The Securities and Exchange Commission has fined a former trader at Morgan Stanley $150,000 and barred him from the securities industry for two years after he fooled its risk management system with bogus equity swap deals.
Morgan Stanley lost more than $24 million as a result of the trader violating SEC regulations which prohibit fraudulent conduct with the purchase or sale of securities or security-based swap transactions, said the SEC.
The trader, Larry Feinblum, worked at Morgan Stanley's dually-registered broker-dealer and investment advisory unit for more than 10 years and ultimately became an executive director and supervisor in the firm’s equity financing products swap desk, according to the SEC's final order in an administrative proceeding, issued on May 31.
As part of its trading strategy, Feinblum and Jennifer Kim, a trader he supervised, generally traded equity swaps – synthetic agreements to buy or sell economic exposure (risk) to particular shares. According to SEC’s order, Feinblum and Kim between October and December 2009 tried to profit from the price difference between U.S. and foreign markets involving American Depositary Receipts and common stock of Wipro Limited, an Indian provider of Internet technology services and United Microelectronics Corp. a Chinese semiconductor maker.
Wipro’s ADRs trade on the New York Stock Exchange and its common stock trades on the Bombay and National Stock Exchanges. UMC’s ADRs also trade on the NYSE and its common stock trades on the Taiwan Stock Exchange.
Morgan Stanley declined to comment on the case. Feinblum’s attorney David Chaudoin with the Washington DC law firm of Wilmer Hale did not return a call for immediate comment. Cynthia Matthews, an attorney in the New York regional office of the SEC, who helped prosecute the case was unavailable for immediate comment.
Feinblum and Kim increased their short positions in the ADRs of the two companies without offsetting their risk with long positions in the underlying common stocks of Wipro and United Microelectronics. Their transactions exceeded Morgan Stanley’s risk limits, according to the SEC.
To avoid being detected by Morgan Stanley’s risk management system, Feinblum and Kim then placed swap orders they had no intention of executing to temporarily and artificially reduce the net risk of their positions. The two traders then cancelled those orders immediately after they were placed. “Feinblum and Kim cancelled the swap orders after they knew that the risk management system coined “ER” had captured false and misleading information about their net risk positions and continued to execute their arbitrage trading strategy at positions beyond certain of MS &Co’s net risk limits," wrote the SEC in its ruling.
The net effect of their bogus swap orders and cancellations: they were able to trick Morgan Stanley’s risk management systems into recording reduced net risk positions below the firm’s limits.
Their trading strategy – and the deceptive entries -- backfired and came to light when the price of the ADRs in Wipro and United Microelectronics rose at a faster rate than the price of the common stocks and the dollar sank against the foreign currencies.
According to the SEC, Feinblum's supervisor first notified him about the size of his net risk position in Wipro in September 2009. The following month a member of the firm's risk management unit notified Kim that she and Feinblum had breached the firm's net risk limit. It was then that Feinblum and Kim began entering their bogus transactions.
In mid-December 2009, when the market moved against Feinblum's positions, his trade book recorded a "significant "notional loss," which Feinblum acknowledged. according to the SEC. He then admitted to his supervisor that he had exceeded the firm’s risk limits repeatedly and how he did so, the SEC said.
When Morgan Stanley unwound the unauthorized trading positions, it sustained a loss of about $24.47 million, said the SEC, adding that Feinblum was immediately terminated.