Morgan Stanley & Co. Inc., and its subsidiary Morgan Stanley Smith Barney LLC, have been fined $1 million and censured by the Financial Industry Regulatory Authority, or FINRA, for excessive markups and markdowns that were charged to customers on corporate and municipal bond transactions.
The firm was also ordered to $371,475 in restitution plus interest to the customers.
In addition, FINRA found that Morgan Stanley’s supervisory system was not reasonably designed to achieve compliance with securities laws and regulations regarding markups and markdowns.
The disciplinary action was announced on Nov. 10, after a Letter of Acceptance Waiver and Consent, or AWC, was submitted by Morgan Stanley to settle the matter. Through the AWC, the firm consented to entry of the findings and to the sanctions, without denying or admitting the charges. Morgan Stanley signed the AWC on Oct. 5, and it was accepted by FINRA on Oct. 28.
Mark-ups and Mark-downs Charged by Morgan Stanley
Morgan Stanley charged markups and markdowns ranging from below 5 percent to 13.8 percent on corporate and municipal bond transactions during a review conducted from 2003 to this year by the Fixed Income staff of FINRA’s Department of Market Regulation, according to the AWC.
The markups and markdowns were deemed excessive given market conditions, the cost of executing the transactions and the value of the services customers received, among other factors, FINRA said in a statement.
Failure to Supervise
The supervisory system for these markups and markdowns was found to inadequate because the reports it generated were not designed to include markups and markdowns below 5 percent, even though these may have been excessive when considered in context.
Moreover, before August 2009, the supervisory system was set up to capture only one of two charges that Morgan Stanley added to the price of a bond. The second charge was not considered by the system as it determined whether a markup or markdown was fair and reasonable, FINRA’s statement said.
As indicated by the AWC, Morgan Stanley Smith Barney LLC will revise its written supervisory procedures pertaining to the review of markups and markdowns in fixed-income transactions with its customers.
Within 90 business days of the acceptance of the AWC by the National Adjudicatory Council, Morgan Stanley is required to submit verification in writing that it has revised its written supervisory procedures to address the deficiencies found by FINRA, plus the date of implementation. The firm is also required to submit written verification that it has paid the proper restitution to its customers, or at least made adequate efforts to do so.
AWC Finds Various Violations
For example, the first quarter 2009 had the highest volume amount of transactions with excessive mark ups or markdowns. The AWC said that in 109 pairs of transactions, Morgan Stanley bought and sold corporate bonds from and to customers at unfair prices. The prices were assessed taking market conditions at the time of the transactions into consideration, as well as the costs of the transactions, and the fact that the firm is entitled to a make profit, among other factors.
The markups and markdowns for the 109 transactions ranged from 3.78 percent to 13.84 percent. The conduct violated FINRA Rule 2010 concerning standards of commercial honor and principles of trade as well as National Association of Securities Dealers, or NASD, Rule 2440 on fair prices and commissions.
The rule subsections on marks ups and markdowns state that it is a violation for a member to enter into any transaction with a customer in any security at any price not reasonably related to the current market price of the security or to charge a commission which is not reasonable.
The most recent period detailed in the AWC was the fourth quarter of 2010. In 30 pairs of transactions during this period Morgan Stanley either purchased municipal securities for its own account from a customer or sold municipal securities from its own account to a customer at an aggregate price that was not fair and reasonable including the markdown or markup.
Again, all relevant factors were taken into consideration, the AWC said. They include the best judgment of the broker, dealer or municipal securities dealer as to the fair market value of the securities at the time of the transactions, the costs of the transactions, the fact that the broker, dealer, or municipal securities dealer is entitled to a profit, and the total dollar amount of the transaction.
The markups for the pairs of transactions ranged from 3.24 percent to 4.81 percent. The pricing violated Rule G-17 of the Municipal Securities Rulemaking Board regarding the conduct of municipal securities and advisory activities, as well as Rule G-30(a) on prices and commissions.
During the supervision review period, FINRA examined the supervisory reports that Morgan Stanley used to monitor the markups and markdowns charged to customers, the AWC said. FINRA found the supervisory system inadequate because the reports were not designed to include markups and markdowns below five percent.
In addition, before August 2009, the firm’s policies and procedures did not identify markups and markdowns by aggregating the sales credit charged to the customer with the wholesale desk compensation for purposes of determining whether a markup or markdown was excessive.
Finally, the AWC noted that this is not the first time Morgan Stanley has been called for violating these or similar rules. In August 2007, Morgan Stanley was censured and fined $1.5 million and ordered to pay restitution of $3.9 million for violations of NASD Rule 2440 on fair pricing and commissions for conduct from February 2001 to June 2001.
Morgan Stanley was Censured & Fined
In August 2009, Morgan Stanley was censured and fined $90,000 and agreed to pay restitution of $40,604 for violations of NASD Rules 2440, among others, during the period January through December 2003.
Guiliano Law Group
The practice of Nicholas J. Guiliano, Esq., and The Guiliano Law Group, P.C., is limited to the representation of investors in claims for fraud in connection with the sale of securities, the sale or recommendation of excessively risky or unsuitable securities, breach of fiduciary duty, and the failure to supervise. We accept representation on a contingent fee basis, meaning there is no cost to unless we make a recovery for you, and there is never any charge for a consultation or an evaluation of your claim. For more information contact us at (877) SEC-ATTY.
