Securities Lending Times | Morgan Stanley to pay $5 Million to SEC for Reg SHO violations

Morgan Stanley is set to pay $5 million to the US financial regulator for violations of Regulation SHO — the framework governing short selling — related to its prime brokerage swaps business.


The US Securities and Exchange Commission’s (SEC) order found that since Regulation SHO’s adoption in 2004, Morgan Stanley has “improperly relied on the exception to firmwide netting of all of its positions in a particular equity security through its use of the long and short units”.


Under Regulation SHO, brokers can gain an exception to the requirement to net all long and short positions in an equity across the entire firm if it establishes an ‘aggregation units’ consistent with Rule 200(f).


An exempt broker may then separately net its long and short positions in a particular security within each unit.


To gain such a reprieve a broker must meet four criteria:


(1) The broker or dealer has a written plan of organisation that identifies each aggregation unit, specifies its trading objective(s), and supports its independent identity


(2) Each aggregation unit within the firm determines, at the time of each sale, its net position for every security that it trades


(3) All traders in an aggregation unit pursue only the particular trading objective(s) or strategy(s) of that aggregation unit and do not coordinate that strategy with any other aggregation unit


(4) Individual traders are assigned to only one aggregation unit at any time


The SEC has now found that Morgan Stanley’s units were not independent of one another and therefore were in violation of the first and third criteria for nearly two decades.


“They had identical management structures, with the same front-line supervisor overseeing both units, and traders from both units sat side-by-side, with traders from one unit routinely substituting for traders in the other unit during absences,” the commission says.


“Furthermore, the long and short units had the same business purpose of hedging the firm’s synthetic exposure to equity securities created by swaps transactions, differentiated only in that the long unit held long hedges while the short unit held short hedges.”


The investment bank was handed a cease-and-desist by the SEC along with the fine but did not admit or deny the agency’s findings.


Morgan Stanley has now committed to operating the desks as independent trading units and aggregate positions in a security to determine its net position.


It has also promised to complete the ongoing process of implementing all necessary system recoding, testing, and migration by not later than 15 December.











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