According to FINRA, Morgan Stanley Smith Barney LLC was fined $1.6 million for repeated failures to timely close out failed inter-dealer municipal securities transactions and to take prompt steps to obtain physical possession or control of municipal securities positions that were short more than 30 calendar days, along with related supervisory failures.

This represents the first disciplinary action in which FINRA charged a firm with violating the close-out requirements of MSRB Rule G-12(h) and related supervisory failures. MSRB Rule G-12(h) requires that failed inter-dealer municipal securities transactions be canceled or closed out no later than 20 calendar days after settlement date. Exchange Act Rule 15c3-3(d)(2) requires broker-dealers to take prompt steps to obtain physical possession or control of securities they failed to receive for more than 30 calendar days.

Morgan Stanley failed to timely cancel or close out 239 inter-dealer municipal transactions aged over 20 calendar days after settlement date with a total value of approximately $9 million from December 2016 through August 2021. Additionally, from January 2016 through August 2021, the firm failed to take required prompt steps to obtain possession or control of 247 municipal securities with a total value of approximately $9.4 million that it had failed to receive for an average of approximately 177 days.

The firm also failed to establish and maintain a supervisory system and written procedures reasonably designed to achieve compliance with these close-out and possession requirements. Morgan Stanley did not modify its system and processes for addressing municipal fails-to-receive until June 2021 or update its procedures until September 2021. This was particularly concerning given that FINRA had previously sanctioned Morgan Stanley for supervisory failures regarding short positions in municipal securities in 2015.

For investors, possession and control requirements exist to protect customer assets and ensure firms maintain adequate controls over securities positions. Failures to close out transactions and obtain possession of securities can create risks to customer assets and undermine market integrity in the municipal securities market.