On Tuesday, the SEC announced that Morgan Stanley will be fined $7.5 million to settle civil charges that it violated customer protection rules, when it used trades involving customer cash to lower its borrowing costs. The SEC said MS will settle the case without admitting or denying the charges, effectively letting slide a violation which, in an exaggerated format, was exposed as a quasi-criminal offense engaged in by Jon Corzine’s now defunct MF Global.
Ok so, Morgan Stanley engaged in some creative “commingling” – what’s the big deal, most banks do it. What makes this particular case curious is the basis of the commingling: it involves some of the more interesting, and abstract, concepts of modern finance, including Morgan Stanley’s “Delta One” trading desk, as well as the rehypothecation of collateral, all of which participated in a complicated violation of customer protection.
While we present more details below, here is a quick primer on the Customer Protection Rule:
“it is intended to safeguard customers’ cash and securities so that they can be promptly returned should the broker-dealer fail. The SEC order finds that from March 2013 to May 2015, Morgan Stanley’s U. S. broker-dealer used transactions with an affiliate to reduce the amount it was required to deposit in its customer reserve account.”
According to the SEC order, Morgan Stanley’s transactions violated the Customer Protection Rule, which prohibits broker-dealers from using affiliates to reduce their customer reserve account deposit requirements.
In the SEC’s order, the regulator says that Morgan Stanley had its affiliate, Morgan Stanley Equity Financing Ltd., serve as a customer of its U. S. broker-dealer, a relationship that allowed the affiliate to use margin loans from the U. S. broker-dealer to finance the costs of hedging swap trades with customers. The margin loans lowered the borrowing costs incurred to hedge these swap trades and reduced the U. S. broker-dealer’s customer reserve account deposit requirements by tens to hundreds of millions of dollars per day.
This post was published at Zero Hedge on Dec 20, 2016.