FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
The market access rule requires broker-dealers to have adequate risk controls in place before providing customers with access to the markets. An SEC investigation found that Morgan Stanley, which offers institutional customers direct market access through an electronic trading desk, did not have the risk management controls necessary to prevent the rogue trader from entering orders that exceeded pre-set trading thresholds. The trader exploited the market access and, without Morgan Stanley’s knowledge, committed a fraud that eventually shuttered the firm where he worked. The SEC and criminal authorities have since charged the trader with fraud, and he has been sentenced to 30 months in prison.
Morgan Stanley agreed to pay a $4 million penalty for violating the market access rule.
“Broker-dealers become important gatekeepers when they provide customers direct access to our securities markets, and in this case Morgan Stanley did not live up to that responsibility,” said Andrew Ceresney, Director of the SEC Enforcement Division. “Morgan Stanley failed to have reasonable controls in place to mitigate the risks associated with granting market access to a customer.”
According to the SEC’s order instituting a settled administrative proceeding, the rogue trader worked at Rochdale Securities LLC and routed to Morgan Stanley’s electronic trading desk a series of orders to purchase Apple stock on Oct. 25, 2012. The orders came steadily throughout the day and eventually tallied approximately $525 million worth of Apple stock, which significantly exceeded Rochdale’s pre-set aggregate daily trading limit of $200 million at Morgan Stanley. In order to execute the orders, Morgan Stanley’s electronic trading desk initially increased Rochdale’s limit to $500 million and later to $750 million without conducting adequate due diligence to ensure the credit increases were warranted. Morgan Stanley’s written supervisory procedures did not provide reasonable guidance for electronic trading desk personnel who determine whether or not to increase customer trading thresholds.
According to the SEC’s order, the rogue trader at Rochdale was using these orders to commit a fraud. He had intentionally enlarged the amount of Apple stock an actual customer wanted to purchase from 1,625 shares to 1,625,000 shares. The trader’s scheme was to profit personally from the excess shares if Apple’s stock price increased or claim the order size was merely an error if the stock price decreased. As it turned out, Apple’s stock price began dropping later that day, so the trader falsely claimed that he had made a mistake in placing order. Rochdale was left holding the unauthorized purchase and suffered a $5.3 million loss. Rochdale subsequently fell below its net capital requirements to trade securities, and ceased all business operations last year.
The SEC’s order finds that Morgan Stanley violated Rule 15c3-5 of the Securities Exchange Act of 1934. Without admitting or denying the findings, the firm consented to the SEC’s order, which censures the firm and requires it to pay the financial penalty and cease and desist from committing or causing violations of the market access rule.
The SEC’s investigation was conducted by Eric Forni, David London, and Michele Perillo of the Market Abuse Unit with assistance from staff in the Division of Trading and Markets. The case was supervised by the Chief of the unit Daniel M. Hawke and the Co-Deputy Chief of the unit Robert Cohen. The SEC appreciates the assistance of the Financial Industry Regulatory Authority.