FINRA Levies $1.6 Million Fine Against Morgan Stanley for Municipal Securities Violations

The Financial Industry Regulatory Authority (FINRA) has imposed a $1.6 million fine on Morgan Stanley Smith Barney LLC for recurrent lapses in timely handling failed inter-dealer municipal securities transactions and addressing municipal security positions held short for more than 30 calendar days, alongside related supervisory failures. This marks the first disciplinary action where FINRA has charged a firm with violating the close-out requirements of the Municipal Securities Rulemaking Board (MSRB) Rule G-12(h) and associated supervisory shortcomings.

In 2015, FINRA had previously sanctioned Morgan Stanley for supervisory failures concerning short positions in municipal securities.

Bill St. Louis, Executive Vice President and Head of Enforcement at FINRA, emphasized the importance of member firms establishing robust controls and procedures to detect, resolve, and prevent the consequences of municipal short positions and fails to receive. This includes strict adherence to the close-out requirements outlined in MSRB Rule G-12(h) and the timely identification and addressing of short positions and fails to receive in municipal securities under Exchange Act Rule 15c3-3.

MSRB Rule G-12(h) mandates that inter-dealer municipal securities transactions failing settlement be canceled or closed out no later than 20 calendar days after the settlement date. Simultaneously, Rule 15c3-3(d)(2) of the Securities Exchange Act of 1934 requires broker-dealers to promptly take steps to obtain physical possession or control of securities they have failed to receive for more than 30 calendar days.

FINRA's investigation revealed that Morgan Stanley failed to promptly cancel or close out 239 inter-dealer municipal transactions aged over 20 calendar days after the settlement date, totaling approximately $9 million from December 2016 to August 2021. Additionally, between January 2016 and August 2021, the firm neglected to take required prompt steps to obtain possession or control of 247 municipal securities, with a combined value of around $9.4 million, that had gone unsettled for an average of approximately 177 days.

Moreover, the firm was found to have lacked a supervisory system and written procedures reasonably designed to ensure compliance with the close-out requirements of MSRB Rule G-12(h) and the possession or control requirements of Exchange Act Rule 15c3-3(d)(2). It only revised its system and processes for addressing municipal fails-to-receive in June 2021 and updated its written supervisory procedures in September 2021.

Morgan Stanley has agreed to the entry of FINRA's findings without admitting or denying the charges. Out of the $1.6 million fine, FINRA has allocated $1.2 million to the MSRB.

This enforcement action serves as a reminder to financial institutions about the critical need for stringent compliance measures in municipal securities transactions, emphasizing the consequences of non-compliance with regulatory requirements.

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