A slow-burning regulatory probe of big share sales on Wall Street has kicked up a notch as watchdogs examine whether banks and hedge fund traders are improperly profiting at the expense of institutional sellers and retail traders.

The US Securities and Exchange Commission first started asking banks with large equity trading arms about “block trades” during the Trump administration, according to two people with direct knowledge of the probe. 

Since then, Morgan Stanley, which is a leading provider of block trade services, has received multiple requests for information. The regulator has also contacted other market participants including hedge funds that trade equities. 

The SEC probe is looking at whether other traders are getting advance word of these large sales — either directly from the banks or in some other way — and improperly profiting by shorting the shares in expectation that prices will fall.

No enforcement action is imminent, and it not clear that any will result, the people said. 

Morgan Stanley declined to comment, as did Goldman Sachs, another big player in the market. The probe was first reported by the Wall Street Journal.

Under chair Gary Gensler, the SEC is making a push to prevent large traders from unfairly benefiting from information that is not available to ordinary investors. While much of this comes in the form of new disclosure proposals, the SEC enforcement arm is also part of the drive.

Block trades are a growing business for banks, with revenues from them in the US rising to $727.9mn in 2021 from $508mn in 2020, according to Dealogic data. Overall last year, there were $70.8bn worth of block trades, up from $41.4bn a year earlier.

With the trades, a bank is engaged to sell a large slug of shares in a company, either by the company itself or a major investor.

The bank guarantees the seller a discounted price on the stock and then aims to sell the shares at a higher price, pocketing the difference. To gauge market appetite, bank traders will speak with potential buyers, often hedge funds, sometimes sharing details of the trade under a non-disclosure agreement and other times using generic terms designed to mask the company involved. 

The practice of so-called “wall crossing” to talk with buyers is fraught with risks that other investors will begin to trade on the information, with a block of shares coming to market likely to weigh on a stock price.

Similar allegations have surfaced before on Wall Street: in 2005, brokers at Merrill Lynch and Lehman Brothers were accused of letting day traders eavesdrop on big market moving orders and profit by trading ahead of them. 

The convictions in the “squawk box” case — named for the internal intercom that the traders listened to — were ultimately overturned because the prosecutors withheld evidence, but the revelations contributed to a sense that financial professionals were stacking the deck against ordinary investors.