Professor Elam

The bank’s total settlement includes an agreement to pay fines of about $112 million to the Securities and Exchange Commission. “We are pleased to resolve these investigations and are confident in the enhancements we have made to our controls around block trading,” the bank said Friday in a statement.

A former executive in charge of block trading, Pawan Passi, admitted that he misled clients from 2018 to 2021 about how he would handle their trades. He agreed to a one-year bar from the securities industry and to pay a $250,000 fine to the SEC.

Passi received a probationary deal known as a deferred prosecution agreement, which typically is reserved for low-level offenders without a criminal history. His separate deal with the SEC allows Passi to seek readmission to the brokerage industry after his one-year bar expires.

George Canellos, an attorney for Passi, said his client was “pleased the U.S. Attorney’s Office agreed to not pursue a criminal conviction of Mr. Passi in this complex matter.”

“The settlements allow Mr. Passi and his family to move past two very difficult years of intense government scrutiny of the block-trading practices on Wall Street,” he added.

Block trades occur when a large shareholder, such as a private-equity firm, wants to sell a swath of stock at once. A bank such as Morgan Stanley offers to buy the block at a discount to the day’s closing price and then sells the shares at a slight markup from what it paid. In the years leading up to the probe, Morgan Stanley was the dominant bank in block trading.

Prosecutors said Passi promised some selling shareholders that he would keep their potential sales confidential but knew he would talk to investors and that they would use the information to trade in advance of the block sales. 

Potential buyers of block shares, such as hedge funds, sometimes short the stock once they hear about the sales. That can drive down the price that the selling shareholder receives.

Morgan Stanley’s settlement includes $64 million in restitution, which would go to compensate sellers harmed by the information leakage. The bank’s civil fraud settlement with the SEC says Passi’s communications with investors reduced Morgan Stanley’s risk in purchasing block trades.

The bank told some sellers of block shares that its process for finding buyers was “less prone to leaks and therefore less risky than the processes run by other banks,” according to a statement of facts attached to Morgan Stanley’s agreement with prosecutors. 

In one example cited by prosecutors, Passi and other Morgan Stanley employees in 2021 told a seller of

stock they would keep a potential 10-million-share block trade confidential. Passi, however, told a hedge fund “on an almost daily basis about the specific details of Morgan Stanley’s discussions with the seller,” according to the statement of facts.

The hedge fund sold short 1.2 million shares of Star Bulk Carriers, prosecutors said. It later bought some of the shares from the Star Bulk seller to cover its short sale.

Star Bulk’s share price fell so much over a one-day period that the seller confronted Passi about whether Morgan Stanley had told anyone about the possible sale. But Passi “lied, falsely assuring the seller that no Morgan Stanley employees had disclosed the upcoming block to the buy side,” according to prosecutors. 

Prosecutors’ investigation was complicated by questions about whether the potential stock sales were material nonpublic information. In some cases, block trades involve shares that sophisticated investors know are coming because the sellers are executives whose stockholdings are publicly disclosed and who are only able to sell after a defined period.

The SEC said block orders could be material nonpublic information. Sellers interested in dealing with Passi’s team at Morgan Stanley sent an email that “typically included an explicit statement requiring confidential treatment of information,” according to the SEC. 

But during the period when Passi ran the team, he and others were told that certain block orders weren’t material nonpublic information, the SEC’s settlement added. Policies the bank used to log and control such sensitive information—intended to prevent insider trading, for instance—weren’t applied to block trades. 

Defense attorneys also pointed out that regulators decades ago had approved of banks’ disclosing block orders so they could find the best price for a seller. The SEC in 1979 issued guidance that said brokers could “search and negotiate for a matching interest” to sell a block for a customer. 

A 2022 Wall Street Journal analysis of nearly 400 block trades over three years indicated that information about the sales routinely leaks out ahead of time.

Morgan Stanley put Passi on leave in November 2021 and discharged him the following year, according to Financial Industry Regulatory Authority records. Charles Leisure, another senior executive who worked with Passi on block trades at the bank, was also discharged in 2022, according to Finra records. Prosecutors didn’t charge Leisure with wrongdoing.

Write to Dave Michaels at dave.michaels@wsj.com, AnnaMaria Andriotis at annamaria.andriotis@wsj.com and Corrie Driebusch