agreements with the bank and Passi to resolve federal criminal charges. Both Morgan Stanley and the Bank agreed under a deal to pay the financial penalties and cooperate with the government’s probe.
“Morgan Stanley, through the supervisor of its block trades business, Pawan Passi, deceived block sellers by promising confidentiality knowing that they would turn around and share that information with others to use to trade,” said Manhattan’s U.S. Attorney Damian Williams. “We are watching. And we will continue to use all the tools at our disposal to root out fraud in our financial markets.”
In a statement, Morgan Stanley said it was “pleased to resolve these investigations and are confident in the enhancements we have made to our controls around block trading, including strengthening our policies, procedures, training and surveillance.”
Passi’s lawyer, George Canellos, said in a statement, “We are pleased that the U.S. Attorney’s Office agreed not to pursue a criminal conviction of Mr. Passi in this complex matter.”
Block trading involves the private sale of large amounts of shares of a publicly-traded company all in one transaction, often at a discount to current market prices. Sellers, typically private equity firms, corporate insiders or firms holding large positions in a stock, often seek out such deals as a way to guarantee a price and enable them to unload their shares in one go, rather than take their chances with the volatility of the open market.
If the transaction goes smoothly, the bank then turns around and sells the shares at a price higher than the discounted price they granted the initial seller, pocketing the difference. From 2018 through 2021, Morgan Stanley earned $1.4 billion in revenue from such trades, prosecutors said.
One key aspect of such a deal is that it be kept confidential, as any leak of an impending block sale can drive the stock price down ahead of the transaction, affecting the price the seller can get.
Prosecutors said that Morgan Stanley marketed its block-trading operation as the most secure in the business — pointing out that it operated out of a side of the bank that was completely separate from its buy-side units, lessening the chance of leaks.
According to court filings, Passi and members of his team, however, would immediately inform a group of hedge funds they worked with about the impending block sales, allowing the funds to either short the stock or make adjustments to any long positions they might have.
Those moves typically would drive the share prices down ahead of closing the block trade, allowing Morgan Stanley to buy at a lower price, investigators said.
The agreement with the hedge funds would be that when the dust settled, the funds would agree to buy the shares from Morgan Stanley at a price that allowed the bank and the funds to make money. However, the transaction would often result in the original seller receiving a lesser price than they would have received had the leak not occurred.
“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.”