(Bloomberg) — Morgan Stanley (NYSE:MS) was accused of using “pump and dump” tactics to manipulate European bond markets and stave off a $20 million loss after its bets on the French sovereign turned sour amid the Greek debt crisis.
The bank’s London desk was long on French bonds and short on German debt, betting the spread would narrow, said Bernard Field, an official at the Autorite des Marches Financiers. But the opposite scenario played out as Greece’s impasse with creditors deepened, causing the desk to lose $6 million on June 15, 2015 and an extra $8.7 million at market open the next day, Field said.
To narrow its losses and avoid hitting a $20 million loss-limit set by Morgan Stanley’s management, the London desk allegedly acquired futures on French and German bonds on June 16, 2015, with the sole objective of increasing the market value of French and Belgian bonds before “massively and instantaneously” selling the latter, Field said at a Paris hearing.
“This was clearly a pump and dump strategy,” added Camille Dropsy, another AMF official speaking on behalf of investigators. “Morgan Stanley consciously fooled the market.”
Morgan Stanley said in an emailed statement it “absolutely and categorically rejects the AMF’s allegations.” It said it was dismayed on learning investigators are seeking a 25 million-euro fine ($28 million). “The firm will continue to defend vigorously its integrity and high standards of professional behavior.”
The AMF enforcement committee assesses market-abuse cases ranging from insider trading to publishing misleading information. It has the power to impose civil fines and bans and typically issues decisions several weeks after hearings.
According to AMF investigators, Morgan Stanley’s tactic enabled the London desk to avoid about 5 millions euros in losses, said Field, who added that French and Belgian bonds are considered interchangeable.
Field, who plays the role of a devil’s advocate in the case, disagreed with investigators on several points. In particular, he said the case should focus only French bonds traded on a platform regulated by the AMF, narrowing the loss Morgan Stanley is accused of unfairly avoiding to 1.7 million euros.
Stephane Benouville, a lawyer for the bank, said the accusations don’t stand up to scrutiny. He said the futures the London desk bought had no impact on French bonds and complained that AMF investigators hadn’t bothered trying to prove any effect.
“When you listen to the prosecution it seems we’re being told that Morgan Stanley should have sat on its positions,” Benouville said. “If we weren’t allowed to deal German futures, French futures or French bonds what were we allowed to do? Sit tight as losses piled up?”
Benouville said any decision to fine Morgan Stanley would send a message that market makers aren’t allowed to hedge themselves and exit risky positions. Ciaran O’Flynn, a managing director speaking on behalf of the bank at Friday’s hearing, went further.
“As a market maker and like all market makers, we must provide a price to clients when they want it. We do not control when that will happen,” O’Flynn said. “All market makers, to provide that function, need to know that at a certain point they will be able to exit the risk. It is fundamental to the provision of liquidity to begin with. Any suggestion otherwise exhibits a poor understanding of the basis function of market making.”