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Morgan Stanley Canada Ltd. has agreed to pay penalties totalling $190,000 after admitting it missed warning signs that a hedge fund client appeared to be manipulating the closing price of Petrowest Energy Services Trust in 2007 and 2008.
Canada's stock market regulator concluded a settlement agreement with the brokerage firm on Monday, requiring Morgan Stanley to pay a fine of $175,000 and costs of $15,000. Morgan Stanley has also ramped up its review of unusual trading patterns by clients in Canada and has hired a full-time chief compliance officer, the Investment Industry Regulatory Organization of Canada said.
IIROC said Morgan Stanley "failed to make adequate inquiries" of an unidentified hedge fund client or "conduct a thorough analysis of the trading by the client" even after the regulator contacted the firm about the unusual trading activity in 2007.
The regulator said the fund entered a "significant number" of high-closing trades in shares of Calgary-based Petrowest Energy Services, which has more recently been renamed Petrowest Corp. following its conversion from an income trust.
High closing involves making manipulative purchases of small numbers of shares at the end of a trading day so the closing price of the shares is higher than it would have been otherwise.
IIROC alleged the hedge fund's trades constituted the highest closing price for Petrowest shares on 81 out of 104 trading days that it bought the securities in 2007, and 103 of 126 trading days in 2008.
In the settlement agreement approved Monday, IIROC said Morgan Stanley's compliance software showed numerous alerts relating to the fund's trading in Petrowest units, but the brokerage firm only selected one alert in October, 2007, for review and concluded it did not appear manipulative on that occasion. IIROC said the firm did not examine other trades in prior months.
In November, 2007, IIROC asked Morgan Stanley for the identity of the client doing the trades. When further trading alerts were triggered in March, 2008, the firm contacted the hedge fund, which explained it was using limit orders to unwind and "re-establish" its position in the securities. Morgan Stanley did not take any further action until further alerts were generated in July, 2008, when brokerage firm staff "discussed monitoring" the trading activity going forward.
The hedge fund's trading generated high closing alerts for the rest of 2008 "without any additional inquiries or analysis" by Morgan Stanley, IIROC said in the settlement agreement.
The agreement notes the trading was done directly on the Toronto Stock Exchange by a "direct market access" institutional client of the firm's U.S. parent, Morgan Stanley & Co. Inc., which means no traders at Morgan Stanley were involved with handling the orders.
It also says Morgan Stanley has implemented "enhancements" to its compliance and supervisory program, including increasing its sample size for testing unusual pattern alerts and creating a training manual for direct market access clients with a section on manipulative and deceptive trading activities.