The U.S. Securities and Exchange Commission settled fraud charges against Morgan Stanley & Co. Inc. for its failure to provide best execution to certain retail orders for over-the-counter securities.

The SEC reported that Morgan Stanley embedded undisclosed mark-ups and mark-downs on certain retail OTC orders processed by its automated market-making system and delayed the execution of other retail OTC orders, for which it had an obligation to execute without hesitation. Morgan Stanley will pay US$7,957,200 in disgorgement and penalties to settle the commission’s charges. All of Morgan Stanley’s revenue from its undisclosed mark-ups and mark-downs will be distributed back to the injured investors through a distribution plan.

Without admitting or denying the commission’s findings, Morgan Stanley consented to the entry of an order by the commission that censures the firm, and requires it to cease and desist from committing any violations of securities rules. It also requires Morgan Stanley to pay disgorgement of US$5,949,222 and prejudgment interest of US$507,978, and imposes a civil money penalty of US$1.5 million. Morgan Stanley also will retain an independent distribution consultant to develop and implement a distribution plan for the disgorgement ordered, and will retain an independent compliance consultant to conduct a comprehensive review and provide a report on its automated retail order handling practices.

The SEC said the violations took place from Oct. 24, 2001, through Dec. 8, 2004, and that Morgan Stanley failed to provide best execution to more than 1.2 million executions valued at approximately US$8 billion. The firm recognized revenue of US$5,949,222 through its improper use of undisclosed mark-ups and mark-downs, it added.

“By recklessly programming its order execution system to receive amounts that should have gone to retail customers, Morgan Stanley violated its duty of best execution and defrauded its customers,” said Linda Chatman Thomsen, director of the commission’s Division of Enforcement. “The duty to provide best execution is a fundamental duty of a broker-dealer. Broker-dealers must be diligent in their efforts to seek the most favorable terms for their customers’ orders.”