In settling this action, the NYSE consented, without admitting or denying the findings, to entry of an order imposing a censure and requiring the NYSE to cease and desist from future violations of the federal securities laws. The NYSE also agreed to several significant remedial measures designed to strengthen the NYSE' oversight of specialists and other floor members. The NYSE agreed to an undertaking of $20 million to fund regulatory audits of the NYSE' regulatory program every two years through the year 2011. The NYSE has also agreed to implement a pilot program for video and audio surveillance on its trading floor for at least an eighteen-month period.
Stephen M. Cutler, Director of the Commission' Division of Enforcement, said, "Self-Regulatory Organizations like the New York Stock Exchange have been a critical part of the regulatory landscape for almost a century now. When SROs don't vigorously police and prosecute wrongdoing in their markets, investors suffer. As our investigation continues, we will be focusing on individuals who may have fallen down on the job and contributed to the failure that resulted in the case we bring today."
Mark K. Schonfeld, Director of the Commission' Northeast Regional Office, added, "This settlement is about protecting investors. The relief we have obtained in this action will raise the bar for regulation at the NYSE and help prevent misconduct on the NYSE floor from going undetected again. The video and audio surveillance will help the NYSE keep a watchful eye on the specialists, and the regulatory auditor will keep a watchful eye on the NYSE's performance as a regulator."
Specifically, the Commission' Order finds that from 1999 through 2003, various NYSE specialists repeatedly engaged in unlawful proprietary trading, resulting in more than $158 million of customer harm. The improper trading took various forms, including "interpositioning" the firms' dealer accounts between customer orders and "trading ahead" for their dealer accounts in front of executable agency orders on the same side of the market. From 1999 through almost all of 2002, the NYSE failed to adequately monitor and police specialist trading activity, allowing the vast majority of this unlawful conduct to continue. The illegal trading went largely undetected because the NYSE' regulatory program was deficient in surveilling, investigating and disciplining the specialists' trading violations.
Specifically, the NYSE failed in 3 primary areas.
- The NYSE Failed to Adequately Surveil for Trading Ahead and Interpositioning Violations: The NYSE established and relied on an overbroad surveillance system for trading ahead, which captured only a small fraction of violations. Despite advice by the NYSE' internal audit group and other indications that the surveillance was inadequate to detect the full extent of trading ahead, the NYSE failed to make necessary adjustments to the surveillance parameters.
- The NYSE Failed to Adequately Investigate Trading Ahead and Interpositioning Violations: Although the NYSE' existing surveillance parameters were designed to capture only the most egregious instances of trading ahead and interpositioning, the surveillance unit responsible for reviewing the alerts routinely ignored scores of likely violations. When the surveillance unit made referrals to the NYSE' investigative unit, investigators failed to investigate the full extent of the misconduct.
- The NYSE Failed to Appropriately Discipline Trading Ahead and Interpositioning Violations: Despite compelling evidence of misconduct, the NYSE routinely failed to take disciplinary action or imposed only the most minor of sanctions.
The Commission' Order finds that the NYSE violated Section 19(g) of the Exchange Act by failing to enforce compliance with the federal securities laws and NYSE rules that prohibit unlawful proprietary trading by specialists – specifically, Section 11(b) of the Exchange Act, Rule 11b-1 thereunder, and NYSE Rules 92 and 104.10. Without admitting or denying the Commission' findings, the NYSE has agreed to a censure, an order to cease and desist from further violations of Section 19(g) of the Exchange Act, and to implement certain remedial undertakings, including:
- Retention of a Regulatory Auditor: The NYSE will set aside a $20 million reserve fund to retain a regulatory auditor to conduct audits of the NYSE' regulatory program every 2 years through 2011. The regulatory auditor will assess whether the NYSE' regulatory policies and procedures are reasonably designed and effective to detect and deter securities laws violations and whether the NYSE' regulatory group is in compliance with its policies and procedures.
- Implementation of a Pilot Audio and Video Surveillance System: The pilot program will be conducted over an eighteen month period and involve at least 20 NYSE stocks. Following an independent evaluation of the pilot program, the Commission will determine whether to modify, eliminate, or expand the program to the entire NYSE trading floor.
Other significant undertakings include: (i) systems and procedures to track the identity of specialists and clerks trading on the NYSE floor; (ii) enhancements to the NYSE' electronic trading systems to prevent specialists from engaging in trading ahead and interpositioning; (iii) enhancements to the NYSE' referral process and the training of its regulatory staff; and (iv) certification by the NYSE' Chief Regulatory Officer every year for a period of 5 years that the NYSE is in compliance with the Commission' Order.
This failure by the NYSE to police trading ahead and interpositioning by specialists follows on the heels of a regulatory failure by the NYSE in the late 1990s involving independent floor brokers, which was addressed by the Commission in an order against the NYSE in June 1999. See In the Matter of New York Stock Exchange, Inc., Release No. 34-41574 (June 29, 1999).
The Commission has previously brought settled enforcement actions against all seven specialist firms responsible for the unlawful proprietary trading at issue in this case. See In the Matter of Bear Wagner Specialists LLC, Rel. No. 34-49498 (March 30, 2004); In the Matter of Fleet Specialist, Inc., Rel. No. 34-49499 (March 30, 2004); In the Matter of LaBranche & Co. LLC, Rel. No. 34-49500 (March 30, 2004); In the Matter of Spear, Leeds & Kellogg Specialists LLC, Rel. No. 34-49501 (March 30, 2004); In the Matter of Van der Moolen Specialists USA, LLC, Rel. No. 34-49502 (March 30, 2004); In the Matter of SIG Specialists, Inc., Rel. No. 34-50076 (July 26, 2004); In the Matter of Performance Specialist Group LLC, Rel. No. 34-50075 (July 26, 2004).
The Commission' investigation of individual misconduct as it relates to the NYSE' failures to police specialists is continuing.
