Morgan Stanley to pay $5M civil penalty for noncompetitive trades

CFTC order says firm lacked controls

CFTC seal CFTC seal

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today issued an order filing and settling charges that, over an 18-month period, Morgan Stanley & Co. LLC (Morgan Stanley), a registered futures commission merchant (FCM), unlawfully executed, processed, and reported numerous off-exchange futures trades to the Chicago Mercantile Exchange (CME) and Chicago Board of Trade (CBOT) as exchanges for related positions (EFRPs). The CFTC order requires Morgan Stanley to pay a $5 million civil monetary penalty and to cease and desist from further violations of the Commodity Exchange Act (CEA) and CFTC regulations, as charged.

According to the CFTC order, because the futures trades were executed noncompetitively and not in accordance with exchange rules governing EFRPs, they constituted “fictitious sales” and resulted in the reporting of non-bona fide prices, in violation of the CEA and CFTC regulations. The order also finds that Morgan Stanley had related supervisory and recordkeeping violations.

The commodity futures trading laws generally require that futures trades be executed on a futures exchange. The laws allow for exceptions to that requirement, such as when the futures trade is part of an EFRP, which is where parties exchange futures contracts for a related cash or over-the-counter (OTC) derivative position, such as an option or a swap. As long as the legal requirements are met, parties are permitted to execute EFRPs away from an exchange but then must report their EFRPs to an exchange after execution.

“The laws requiring that futures trades be executed on an exchange serve important price discovery and transparency principles,” said David Meister, Director of the CFTC’s Division of Enforcement. “As today’s action should demonstrate, when an FCM reports that it properly conducted an off-exchange futures trade as part of an EFRP, that report had better be accurate. In all cases, firms must have appropriate systems and controls in place designed to detect and prevent the conduct described in the order.”

According to the CFTC’s order, from at least April 18, 2008 through October 29, 2009, Morgan Stanley noncompetitively executed numerous futures trades and improperly reported them as EFRPs, since they did not have the required corresponding cash or OTC derivative positions.

The order finds that Morgan Stanley’s supervisory systems and internal controls were not adequate to detect and deter the noncompetitive trading of futures contracts improperly designated as EFRPs. For example, although Morgan Stanley’s Futures Operations department had the responsibility to report EFRPs to the CME and CBOT, that department was not required to verify that the EFRPs had the required corresponding related cash or OTC derivative positions, nor was any other operations department required to do so. The order further finds that Morgan Stanley failed to ensure that its employees involved in the execution, handling and processing of EFRPs understood the requirements for executing bona fide EFRPs. Moreover, the order finds that Morgan Stanley lacked sufficient surveillance systems to identify trades improperly designated as EFRPs. The order also finds that Morgan Stanley failed to designate the trades as EFRPs on all orders, records, and memoranda pertaining to EFRPs, as required.

The order recognizes Morgan Stanley’s significant cooperation in the Division of Enforcement’s investigation of this matter.

In a related proceeding, the CME Group is issuing a notice of disciplinary action against Morgan Stanley today. The CFTC thanks the CME Group for its assistance.

CFTC Division of Enforcement staff members responsible for this case are Brian G. Mulherin, Timothy M. Kirby, Brandon T. Tasco, Gretchen L. Lowe, and Vincent A. McGonagle.

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