Morgan Stanley & Co. agreed to pay $7.5 million to settle the Securities and Exchange Commission charges that it misused customer cash to lower the firm’s borrowing costs in violation of the SEC’s Customer Protection Rule.
The SEC found that Morgan Stanley violated the commission’s Customer Protection Rule by misusing customers’ cash and securities that should have been deposited in a reserve account. The firm engaged in transactions with an affiliate that artificially reduced the required deposit of customer cash in the reserve account.
The practice, which occurred between March 2013 to May 2015, freed up tens to hundreds of millions of dollars per day that its affiliate, Morgan Stanley Equity Financing Ltd., used to finance hedging its own swap trades with customers. The margin loans lowered the borrowing costs incurred to hedge these swap trades but should a misstep have occurred in the midst of these trades, customers would have been exposed to a massive shortfall.
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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.”
The SEC order finds that Morgan Stanley’s affiliated transactions also violated the Customer Protection Rule by submitting inaccurate reports to the SEC after failing to accurately calculate its customer reserve account requirements.
Morgan Stanley agreed to pay $7.5 million in disgorgement and penalty, but without publicly acknowledging violations of the federal securities laws.
The order further states that Morgan Stanley promptly took substantial remedial acts to address violations, including significantly increasing the amount of excess funds it maintains in its customer reserve account.