FINRA announced today a $1.6 million sanction on Morgan Stanley Smith Barney LLC for its repeated failure to implement timely closing out of inter-dealer municipal security transactions and take such action as must ascertain possession or control of municipal security inventory positions short more than 30 calendar days and the supervisory issues thereof.
MSRB Rule G-12(h) charges constitute the first toned MSRB violation by an entire company and the related supervisory mistakes, which is a serious matter. In 2015, Morgan Stanley had been charged by FINRA authorities for supervisory breakdowns in connection with short positions on municipal securities.
FINRA Head, Bill St. Louis statement
“Member firms must establish and maintain controls and procedures for detecting, resolving, and preventing the consequences of municipal short positions and failure to receive. That includes strictly adhering to the close-out requirements under MSRB Rule G-12(h) and timely identifying and addressing short positions and fails to receive in municipal securities under Exchange Act Rule 15c3-3.”
Municipal Securities Rulemaking Board (MSRB) Rules
The MSRB Rule stipulates that the arising circumstances of inter-dealer government bonds are to be closed out or, by and large, canceled 20 business days after the settlement. Moreover, the Exchange Act instructs brokers to promptly secure physical possession or control of security that has not been acquired for more than 30 calendar days.
The subsequent investigation by the FINRA determined that Morgan Stanley could not cancel or settle 239 transactions from one broker to another in a timely, and the 20 deals that were not settled in 20 calendar days exceeded the tolerance level. These corresponded to monetary volumes of about $9 million estimated over the period from December 2016 to August 2021. In addition, the business neglected to take the necessary steps to possess or control 247 municipal securities valued at about $9.4 million, which it regularly received for an average of 177 days from January 2016 to August 2021.
Lack of supervisory system at Morgan Stanley
It was found that Morgan Stanley lacked the supervision system and the provision in writing to make sure that the MSRB Rule and Exchange Act Rule were being followed. It was not until June 2021 that the company changed its procedures governing handling conditions that did not relate to the issue. However, the company did not update its written instructions to supervisory personnel until September 2021.
The conflicts were avoided using the issue resolution mechanism wherein Morgan Stanley agreed to the FINRA’s findings, not admitting or denying the charges. By the settlement terms, FINRA had to distribute the $1.2 million fine out of the $1.6 million of the total penalties paid to the MSRB.