MORGAN STANLEY & CO. LLC
CBOT RULE VIOLATIONS:
538. EXCHANGE OF FUTURES FOR RELATED POSITIONS (Legacy) (In Relevant Part)
The following transactions shall be permitted by arrangement between parties in accordance with the requirements of this rule:
4. An Exchange of Futures for a Related Position (“EFRP”) consists of two discrete, but related simultaneous transactions. One party must be the buyer of (or have the long market exposure associated with) the related position and the seller of the corresponding futures, and the other party must be the seller of (or have the short market exposure associated with) the related position and the buyer of the corresponding futures….
538. EXCHANGE FOR RELATED POSITIONS (Effective September 14, 2009) (In Relevant part)
The following transactions shall be permitted by arrangement between parties in accordance with the requirements of this rule.
Exchange for Physical (“EFP”) – A privately negotiated and simultaneous exchange of an Exchange futures position for a corresponding cash position.
Exchange for Risk (“EFR”) - A privately negotiated and simultaneous exchange of an Exchange futures position for a corresponding OTC swap or other OTC instrument.
MARKET REGULATION ADVISORY NOTICE RA 1006-5 (Effective June 11, 2010) (In Relevant Part)
Q17: If an EFRP is submitted via Front-End Clearing (FEC), how soon after execution must the EFRP be submitted?
A17: CME and CBOT Products
For EFRPs executed between 6:00 a.m. and 6:00 p.m. Central Time, firms must submit the trade within one hour. For EFRPs executed between 6:00 p.m. and 6:00 a.m., Central Time, firms must submit the trade no later than 7:00 a.m. Central Time.
432.Q. GENERAL OFFENSES – Acts Detrimental
It shall be an offense to commit an act which is detrimental to the interest or welfare of the Exchange or to engage in any conduct which tends to impair the dignity or good name of the Exchange.
Pursuant to an offer of settlement in which Morgan Stanley & Co. LLC (“Morgan Stanley”) neither admitted nor denied the findings upon which the penalty is based, on April 11, 2012, a Panel of the CBOT Business Conduct Committee found that from April 2008 through October 2009, a Morgan Stanley salesperson executed 119 customer orders, 115 of which involved Treasury futures that were executed with various traders on Morgan Stanley’s U.S. Swaps Desk and U.S. Government Trading Desk. All of the transactions were submitted for clearing as EFRP transactions. However, the subject transactions were not bona fide EFRPs because they involved the simultaneous purchase and sale of futures contracts without any corresponding transaction in a cash or OTC derivative instrument. As such, the transactions submitted by Morgan Stanley’s employees as EFRPs were, in fact, multiple noncompetitively executed futures transactions that circumvented the exchange’s competitive execution requirements.
In addition, Morgan Stanley executed approximately 930 Treasury futures EFRPs through third-party brokers from January through September 2011 that were reported on the trade date, but outside of the one-hour time frame required by Market Regulation Advisory Notice RA 1006-5.
The Panel concluded that Morgan Stanley, by its employees’ noncompetitive execution of 115 transactions that involved various Treasury futures, and by its employees’ improper submission of those transactions as EFRPs, violated CBOT Rules 432.Q. and 538. The Panel also found that Morgan Stanley violated CBOT Rule 538 by failing to submit EFRP transactions for clearing within the established time requirements.
In accordance with the settlement offer, the Panel fined Morgan Stanley $1,000,000.
In levying this penalty, the Panel considered the fact that, upon receiving the initial inquiry from Market Regulation regarding one of the non-bona fide EFRPs, Morgan Stanley undertook an internal investigation and shared with Market Regulation the results of that investigation, and self-reported the broader pattern of non-bona fide EFRPs and late-reported EFRPs. The Panel also considered actions taken by Morgan Stanley to implement significant improvements to its employee training programs with respect to compliance with EFRP rules and to establish additional controls related to the firm’s processing of EFRPs. Finally, the Panel also took into consideration the CFTC’s corresponding action against Morgan Stanley for its failure to adequately supervise its employees in connection with the subject activity.
June 5, 2012