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Morgan Stanley Fined $675,000 for Failing to Address Short Positions in Tax-Exempt Municipal Bonds

Morgan Stanley & Co. and Morgan Stanley Smith Barney LLC of New York submitted a Letter of Acceptance, Waiver and Consent to the Department of Enforcement of the Financial Industry Regulatory Authority (FINRA) for allegedly failing to supervise and implement adequate written procedures to comply with Municipal Securities Rulemaking Board (MSRB) rules relating to short positions in tax-exempt municipal bonds.

Morgan Stanley Smith Barney LLC (MSSB) was formed through the combination of Global Wealth Management Group of Morgan Stanley & Co. Incorporated and the Smith Barney Division of Citigroup Global Markets, Inc. MSSB has been a FINRA member since 2009 and operated as a joint venture until 2013. Morgan Stanley & Co. LLC (MS&Co.) provided clearing services for MSSB and was responsible for sending specified account statements and Forms 1099 to MSSB’s customers between 2009 and 2010.

FINRA alleged that between July 2009 through December 2013, MSSB and MS&Co. failed to have adequate supervisory procedures to address short positions in tax-exempt municipal bonds that resulted primarily from the trading errors at the firm’s retail branches. Due to these alleged failures, the firm misrepresented to at least 1,500 customers that at least $880,000 in interest paid to those customers was exempt from taxation. FINRA found that Morgan Stanley did not hold the bonds for customers and that the interest that customers received was from Morgan Stanley and therefore taxable as ordinary income.

Municipal bonds usually pay tax-exempt interest on a semi-annual basis. The only way an individual is exempt from federal income tax is if interest is received from a municipal issuer. If a firm is short a tax-free municipal bond that matches a customer’s long position, the firm will pay the customer appropriate interest. Morgan Stanley held more than 1,500 in short positions in tax-exempt municipal positions that corresponded with long positions in client accounts.

Of these 1,500 short positions, most were moved to a centralized error account by the firm’s Municipal Bond Trading Desk. When these short positions were discovered, the market structure and illiquidity of municipal bonds made it difficult for Morgan Stanley to cover the short positions. FINRA found that Morgan Stanley often did not cover municipal short positions for periods sometimes over a month and in July 2012 the firm still held 400 municipal short positions with a par value of $9.9 million. In addition, as a result of a lack of proper supervisory procedures, Morgan Stanley failed to disclose to customers that, because the firm was short the security, they were not receiving tax exempt interest from the issuers of the municipal securities reflected on their alleged false account statements.

For their alleged violations Morgan Stanley was fined $675,000 of which $124,406.93 was imposed jointly and severally with Morgan Stanley & Co., LLC.

Stockbrokers have been known to engage in many types of practices which violate industry and firm rules, practices, and procedures. In order to protect customers from stockbroker misconduct, FINRA rules require broker-dealers Morgan Stanley to establish and implement a reasonable supervisory system. The implementation of the rules require supervisors to monitor employees to ensure they comply with federal and state securities laws, securities industry rules and regulations, and the firms, such as Morgan Stanley own policies and procedures. If broker dealers and/or their supervisors do not establish and implement these protective measures, they may be liable to investors for damages which flow from the misconduct. As a result, investors who have suffered losses because of their stockbroker’s unlawful or prohibited conduct can file a claim to recover damages against broker dealers like Morgan Stanley, which should consistently oversee its employees in order to prevent stockbroker misconduct.

Have you suffered losses in your Morgan Stanley investment account due to your stockbroker’s misconduct? If so, call Robert Pearce at the Law Offices of Robert Wayne Pearce, P.A. for a free consultation. Mr. Pearce is accepting clients with valid claims against stockbrokers for unsuitable recommendations, misrepresentations, and/or other unauthorized and prohibited conduct.

The most important of investors’ rights is the right to be informed! This Investors’ Rights blog post is by the Law Offices of Robert Wayne Pearce, P.A., located in Boca Raton, Florida. For over 35 years, Attorney Pearce has tried, arbitrated, and mediated hundreds of disputes involving complex securities, commodities, and investment law issues. The lawyers at our law firm are devoted to protecting investors’ rights throughout the United States and internationally! Please post a comment, call (800) 732-2889, send Mr. Pearce an email at pearce@rwpearce.com, and/or visit our website at www.secatty.com for answers to any of your questions about this blog post and/or any related matter.