In a joint investigation, the NYSE and SEC found that, between 1999 and 2003, the two firms, through particular transactions by certain of their registered specialists, violated federal securities laws and Exchange rules by executing orders for their dealer accounts ahead of executable public customer or "agency" orders. Through these transactions, the firms violated their basic obligation to match executable public customer buy and sell orders and not to fill customer orders through trades from the firm's own account when those customer orders could be matched with other customer orders. Through this conduct, the firms improperly profited from trading opportunities; disadvantaged customer orders, which either received inferior prices or went unexecuted altogether; and breached their duty to serve as agents to public customer orders. In the settlements, the firms have neither admitted nor denied the findings.
The settlement provides that the firms' $5.2 million payment will go to a Distribution Fund for the benefit of injured customers. This includes the $1.7 million in civil money penalties, which, under the Sarbanes-Oxley Act of 2002, may be distributed to victims in SEC enforcement actions. The firms also will consent to charges that they (a) willfully violated Exchange Act Section 11(b) and Rule 11b-1 by failing to maintain a fair and orderly market through their improper proprietary trading; (b) violated various NYSE rules; and (c) in certain interpositioning transactions involving six stocks at each firm, failed adequately to supervise certain of their individual specialists, who themselves engaged in fraud through that proprietary trading in violation of Exchange Act Section 10(b) and Rule 10b-5.
The NYSE and SEC found that the improper proprietary trading took various forms. Sometimes, certain of the firms' specialists "interpositioned" the firms' dealer accounts between customer orders by trading into both of them in succession - for example, buying into a customer market sell order first, and then selling, at a higher price, into the opposite market buy order, thus allowing the firm dealer account to profit from the spread. The regulators also found that the specialists traded for their dealer accounts ahead of executable agency orders on the same side of the market, orders that were executed later at prices inferior to the prices of dealer account trades. At other times, the specialists traded ahead of marketable limit orders, which then went unexecuted and ultimately were cancelled by the customers entering the orders.
The NYSE and SEC found that the interpositioning transactions, in particular, were heavily concentrated in a few stocks overseen by a small number of specialists at each firm. With certain interpositioning transactions in six stocks at each firm, the NYSE and SEC found that certain unnamed individual specialists engaged in fraud by violating their implied representations to public customers that they were limiting dealer transactions to those "reasonably necessary to maintain a fair and orderly market." Neither of the specialist firms, according the findings, had in place reasonable systems or procedures to monitor, detect, or prevent those violations.
The investigation is continuing. The NYSE and SEC will continue to coordinate in the investigation of individual responsibility for the violative conduct that is the subject of the enforcement actions announced today.
