Investment Operations

Morgan Stanley to Pay $5 Million for Violations in Prime Brokerage Swaps Business


The Securities and Exchange Commission today confirmed settled charges against Morgan Stanley for violations of Regulation SHO, the regulatory framework governing short sales.

According to the SEC’s order, the structure of Morgan Stanley’s prime brokerage swaps business resulted in violations of Reg SHO. As set forth in the order, Morgan Stanley hedged synthetic exposure to swaps by purchasing or selling the securities referenced in the swaps, and it separated its hedges into two aggregation units – one holding only long positions, and the other holding only short positions. According to the order, Morgan Stanley was able to sell its hedges on the long swaps and mark them as “long” sales without concern for Reg SHO’s short sale requirements.

The order finds that Morgan Stanley’s “long” and “short” units failed to qualify for a Reg SHO exception permitting broker-dealers to establish aggregation units because they were not independent and did not have separate trading strategies. The order also finds that the units had identical management structures, locations, and business purposes as well as the same strategy or objective. The order further finds that, as a result, Morgan Stanley should have netted the long and short positions of both units together or across the entire broker-dealer and marked the orders as long or short based on that netting. The order finds that the failure to do so resulted in Morgan Stanley improperly marking certain sell orders in violation of Reg SHO.

“Market participants cannot disregard the rules of the road established by Reg SHO for all short sales,” said Daniel Michael, Chief of the Complex Financial Instruments Unit.  “For many years, Morgan Stanley has improperly relied on Reg SHO’s aggregation unit exception, resulting in orders being mismarked for countless transactions.”

The order charges Morgan Stanley with violating Rule 200(g) of Reg SHO.  Without admitting or denying the findings, Morgan Stanley consented to a cease-and-desist order imposing a censure and a $5 million penalty.

The SEC’s investigation was conducted by Joshua Brodsky and Brent Mitchell of the Complex Financial Instruments Unit, with assistance from Richard Hong and Eli Bass of the SEC’s New York Regional Office, and was supervised by Osman Nawaz.