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.
Analysts said while Morgan Stanley will lose the proprietary trading units' lucrative returns, the arrangement of PDT Advisers' spin off will minimize the impact.
"This won't be a parent-child relationship anymore, but it might be a sibling relationship," said Brad Hintz, analyst at Sanford C. Bernstein & Co LLC.
Hintz said the new firm is likely to continue a close business relationship with the former parent.
"Morgan Stanley's a loser in this deal, but not a 100 per cent loser," he said.
A bank spokesman was not immediately available for comment on the plans for the proprietary trading unit.
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.
Morgan Stanley's move is its second major divestiture 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.
Morgan Stanley shares were down one per cent to $27.93 in afternoon trading on the New York Stock Exchange.