Morgan Stanley Settles SEC Charges of Customer Protection Rule Violations

Investing

Published: December 21, 2016 12:35 pm

Last Updated: January 12, 2020 4:32 pm

The U.S. Securities and Exchange Commission (SEC) recently announced that Morgan Stanley has agreed to pay $7.5 million to settle charges it used trades involving customer cash to lower the firm’s borrowing costs in violation of the SEC’s Customer Protection Rule.

The Customer Protection Rule is intended to safeguard customers’ cash and securities so that they can be promptly returned should the broker-dealer fail.

The SEC found that from March 2013 to May 2015, Morgan Stanley’s U.S. broker-dealer used transactions with an affiliate to reduce the amount it was required to deposit in its customer reserve account. According to the order, the transactions violated the Customer Protection Rule, which prohibits broker-dealers from using affiliates to reduce their customer reserve account deposit requirements.

According to the SEC’s order, Morgan Stanley had its affiliate, Morgan Stanley Equity Financing, serve as a customer of its U.S. broker-dealer, a relationship that allowed the affiliate to use margin loans from the U.S. broker-dealer to finance the costs of hedging swap trades with customers. The margin loans lowered the borrowing costs incurred to hedge these swap trades and reduced the U.S. broker-dealer’s customer reserve account deposit requirements by tens to hundreds of millions of dollars per day.

Michael J. Osnato, chief of the SEC Enforcement Division’s Complex Financial Instruments Unit, commented:

The Customer Protection Rule establishes crucial safeguards for investors to ensure that their cash and securities are secure when held by a broker-dealer. Complex trading schemes designed to artificially reduce the amount a broker-dealer must maintain in its customer reserve account run contrary to these basic obligations.

Without admitting or denying the findings, Morgan Stanley agreed to pay a $7.5 million civil penalty, to cease and desist from committing or causing any similar violations in the future and to be censured.