Morgan Stanley has agreed to pay $249.4m to end years-long criminal and civil investigations into its handling of large stock trades for customers, US authorities have confirmed. The payment includes fines, restitution and the forfeiture of ill-gotten gains.

The settlements with the DOJ and SEC resolve charges of securities fraud and compliance failures and over its block trading practices, and the resolution takes the form of a three-year non-prosecution agreement, so no criminal charges will apply.

A block trade is a large, privately negotiated securities transaction, arranged outside the public markets to lessen the effect on the security’s price. Such transactions are usually carried out by hedge funds and investment banks on behalf of institutional investors.

The New York Stock Exchange and Nasdaq define a block trade as one involving at least 10,000 shares of stock, or one worth more than $200,000. But most block trades far exceed these minimums.

MNPI between business divisions

The SEC’s order says that from at least June 2018 through August 2021, the former head of Morgan Stanley’s Syndicate Desk and a former senior member of the firm’s Syndicate Desk (research and pricing reps) disclosed to certain buy-side investors non-public, potentially market-moving information concerning impending block trades that the firm had been invited to bid on or was in the process of negotiating with the selling shareholders.

Those buy-side investors used the information to take a short position in the stock that was the subject of the upcoming block trade, the SEC says.

Such disclosures by these employees of the Syndicate Desk violated the selling shareholders’ expectations of (and, in some instances, express requests for) confidentiality that had been conveyed to the Syndicate Desk. These had featured in representations of confidentiality made by the Syndicate Desk, as well as stated in Morgan Stanley’s policies regarding the treatment of material non-public information (MNPI).

Morgan Stanley also failed to enforce written policies and procedures reasonably designed to prevent the misuse of MNPI, particularly details involving certain block trades being offered from the private side of Morgan Stanley (the Syndicate Desk) going to the Institutional Equity Division on the public side.

Top executive’s deferred prosecution agreement

“Morgan Stanley, through the supervisor of its block trades business, Pawan Passi, deceived customers by promising confidentiality knowing that they would turn around and share that information with others to use to trade,” Manhattan US Attorney Damian Williams said in the DOJ’s press release.

The Justice Department agreed to hold off prosecuting Pawan Passi, 40, former head of Morgan Stanley’s US equity syndicate desk. Passi entered a deferred prosecution agreement (DPA) and admitted wrongdoing. He admitted to promising sellers of large blocks of stock that he would keep details about the sales confidential, despite knowing he would disclose the information to others.

“The government gets a major fine and tells Wall Street that it has to block-trade by the book. And Morgan Stanley gets to move on from this without any lasting damage, and clean the closet for their new CEO.”

Richard Hong, former SEC enforcement official and currently partner at Morrison Cohen

The SEC and DOJ did not fine Passi, noting that he had already forfeited $7.4m in compensation.

He was discharged from Morgan Stanley in November 2022 when his communications about impending block trades were discovered in the firm’s investigation, brokerage industry records show.

Authorities said a second employee involved in these matters, who was not identified nor charged, worked on the equity syndicate desk.

Resolution serves both sides

It is not typical for prosecutors to give DPAs to individuals, but Passi’s conduct fell into a legal “gray area,” New York lawyer Bob Frenchman said.

“Traders are allowed to do anticipatory hedging, and there have not been clear standards on what you can and cannot do,” Frenchman said. “Prosecutors really would have been pushing the boundaries and taking significant risk to go to trial.”

Bankers routinely approach prospective buyers about their hypothetical interest in specific stocks – but they need to be careful of leaking any details about deals actually in the works.

“It’s a win for everybody,” Richard Hong, a former SEC trial lawyer and now a partner at the law firm Morrison Cohen, commented about the resolution. “The government gets a major fine and tells Wall Street that it has to block-trade by the book. And Morgan Stanley gets to move on from this without any lasting damage, and clean the closet for their new CEO.”

Morgan Stanley said it was pleased to settle and that it was confident in the upgrades it has made to its policies, training and surveillance. “The core of this matter is the misconduct of two employees who violated the firm’s policies, procedures and our core values,” the bank said.