In January 2024, the Securities and Exchange Commission (SEC) filed a high-profile administrative and cease-and-desist order against Pawan Kumar Passi, the former Managing Director and head of the Equity Syndicate Desk at Morgan Stanley. This case sheds light on insider trading practices and confidentiality breaches within the realm of large block trades.
What Happened?
The SEC’s findings highlighted that from June 2018 through August 2021, Passi disclosed non-public, market-moving information related to block trades to select investors, particularly buy-side investors like hedge funds. These trades involved large quantities of stock being sold by institutional investors, often private equity or venture capital firms, through Morgan Stanley’s Syndicate Desk.
Passi violated multiple confidentiality agreements by sharing sensitive information with potential buyers before the block trades occurred. As a result, these buyers pre-positioned themselves by taking short positions, thereby benefiting from inside knowledge of upcoming stock transactions. This type of behavior is not only unethical but also goes against Morgan Stanley’s own policies, which prohibit employees from leaking confidential and market-sensitive information.
The Mechanics of Block Trades
Block trades involve the sale of a large number of shares outside the public market, which are typically arranged privately between sellers and buyers. These trades usually occur after significant events, such as the expiration of a lockup period or a company earnings report. While sellers want to obtain the highest price for their shares, investment banks like Morgan Stanley aim to buy them at the lowest possible price to maximize their own profit.
In a block trade, maintaining confidentiality is paramount to prevent market speculation and price manipulation. If investors suspect that a large block of shares is about to flood the market, they might start selling shares or shorting the stock, causing a decline in its price. This scenario jeopardizes both the seller’s profit and the bank’s ability to execute the trade at favorable terms.
Passi’s Conduct
The investigation revealed multiple instances where Passi violated these confidentiality agreements by disclosing sensitive details of block trades. One example involved Medpace Holdings Inc. (MEDP) in June 2018. Passi informed a portfolio manager at a hedge fund about an impending block trade, and the fund began shorting MEDP shares before the trade occurred, benefiting from the price decline once the trade was publicly announced.
Passi’s actions not only violated Morgan Stanley’s internal policies but also broke federal securities laws, including Section 10(b) of the Securities Exchange Act and Rule 10b-5, which prohibits insider trading and market manipulation.
The Aftermath
The SEC’s ruling against Passi includes a cease-and-desist order, a civil money penalty of $250,000, and a ban from working with any broker, dealer, or investment advisor. This ban extends to participating in any penny stock offerings and acting in a supervisory capacity within the financial industry for at least two years.
Implications for the Financial Industry
The Passi case is a stark reminder of the importance of upholding confidentiality in financial markets. Insider trading and the improper use of non-public information undermine the integrity of the market and create an uneven playing field for investors. While the penalties imposed on Passi are significant, the reputational damage to Morgan Stanley is equally notable.
The case also highlights the ongoing regulatory scrutiny in the financial industry. Investment banks and their employees must adhere to strict guidelines when handling sensitive information, and breaches of these protocols can result in severe legal and financial consequences.
For investors, the lesson is clear: insider trading is not only unethical but also illegal. The SEC’s actions serve as a warning that violations of securities laws will be met with firm regulatory action.
In conclusion, the SEC’s case against Pawan Kumar Passi marks a significant moment in the fight against insider trading and market manipulation. As financial markets continue to evolve, the importance of maintaining fair and transparent practices has never been greater.
About Michael Rasmussen
Michael Rasmussen is the founder of United Atlantic Legal Services. He is a licensed attorney in Florida and registered solicitor in the United Kingdom. Michael has acted as General Counsel and Chief Compliance Officer to several investment advisers, including private fund managers, responsible for the management of billions of dollars in client assets.
Michael is also the founder of FinProLaw, an online learning platform where Michael has created courses designed for investment adviser compliance professionals. These courses include:
- Investment Adviser Compliance Essential for Chief Compliance Officers
- Foundations of Investment Adviser Compliance
- What is a “Security”?
- Investment Adviser Marketing Rule
- Regulation A – Exemption from Registration
- Regulation Crowdfunding – Exemption from Registration
- Regulation D – Exemption from Registration
Michael can also be found on LinkedIn.
Investment adviser firms who are also clients of United Atlantic Legal Services can receive many of these courses at a significantly reduced fee or, in some cases, at no expense. Contact us today or visit the FinProLaw to learn more.