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SEC Charges iCapital Markets LLC, Successor To Datek Securities, With Securities Fraud - Firm Will Pay $6.3 Million Penalty To Settle Charges

Date 24/01/2002

The Securities and Exchange Commission today charged iCapital Markets LLC, formerly Datek Securities Corp., with securities fraud and widespread violations of the Commission's broker-dealer books and records and reporting provisions. The Commission censured the firm and ordered iCapital to pay a $6.3 million penalty. iCapital consented to the issuance of the order without admitting or denying the findings contained in it, and to the relief imposed.

The Commission found that from at least 1993 through March 1998, when it sold its day-trading business, Datek Securities engaged in a widespread fraudulent scheme by illegally executing proprietary trades through the Nasdaq Stock Market's Small Order Execution System (SOES). The SOES system was designed for small public customers, and until last year, a broker-dealer was prohibited from using the SOES system to trade for its own account. The SOES system was the only Nasdaq trading system that offered automatic execution at the best available price.

"Today's tough action by the Commission underscores the obligations of a broker-dealer to speak truthfully to the securities markets and to regulators," said William R. Baker III, Associate Director of the Division of Enforcement.

By hiding its use of the SOES system for proprietary trading, Datek Securities obtained SOES automatic execution which, combined with Datek Securities' day-trading software, gave it a significant advantage. The Commission found that Datek Securities fraudulently used the SOES system to execute millions of proprietary trades, resulting in tens of millions of dollars in trading profits. Datek Securities accomplished the fraud through the use of sophisticated software, dozens of nominee accounts, concealment and misrepresentations to regulators, fictitious books and records, and false reports filed with the Commission.

The Commission's order finds that:

  • From at least 1993 through March 1998, Datek Securities' New York City branch, the profit center for the entire firm, operated as a day-trading firm. Unlike other day-trading firms that provide services for customers who trade for their own accounts, Datek Securities traders traded for firm proprietary accounts. Datek Securities' volume of proprietary trading through SOES was enormous: from 1995 through March 1998, Datek Securities trades constituted over 30 percent of all SOES trades.
  • To hide its proprietary trading, Datek Securities set up nominee accounts and paid the nominees for the use of their identities and complete discretionary trading. Initially, nominees provided their own funds to set up the accounts, and Datek Securities promised to pay them a fixed rate of return.
  • In 1997 undisclosed principals of the firm began funding nominee accounts with profits from the illegal SOES scheme. Between May 1997 and March 1998, the undisclosed principals capitalized over 125 nominee accounts with a total of at least $50 million. Nominees received payments from Datek Securities for the use of their identities.
  • In 1995 and 1996, Datek Securities distributed over $200 million to undisclosed principals of the firm. Datek falsely recorded and reported the distribution of trading profits, which were made to companies owned by the principals, as expenses for "computer services."
The Commission found that, from at least 1993 through March 1998, Datek Securities willfully violated:
  • The antifraud provisions, Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) and Rule 10b-5 thereunder, by devising and implementing the fraudulent scheme to gain access to and use the SOES system for proprietary trading;
  • Broker-dealer record-keeping provisions, Section 17(a) of the Exchange Act and Rules 17a-3(a)(1), 17a-3(a)(2), 17a-3(a)(3), 17a-3(a)(7), 17a-3(a)(9), and 17a-3(a)(12), by creating and maintaining false books and records that allocated proprietary trades to nominee accounts, recorded trades as customer trades, failed to reflect the true beneficial owner of the nominee accounts, improperly recorded the distribution of trading profits, and failed to maintain accurate forms relating to its traders;
  • Broker-dealer reporting provisions, Section 17(a)(1) of the Exchange Act and Rules 17a-5(a) and (d), by filing FOCUS reports and annual audited financial statements that were inaccurate as a result of the systematic allocation of trades and the improper classification of the distribution of trading profits;
  • Broker-dealer reporting provisions, Section 15(b) of the Exchange Act and Rule 15b3-1, by filing Forms BD and amendments to these forms that concealed and failed to disclose the control persons of the firm; and
  • Broker-dealer provisions, Section 15(b) and Rule 15b7-1, by permitting unregistered traders to purchase and sell securities, and by employing supervisors who never passed the requisite supervisory examinations, or who supervised Datek Securities employees even after they were no longer officially registered with Datek Securities.
The Commission's order finds that in February 1998, Datek Securities reorganized under a holding company (the Company). On March 30, 1998, Datek Securities sold the assets of its day-trading business to Heartland Securities Corp. In the years following this sale, the Company hired new managers and other industry professionals without prior ties to Datek Securities. It also undertook to eliminate control and reduce ownership of certain shareholders in the Company. In determining to accept iCapital's offer of settlement, the Commission considered remedial acts undertaken by iCapital, and the Company's new management and investors, and cooperation afforded the staff.

The Commission's investigation as to others is continuing.