A big block of shares would come up for sale, and block-trading head Pawan Passi would tip off the funds. One even told Passi he had put that investor “in the game” (adding a colorful modifier) and that the investor “would be at the kiddie table” if not for him.
“I know who my daddy is,” the investor said in a call, according to federal prosecutors.
On Friday Passi entered into a deferred-prosecution agreement with the US Justice Department, in which he pleaded not guilty to securities fraud, to settle a long-running probe into his and Morgan Stanley’s trading practices. He mishandled confidential information, he acknowledged, agreeing to a one-year ban from the brokerage business.
That agreement and the bank’s own nonprosecution deal with the US, which Bloomberg reported on Thursday, come after a years-long descent for Passi, once a beloved member of Morgan Stanley whose desk brought in $1.4 billion in revenue from 2018 to 2021.Passi’s fall also scarred Morgan Stanley, which agreed on Friday to pay a total of $249 million to the Justice Department and the Securities and Exchange Commission to settle their probes into its block-trading business. Its pact allows the bank to avoid criminal charges.
Gray Areas
Talks with investors about block trades — purchases or sales of amounts of stock big enough to move the share price — often occur in legal gray areas. Bankers routinely canvass prospective buyers about their hypothetical interest in specific stocks. They take care not to leak deals that are actually in the works.
Except when they don’t. Prosecutors outlined a case against Passi and the bank that included years of alleged leaks, lies and compromised confidential information.
Here’s what the government claimed:
For years Passi and another employee at the bank’s market-leading equities syndicate desk, who wasn’t charged, told select investors about upcoming sales of large blocks of shares of public companies — information they had promised to keep to themselves. In multiple instances, the investors shorted the stock ahead of the sale.
The equities-syndicate desk was contacted in 2018 about a block of 10 million Canada Goose shares. That same day, an investor asked a desk employee whether there was anything he should be focusing on. “How is your store of cold weather jackets,” the employee replied. The investor made a $760,000 profit from shorting the stock, according to prosecutors.
In another instance, involving a 2021 sale of millions of shares of Star Bulk Carriers Corp., Passi told the seller that he would keep the prospective sale confidential. He proceeded to share the details of the negotiations of the sale with a hedge fund “on an almost daily basis.” The fund then shorted Star Bulk Carriers on its very first trade in the company’s shares. It would later buy a chunk of the block to cover its short.
Passi even suggested to hedge funds how they should trade ahead of upcoming block trades he was running, and many took short positions. He then promised “favored buy-side investors” they would get enough of the allocation of the block trade to cover their shorts.
Suspicion of such leaks spread not only on the Street — some perhaps driven by envy of Morgan Stanley’s block-trading success — but also within the bank itself. Investors were too perfectly positioned to make money on the trades, one employee said. “How are they set up for every one of these f—ing things?!” the employee asked Passi in August 2021.
The question came after a suspect move in iHeartMedia Inc. shares the day the bank was executing a block trade on behalf of a client. Passi blamed a different bank for leaking information about the deal. The day before, he had sent information about the trade to a hedge fund that was shorting the media company.
Morgan Stanley said in a statement that “the core of this matter is the misconduct of two employees who violated the firm’s policies” and that it is “confident” in its enhanced controls. Passi’s lawyer George Canellos said earlier that he was pleased the government didn’t pursue a criminal conviction of his client.
The SEC has been concerned for years about potential abuses in the highly secretive world of block trading. Executives overseeing the practice had privately expressed doubts that authorities would find anything.
In the end, Passi — the center of the government’s case — can move to have the charge against him dismissed after six months if he abides by the terms of his agreement. And Morgan Stanley, accused of lax controls over how it handled confidential information, had to concede that it engaged in misconduct and pay a fat penalty but escaped criminal prosecution.
A ‘Win for Everybody’
Richard Hong, a former SEC enforcement official now at the law firm Morrison Cohen, called it “a meaningful case for the SEC and DOJ,” though not one he expects to change the industry overnight.
“This is not going to shake the Earth,” Hong cautioned.
Still, he said, “it’s a win for everybody. The government gets a major fine and tells Wall Street that it has to block-trade by the book. And Morgan Stanley gets to move on from this without any lasting damage, and clean the closet for their new CEO.”
At Passi’s court appearance Friday, the judge had some advice.
“You have been given a real opportunity here today to avoid a criminal conviction,” US Magistrate Judge Robyn Tarnofsky told Passi in approving his deal with the government. “I hope this is the only time I see this case again.”