(Bloomberg) - Just after lunch on a Tuesday in March 2019, a top-ranking Blackstone Inc. executive emailed Morgan Stanley’s Pawan Passi, seeking help to start exiting one of the investing giant’s most lucrative real estate bets ever.
The very minute Passi got the message, he called a hedge fund, which spent the next two hours wagering against the shares of Invitation Homes Inc. After US markets closed, Morgan Stanley offered Blackstone its bid for a block of stock and won the mandate.
In the process, Blackstone’s request for secrecy was ignored. Morgan Stanley allocated the hedge fund about 2.5 million shares of Invitation Homes, allowing the firm to unwind its bet. The New York-based bank made a clean $3.4 million from that afternoon’s work.
These were among the findings disclosed Friday by federal prosecutors in Manhattan and the US Securities and Exchange Commission, who accused Morgan Stanley of betraying the trust of its clients by leaking non-public information and levied a $249 million penalty to end a multiyear probe into a dominant business in the bank’s vaunted equities unit.
Passi, who was running the US equity syndicate desk when he was put on leave in 2021, was barred from the industry for a year by the SEC.
While authorities omitted names in describing the transactions they unearthed, the deals involve some of the finance industry’s most prized clients in New York and London. Beyond Blackstone, the world’s biggest alternative-asset manager, other firms whose deals were leaked by Passi include Oaktree Capital Management, which oversaw $183 billion at the end of September, and European private equity pioneer Cinven.
Rather than by name, their identities are revealed in the granular details cited by investigators — such as the specific size of certain past stock holdings or the trades in which they participated. Representatives for all three firms declined to comment.
“This whole affair points to a failure of risk culture,” said Moorad Choudhry, a former NatWest Group Plc banker who wrote The Principles of Banking. “It is further bad behavior from a senior executive at a bank. The solution lies in what kind of person large banks want to appoint to executive-committee positions, and whether the risk culture in place means they actually do what they say they do.”
Hugh Fraser, a Morgan Stanley spokesman in London, referred to the bank’s statement last week that said “the core of this matter is the misconduct of two employees” who violated polices and that the firm is “confident” in its enhanced controls.
George Canellos, a lawyer for Passi, said last week that he was pleased the government didn’t pursue a criminal case against his client.
Easy Money
Block trades are highly sensitive transactions, often involving enough stock to move the market price. Banks compete to handle the sales, flipping the shares to other investors — such as hedge funds — for a profit.
In the cases outlined by the SEC, Passi allegedly tipped off hedge funds that bet against — or “shorted” — shares before they were sold through a block trade and later repurchased them at a lower price from Morgan Stanley, locking in near-certain profits.
The bank benefited because those ready buyers lowered any risk to its balance sheet as it bid alongside competitors to win mandates. The desk run by Passi dominated the business.
Read More: Morgan Stanley banker lifts hedge fund from ‘kiddie table’ with stock tips
In Blackstone’s case, it wasn’t just any investment it was looking to sell. The firm had created Dallas-based Invitation Homes by pouring billions of dollars into distressed residential real estate after the 2008 financial crisis. It gobbled up homes and emerged as a major player in the US rental sector, withstanding intense political scrutiny as it scored big gains from that bet.
At 1:35 p.m. on March 19, 2019, a top Blackstone executive emailed Passi about arranging a potential block trade: “As we just discussed, we appreciate your protecting the confidentiality of this discussion from the marketplace, as well as your consideration and thoughts.”
Before the minute turned, Passi called a hedge fund portfolio manager and discussed the proposed sale, according to the SEC. By the time markets closed, the fund had made a $22 million bet against Invitation Homes, amounting to almost half of the total volume of shares traded that day.
The SEC didn’t identify the hedge fund, the portfolio manager or the Blackstone executive.
Talks with investors about block trades often occur in legal gray areas. Bankers routinely canvass prospective buyers about their hypothetical interest in specific stocks. They take care not to leak deals that are actually in the works — except when they don’t.
In late April 2021, an Oaktree executive contacted a Morgan Stanley employee about possibly offloading a large stake in Star Bulk Carriers Corp., an Athens-based shipping company whose motto is “Give me a Ship and I shall move the Earth.” A Morgan Stanley banker warned colleagues that Oaktree’s executive was “VERY focused on confidentiality,” and the executive himself told Passi and others he didn’t want the market to know about the transaction until it occurred, according to the SEC.
By mid-May, Passi had alerted the founder and head of an investment firm, who began betting against Star Bulk’s stock, the agency said. A week later, Morgan Stanley bought 10.6 million shares from Oaktree and sold 2 million of them to the investment firm, generating $3.7 million in profits.
The SEC didn’t identify the investment firm or its founder.
“The problem with trust is that it can make you vulnerable to exploitation,” said Renee Adams, a professor at the University of Oxford’s Saïd Business School. “This seems to be exactly what happened in this case: Mr. Passi clearly exploited the trust placed in him.”
Preventing ‘Leakage’
Passi’s team also worked with Cinven in mid-2018 to cut its stake in clinical researcher Medpace Holdings Inc., and the pattern was the same. That June, acting on a tip from Passi, a hedge fund shorted the shares, accounting for almost 89% of all trading in the stock that day. Morgan Stanley bought the block and allocated shares to the fund, generating almost $2 million in profits.
A few weeks later, Passi’s team pitched Cinven on another block sale. One of the advantages of working with Morgan Stanley, according to a presentation the bankers made, was that information wouldn’t creep into the market and cause the price to fall. They cited the June deal as an example.
Cinven agreed to proceed and Passi received an email about it at 1:02 p.m., requesting confidentiality. Minutes later, he called a hedge fund portfolio manager, who bet against Medpace almost immediately, the SEC said. The bank successfully bought the block later that afternoon, flipping 12% of the stock to the fund and clearing roughly $3.1 million of profits.
As the evening approached, Passi sent an email to several Cinven employees.
“Pleased we were able to execute this block for you,” he wrote. “Hopefully you felt that Morgan Stanley was good to our word.”
Passi’s team made its discretion a calling card. In a presentation, it claimed that when rival banks sold about $652 million of shares in winter-clothing company Canada Goose Holdings Inc., someone “leaked” on that deal.
The team neglected to mention that just a few months earlier, the Morgan Stanley team had heard that another Canada Goose block trade was in the offing. While Passi’s desk didn’t take part in the deal, one of his colleagues still tipped off a hedge fund, which bet against the stock and cleared a $760,000 profit, the Justice Department said.
By Sridhar Natarajan and Donal Griffin
With assistance from Jenny Surane
