WASHINGTON — The Financial Industry Regulatory Authority has fined Morgan Stanley $1 million and ordered it to pay $371,476 in restitution to customers for excessive markups and markdowns on municipal and corporate bonds.

FINRA said that it found markups and markdowns ranging from below 5% to 13.8%, which it said were higher than warranted taking into account various factors, including market conditions, the cost of executing the transactions, and the value of the services rendered to the customers.

The case is noteworthy in that it makes clear FINRA does not regard 5% as a bright line between reasonable and excessive markups and markdowns. For years, dealers have sought a bright line test on pricing, but the self-regulator has refused to provide one, insisting that each markup and markdown should be considered on a case-by-case basis, weighing a number of factors, including a firm's right to make a profit.

FINRA also found that Morgan Stanley's supervisory system for bond markups and markdowns was inadequate because it did not track them if they were below 5%, even if they were excessive. Also, the firm did not properly calculate the markups and markdowns, it said.

The self-regulator ordered the firm to revise its written supervisory procedures for reviewing markups and markdowns in fixed-income transactions.

"Firms must ensure that customers who buy and sell securities, including corporate and municipal bonds, receive fair and reasonable prices regardless of whether a markup or markdown is above or below 5%," Thomas Gira, FINRA's executive vice president for market regulation, said in a release.

Morgan Stanley neither admitted nor denied the charges, but consented to the publishing of FINRA's findings.

A spokesperson for the firm said, "Morgan Stanley Smith Barney cooperated fully with FINRA and is pleased to settle this matter. The trades in question represent a tiny fraction of the millions of trades executed for clients during the time period, and we are continuing to improve our control processes governing pricing."

FINRA examiners looked at Morgan Stanley's pricing of muni transactions during the first and fourth quarters of 2007, the third quarter of 2008, the second quarter of 2009, and the first and third quarters of 2010. It reviewed the firm's supervisory system from the beginning of 2003 through at least the end of 2010.

The self-regulator said that during that time, it found excessive markups and markdowns on 193 pairs of municipal bond transactions ranging from 3.01% to 8.48%. These violated the Municipal Securities Rulemaking Board's Rule G-17 on fair dealing and Rule G-30 on prices and commissions, FINRA said.

The inadequacies in the firm's supervisory system violated Rules G-17 on fair-dealing and G-27 on supervision, FINRA said.

Besides excluding certain transactions from review, the firm's policies and procedures failed to "identify markups and markdowns by aggregating the sales credit charged to the customer with the wholesale desk compensation for purposes of determining whether a markup or markdown was excessive," the self regulator said.

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