South Florida Arbitration & Litigation Lawyer Blog
FINRA Arbitration Fraud, Mismanagement and Breach of Fiduciary Duty Attorney, Russell L. Forkey, Esq.
August, 2011:
Morgan Stanley & Co. Incorporated nka Morgan Stanley & Co. LLC (CRD #8209, New York, New York) submitted a Letter of Acceptance, Waiver and Consent in which the firm was censured and fined $575,000. Without admitting or denying the findings, the firm consented to the described sanctions and to the entry of findings that it failed to establish and/or enforce adequate WSPs, and failed to adequately supervise total return swaps and off-shore stock loans. The findings stated that these transactions were designed to generate for certain off-shore clients a perceived tax advantage related to dividend income on U.S. equities. The findings also stated that the advantage was referred to as various terms, including “yield enhancement,” and represented the amount that would have been withheld in taxes on a dividend, but that the client obtained through a transaction with the firm and/or its affiliates; but in both types of transactions, the client did not hold the stock on the dividend record date but, instead, the firm structured the transaction as a swap or loan, and provided yield enhancement as part of a securities derivative or stock loan-related payment.
The findings included that some clients sold the underlying equity before entering the swap, and bought the equity back after the swap terminated. The findings also included that, in such circumstances, yield-enhancement payments were appropriate only if the client surrendered beneficial ownership of the underlying equity during the life of the swap and engaged in market risk in the buying and selling of the equity. The findings further included that the firm was unable to substantiate the propriety of some yield enhancement payments because of supervisory deficiencies in the use of "crosses," short term transactions and market-on-close pricing; and in a cross, the firm and its counterparty conducted securities transactions directly with one another, and executed them in the over-the-counter market.FINRA found that the firm allowed its clients to both "cross in" and "cross out" on securities transactions that were related to the swap transactions. In addition, FINRA found that allowing clients to do this, particularly in trades that bracketed the dividend record dates, enabled these clients to re-establish their original securities position after the swap terminated in a manner that minimized the clients’ market risk. FINRA further found that the firm’s procedures failed to prevent customers from unwinding a swap at the closing price of the underlying equity, which also allowed clients to re-establish their securities positions at minimal market risk. Furthermore, FINRA found that regarding off-shore stock loans, the firm failed to establish WSPs and lacked effective working control of business operations that involved firm clients, client securities that were custodied in accounts at the firm, and firm personnel. FINRA also found that the firm allowed affiliates to initiate and conduct the off-shore stock loan transactions without sufficient oversight from the firm; and as a result, the firm was unable to supervise this aspect of its business and substantiate that these transactions were conducted in a manner that made certain the yield-enhancement payments were appropriate. The findings also included that after the firm reviewed its off-shore stock loans, it determined to stop sourcing U.S. equities from its off-shore customers for such transactions because of the firm’s concerns about its ability to maintain adequate controls over these operations. (FINRA Case #2008015717101).