Morgan Stanley Reaches Settlement with FINRA over Market Access Rule Violations

Morgan Stanley recently took another compliance hit, adding to its ongoing tangle with regulators. In a Letter of Acceptance, Waiver, and Consent (AWC) submitted to FINRA, Morgan Stanley agreed to a settlement for alleged rule violations related to market access controls—an agreement that, if accepted, would shield the firm from future actions tied to the same issues. This latest chapter is part of an ongoing saga involving market access rule violations, with Morgan Stanley previously settling similar allegations just a few years ago.

Morgan Stanley, a FINRA member since 1970, has long been a heavyweight in the financial industry, serving corporate, broker-dealer, and institutional clients across its vast network of approximately 40 branches and 4,200 registered representatives. However, with great power comes great regulatory oversight. Back in 2018, the firm faced a similar wave of regulatory fines when it reached nine settlements with FINRA and several exchanges, facing $1.1 million in penalties and a stern mandate to fix gaps in its market access procedures.

Fast-forward to today, and it appears that FINRA still isn't fully satisfied. This latest settlement addresses violations that occurred between August 2019 and June 2023, with FINRA charging that Morgan Stanley’s internal controls—meant to prevent erroneous trades and manage market risks—had failed to hold up under scrutiny.

The Core Issues: A System Falling Short

Market access rules are designed to keep trading environments secure and stable, particularly when high volumes or risky orders are in play. For a financial giant like Morgan Stanley, with its direct market access, ensuring robust risk management is essential. Yet, according to FINRA, the firm struggled with maintaining a comprehensive and effective system for handling these risks.

Morgan Stanley operates using two primary order-handling models: "low touch" and "high touch." Low-touch orders flow through the firm’s trading systems with minimal human intervention, managed via pre-set controls tailored to individual customer needs. High-touch orders, on the other hand, involve a hands-on approach, with traders manually assessing and handling orders based on customer instructions and real-time market factors. However, FINRA pointed to cracks in Morgan Stanley’s system, suggesting that procedures for onboarding new clients and setting trading thresholds weren’t as transparent or documented as they should be.

In FINRA's view, the firm’s market access controls were missing the mark. For instance, Morgan Stanley had "soft blocks" or “hold limits” in place to temporarily pause orders that exceeded risk thresholds. While this practice is intended to add a layer of review before executing a potentially risky trade, FINRA noted that the firm didn’t require reviewers to document why these orders were ultimately released, a crucial step in maintaining a strong compliance posture.

Additionally, the firm’s setup allowed some reviewed orders to be modified and resubmitted without a second round of scrutiny, creating room for potentially risky trades to slip through unnoticed. This, according to FINRA, underscored a broader issue: the lack of documented rationale for many of Morgan Stanley’s key decisions in its market access processes.

Untangling the Complexities of Compliance

While the concept of "risk management" may seem cut-and-dry, in the fast-paced world of financial markets, it’s anything but. Morgan Stanley found itself contending with the challenge of customizing controls for a diverse range of customers, from high-frequency traders using advanced software to more conservative clients engaging in fewer transactions. For low-touch customers, the firm’s standard "price away" and "notional value" controls weren’t consistently documented, meaning there was little record to justify the parameters applied to each client. For high-touch traders, thresholds were set based on each trader's experience level, but again, without clear documentation of why certain limits were deemed appropriate.

Moreover, Morgan Stanley’s methods for evaluating the effectiveness of these thresholds were called into question. Regular reviews, the bedrock of any solid compliance system, were found lacking. Although the firm stated it would periodically review controls to ensure compliance, FINRA highlighted that this was not always done consistently, particularly in cases where thresholds appeared disproportionately high.

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