The unit, known internally as process driven trading, will be named PDT Advisers and will be run by Morgan Stanley's proprietary trading chief, Peter Muller.
PDT Advisers will include 60 employees from Morgan Stanley's global proprietary trading business. During a two-year transition period, it will continue to manage Morgan Stanley's proprietary trading and will expand its business to include third-party investors.
The spin-off is part of a continuing push by U.S. banks to comply with the so-called Volcker Rule, a provision of the financial reform legislation passed last July that bars banks from trading and making market bets with their own capital, known as proprietary trading.
The rule is named for former Federal Reserve Chairman Paul Volcker, a key adviser to President Barack Obama who suggested banks be barred from such trading.
The move is the second major spin-off by Morgan Stanley because of the Volcker Rule. In October, the New York-based investment bank announced plans to sell hedge fund FrontPoint back to its portfolio managers.
The FrontPoint sale came just four years after the bank paid $400 million to acquire the firm, co-founded by Morgan Stanley's former chief financial officer, Phil Duff.
A bank spokesman was not immediately available for comment on the plans for the proprietary trading unit.
Morgan Stanley shares were down 1.2 percent to $27.86 in midday trading on the New York Stock Exchange.
(Reporting by Joe Rauch; editing by John Wallace)
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