NASD Regulation Sanctions Morgan Stanley and Seven Traders
Washington, D.C.—NASD Regulation, Inc., today issued a decision by its Market Regulation Committee that fined Morgan Stanley & Co., Inc., $1 million for manipulating the price of 10 securities that underlie the Nasdaq 100 Index (NDX) on two separate "expiration Fridays" in 1995. The NDX options expire on the third Friday of every month.
Seven Morgan Stanley traders, including the firm’s then-OTC Desk Head Trader, were sanctioned. David Slaine, the former head of OTC trading at Morgan Stanley, was suspended from the brokerage industry for 90 days and fined $100,000. The six other traders – Thomas Anthony Crocamo, Carl DeFelice, Joseph Louis Ferrarese, Peter William Ferriso, Jr., Robert Scott Ranzman, and Charles McMichael Simonds – were each suspended for 30 days and fined $25,000. Morgan Stanley is jointly and severally liable for the traders’ fines.
After a five-day hearing before a panel of industry members, the Market Regulation Committee found that Morgan Stanley, in order to ensure that the firm’s Program Trading Desk did not suffer a loss when its NDX options expired, had an arrangement with the firm’s OTC Desk to sell to the Program Trading Desk the exact amount of each security necessary to close out pre-existing stock positions. As part of this agreement, the Morgan Stanley OTC Desk would sell the securities to the firm’s Program Trading Desk at the opening print price – the first reported trade in each of the securities.
The initial complaint against Morgan Stanley and the seven individuals in this case was issued by NASD Regulation on October 25, 1996. This case, which began with complaints about locked and crossed markets from other market makers, was uncovered after a lengthy investigation by the Market Regulation Department. A locked market occurs when the bid price equals the sell price in the same security, and a crossed market occurs when the bid price is greater than the sell price of a security.
The Committee found that, in connection with this arrangement, on March 17, 1995 and October 20, 1995, Morgan Stanley’s OTC Desk improperly and fraudulently raised the price at which it would buy the securities in the open market, moving the market for each security – and the opening print price in that security – higher. The firm raised its bid without purchasing any stock in an effort to make Friday’s opening print price equal to or exceed Thursday’s closing sell price. The Committee found that Morgan Stanley’s OTC Desk assumed the risk for more than $300 million of the firm’s capital as a result of the intra-firm transaction, thereby enabling the Program Trading Desk to cover its short position at a price (in this case, the opening print price) that would prevent substantial losses, and enable the OTC Desk later to cover the short position at a profit, or at least to break even.
Morgan Stanley was able to manipulate the price of the NDX because, as a capitalization-weighted index, the cash settlement value of the NDX options was, at the time, determined by the opening print price for each of the 100 stocks. Since April 1996, the cash settlement value of NDX options has been based on a volume-weighted average of the prices in each of the component securities, as reported during the first five minutes of trading.
The Committee found that the prices of five securities were manipulated on March 17, 1995, and the prices of a separate set of five securities were manipulated on October 20, 1995.
Morgan Stanley aggressively raised its bid for the 10 securities, before the market opened, creating the last new inside bid price prior to the opening. Generally, raising the bid price prior to the opening on expiration Friday does not attract many sellers because market makers are reluctant to trade prior to the opening. Morgan Stanley was the first market maker to decrease its bid for every one of the 10 securities within minutes after the market opened, and in some instances without buying any stock at all.
Locked and crossed markets resulted from this manipulative bidding activity. NASD rules require firms to make reasonable attempts to trade prior to locking or crossing the market during normal business hours, and there was no evidence that the traders attempted to contact and transact with other market makers whose quotes they locked or crossed.
On March 17, the markets for three of the five securities opened locked, and one opened crossed; and on October 20 the markets in all five opened locked. The Committee found this activity to be an element of the manipulative scheme as well as violative of the NASD Rule governing locked and crossed markets, but did not conclude that Morgan Stanley’s written supervisory procedures were inadequate to deter locked and crossed market activity.
The Committee also noted took notice that Morgan Stanley engaged in a similar pattern of pre-opening quoting activity in 67 other Nasdaq National Market securities underlying the NDX on those two expiration Fridays. In these examples, the firm increased its bids in pre-opening trading, did not purchase any stock prior to the opening, and decreased the price within minutes after the shares were transferred to the Program Trading Desk.
NASD Regulation found no evidence that any of the companies whose securities were involved in this case were aware of what was happening.
Initial actions, such as this, by NASD Regulation disciplinary committees are final after 45 days, unless they are appealed to NASD Regulation’s National Adjudicatory Council (NAC), or called for review by the NAC. The sanctions are not effective during this period. If the decision in this case is appealed or called for review, the findings may be increased, decreased, modified, or reversed.
NASD Regulation’s Market Regulation Committee is currently comprised of 13 members, six from the securities industry and seven who are non-industry members. All members serve three-year terms.
NASD Regulation oversees all U.S. stockbrokers and brokerage firms. NASD Regulation, and The Nasdaq Stock Market, Inc., are subsidiaries of the National Association of Securities Dealers, Inc. (NASD®), the largest securities-industry self-regulatory organization in the United States.