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(Bloomberg) — Hedge funds have known for years that a single Morgan Stanley employee can make millions of dollars.
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A large number of shares will be sold and block trading head Pawan Passi will tip off the funds. One even went so far as to tell Passi that he had “put the investor in the game” (with a colorful qualifier) and that if he hadn’t been there, the investor “would have been at the kid’s table.” Told.
“I know who the father is,” the investor said on the phone, according to federal prosecutors.
On Friday, Mr. Passi entered into a deferred prosecution agreement with the U.S. Department of Justice, pleading not guilty to securities fraud charges, resolving a long-running investigation into his and Morgan Stanley’s trading practices. He admitted mishandling his confidential information and agreed to a one-year ban from his brokerage business.
The agreement, as well as the bank’s own non-prosecution agreement with the U.S., which Bloomberg reported on Thursday, comes after the bank, once a beloved member of Morgan Stanley, earned $1.4 billion on its desk from 2018 to 2021. The deal comes after several years of decline for Passi.
Read more: Morgan Stanley pays $249 million to end block trade investigation
Mr. Passi’s fall from grace also hurt Morgan Stanley. Morgan Stanley agreed on Friday to pay a total of $249 million to the Department of Justice and the Securities and Exchange Commission to resolve investigations into its block trading business. The agreement allows banks to avoid criminal charges.
gray zone
Discussions with investors about block trades (buying and selling enough stock to move stock prices) often occur in a legal gray area. Bankers regularly persuade prospective buyers of a hypothetical interest in a particular stock. They are careful not to leak any transactions that are actually in progress.
Quick Take: How Block Trades Work and Why They Raise Suspicion
Unless you don’t. Prosecutors outlined the case against Passi and the bank, which includes allegations of divulging, lying and violating confidential information over many years.
The government’s argument is as follows.
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Mr. Passi and another employee of the bank’s market-leading equity syndication desk, who have not been charged, have for years been selected investors for upcoming sales of large stakes in public companies. , but was promised to keep this information secret. There are also multiple instances of investors shorting stocks before selling.
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In one instance, in connection with the sale of millions of shares in Star Bulk Carriers Inc. in 2021, Mr. Passi told the seller he intended to keep the planned sale confidential. He continued to share details of sale negotiations with hedge funds “on an almost daily basis.” The Fund then shorted Star Bulk Carriers, Inc. stock in its first transaction. Then buy chunks of blocks to cover the short.
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Passi suggested to hedge funds how to trade ahead of his upcoming block trades, and many took short positions. He then promised “favored buy-side investors” that they would get enough block trade quotas to cover their shorts.
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Suspicions of such leaks spread not only on the streets, where some may have been filled with envy at Morgan Stanley’s successful block trades, but also within the banks. One employee said the investors were in a perfect position to make money on the deal. “How are we set up for all these eventualities?!” an employee asked Passi in August 2021.
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This question arose after there was suspicious activity in iHeartMedia Inc.’s stock on a day when iHeartMedia Inc. was executing block trades on behalf of its customers. Passi accused another bank of leaking information about the transaction. The day before, he had sent information about the trade to a hedge fund that had shorted the media company.
“At the heart of this matter is the misconduct of two employees who violated the company’s policies,” Morgan Stanley said in a statement, adding that it was “confident” in the strengthened controls. Mr. Passi’s lawyer, George Kanellos, earlier said he was satisfied the government did not pursue his client’s conviction.
The SEC has long been concerned about the potential for abuse in the highly confidential world of block trades. Officials overseeing the operation had privately expressed doubts that authorities would discover anything.
Ultimately, Mr. Passi, who is at the center of the government’s case, could move to have the charges dismissed in six months if he abides by the terms of the agreement. And while Morgan Stanley was accused of lax controls over the handling of classified information and had to admit wrongdoing and pay hefty fines, it avoided criminal prosecution.
“Everyone wins”
Richard Hong, a former SEC enforcement officer who now works at the law firm Morrison Cohen, said this is a “meaningful case for the SEC and the Department of Justice,” but he doesn’t expect it to change the industry overnight. He says there is no.
“This is not earth-shaking,” Hong warned.
Still, he said: “This is a win for everyone. The government will be fined hefty sums and tell Wall Street that it must follow the law to block trade. And Morgan Stanley will emerge from this situation without any lasting damage. You can get back on your feet and clean out your closet for the new CEO.”
At Passi’s court appearance on Friday, the judge offered some advice.
“You have a real opportunity here today to avoid a criminal conviction,” U.S. Magistrate Judge Robin Tarnofsky told Mr. Passi in approving the deal with the government. “I hope this is the only time we see this happen again.”
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