The execution reports, published monthly, provide data that must be made public under Securities and Exchange Commission (SEC) rules. INET's and Instinet's flawed reports compromised the ability of the investing public and other market participants to accurately assess execution quality and compare venues for execution. The inaccurate reports published by the firms involved as much as 30 percent of Nasdaq executions.
Of the $1.475 million in sanctions imposed on Instinet and INET, $700,000 is for publication of inaccurate reports on order execution quality in violation of SEC Rule 11Ac1-5 and related supervisory violations, and $775,000 is for wide-ranging market violations, including failure to honor posted quotes and inaccurately reporting millions of orders and trades.
NASD found that from the time SEC Rule 11Ac1-5 took effect in June 2001 through August 2004, Instinet and Island (later INET), published execution reports that contained numerous errors. These errors included the misclassification of shares, miscounting of cancelled shares, improper exclusion of orders, improper calculations based on erroneous times, improper categorizing of orders, inaccurate order execution information, incorrect calculation of spreads and other incorrect calculations. The effect of the erroneous reports varied. In certain instances, the reporting errors resulted in execution quality statistics being reported in a worse light than was actually the case.
NASD's investigation showed that these errors resulted from the entities' heavy reliance on automated systems to comply with the publication requirements of SEC Rule 11Ac1-5 without adequately testing those systems, their failure to adequately respond to the repeated findings of errors in the published reports, and their failure to implement adequate supervisory systems.
"A firm's duty to supervise automated systems is every bit as important as its duty to supervise employees," said NASD Vice Chairman Mary L. Schapiro. "When critical tasks are automated, firms must verify that the automation functions as intended. These firms' failure to meet that responsibility seriously compromised market participants' access to reliable information crucial for making informed trading decisions."
NASD found that supervision at Instinet, Island and INET was deficient. For years, the firms failed to designate a registered principal to supervise for compliance with SEC Rule 11Ac1-5, and the firms failed to allocate sufficient resources to supervision. Despite notification by NASD and others of errors in the firms' published reports, the firms did not undertake supervisory reviews.
NASD also found that Instinet submitted over 193 million inaccurate reports to the Order Audit Trail System ("OATS") from April 2002 through September 2002. Additionally, Instinet failed to report millions of orders to NASD's Alternative Display Facility (ADF) and also inaccurately reported millions of transactions to ADF. NASD found that INET engaged in OATS, ACT reporting, trade reporting and trading halt violations. The reporting violations adversely impacted NASD's ability to conduct effective market surveillance, since regulators rely on the integrity of the information. Both INET and Instinet failed to implement effective supervisory systems and written supervisory procedures designed to detect and prevent these violations.
As part of the settlement announced today, INET and Instinet agreed to obtain an independent regulatory auditor to conduct a comprehensive audit of their compliance with SEC Rule 11Ac1-5 during 2006. INET and Instinet were also ordered to revise their written supervisory procedures within 45 days.
In settling this matter, the firms neither admitted nor denied the charges, but consented to the entry of NASD's findings.
Separately, the SEC settled with Instinet and INET for $700,000 for the violations of SEC Rule 11Ac1-5 as part of a parallel investigation.
Investors can obtain more information about, and the disciplinary record of, any NASD-registered broker or brokerage firm by using NASD's BrokerCheck. NASD makes BrokerCheck available at no charge to the public. In 2004, members of the public used this service to conduct more than 3.8 million searches and request almost 190,000 reports for existing brokers or firms. Investors can link directly to BrokerCheck at www.nasdbrokercheck.com . Investors can also access this service by calling 1-800-289-9999.
NASD is the leading private-sector provider of financial regulatory services, dedicated to investor protection and market integrity through effective and efficient regulation and complementary compliance and technology-based services. NASD touches virtually every aspect of the securities business - from registering and educating all industry participants, to examining securities firms, enforcing both NASD rules and the federal securities laws, and administering the largest dispute resolution forum for investors and member firms. For more information, please visit our Web site at www.nasd.com.
("Copyright 2005 National Association of Securities Dealers, Inc.")
