Reported by Craig Coben

On Friday the US Securities and Exchange Commission charged Morgan Stanley and its former equity syndicate desk head Pawan Passi with fraud in the conduct of block trading business. The SEC’s report describes several damningly flagrant breaches of confidentiality, but one example stands out as the epitome of chutzpah.

According to the SEC, in June 2018 Morgan Stanley was invited along with other banks to bid for a block of Medpace shares to be sold by private equity firm Cinven (“Selling Shareholder A” in its report, but it’s clear who it was). Passi leaked the news to a portfolio manager who in turn shorted Medpace, forcing the share price lower. Morgan Stanley won the auction and allocated over 11 per cent of the offering to that investor.

Two months later, at Passi’s urging, his investment banking colleagues implored Cinven to mandate Morgan Stanley exclusively for the next Medpace share sale and not invite bids from other banks in an auction. Why? Because the share price had fallen while the previous auction in June was happening! 

“A negotiated trade,” the Morgan Stanley slide deck said, “can prevent . . . ‘leakage’ and ensure an unaffected share into a block execution [and] . . . save important basis points in a stock price vs. an auction.”

In the end, Cinven auctioned the block again. According to the SEC, Passi tipped off the same portfolio manager, who in turn shorted shares again and, when Morgan Stanley won the auction again, was allocated 12 per cent of the deal. Wash, rinse, repeat.

This conduct is as shameless and it is shameful, so let’s not mince words: Morgan Stanley has gotten off very, very lightly – a $249mn fine, along with a three-year non-prosecution agreement with the US Attorney’s Office.

That’s not to say that the block trading probe hasn’t inflicted damage. Passi and another equity syndicate professional lost their jobs, careers, and millions of dollars of unvested stock. The investigation also demoralised and distracted Morgan Stanley’s bankers, deflating its market share in equity underwriting. Legal and compliance teams stepped up oversight, putting a crimp on day-to-day execution.

But this could have turned out a lot worse. 

The Department of Justice and SEC were investigating the block trade practices as both a criminal and civil matter. Investigators were examining Morgan Stanley’s relationships with hedge funds, and the DOJ was reviewingcommunications by other senior bankers. Funds filed suit, alleging monetary damages from leaks from Morgan Stanley in the run-up to share sales. Competitors, including Goldman Sachsand Credit Suisse, had taken the extraordinary step of complaining to prosecutors and regulators about Morgan Stanley’s block trade practices.

Morgan Stanley had been the “dominant” bank in block trades, and the business was making bucketloads of money — $1.4bn from January 2018 to August 2021. This is easily several times more revenue than what its competitors were generating.

Read full report: https://www.ft.com/content/b8e4306f-ab45-47f4-8455-fdddf9843228