The Securities and Exchange Commission has instituted administrative and cease-and-desist proceedings against 20 former New York Stock Exchange specialists on charges of securities fraud and other improper trading practices.
According to regulators, between 1999 and mid-2003, the traders pervasively executed proprietary orders for their firms ahead of the orders of public customers or agencies placed through the NYSE's electronic system. The SEC has come to a $20 million settlement with the big board for its oversight in policing the alleged wrongdoing.
"These individuals violated the public trust by abusing the privileged position that had as specialists on the New York Stock Exchange," said Stephen M. Cutler, director of the Commission's Division of Enforcement, in a statement. "We have zero tolerance for specialists who trade for their firm's proprietary accounts when they should be trading for the accounts of their customers."
In related news, federal prosecutors have filed charges against 15 of the former specialists, accusing them of putting their firm's interests ahead of the general public and costing those investors $19 million.
"Over time, these small thefts accumulate into large profits that translate into higher compensation and bonuses for specialists who execute the trades," said David Kelley, a U.S. attorney for the Southern District of New York. The joint investigation is ongoing, officials said.
The fraudulent conduct alleged by the SEC took at least two forms: "interpositioning" and "trading ahead." In the first form, SEC officials said, the specialists interpositioned their firms' proprietary accounts between two customer orders by trading into both customer orders in succession. For example, a specialist would buy into a customer sell order first, and then sell, at a higher price, into the opposite market buy order. In doing so, they were able to make guaranteed, riskless profits for their firms' proprietary accounts at the expense of customer orders.
In the second form, the specialist would fill one agency order through a proprietary trade for their firm's proprietary account and in doing so improperly "step in front" of, or trade ahead of, the other agency order. By trading ahead, the specialist locked in a better price for the proprietary trade, and then later filled the agency order at an inferior price, thus disadvantaging the agency order, the SEC said. Thousands of such trades were conducted, regulators said, causing customer losses in the millions of dollars.
The SEC also charges several of the specialists with "particularly egregious conduct." For example, in several instances of interpositioning, the specialists not only disadvantaged both a buy and a sell order, but also moved the price up or down from the last sale price to further advantage their firm's proprietary account. In other instances, several of the specialists punctuated their improper trading with profane statements against the NYSE's electronic service, "as they were in fact disadvantaging agency orders," SEC officials said.
Former specialists charged by the SEC include David A. Finnerty, Donald R. Foley II, Scott G. Hunt, and Thomas J. Murphy, of Fleet Specialists, a Bank of America unit; Kevin M. Fee and Frank A. Delaney IV of Bear Wagner, a division of Bear Stearns; Freddy DeBoer of LaBranche & Co.; Todd J. Christie, James V. Parolisi, Robert W. Luckow, Patrick E. Murphy, and Robert A. Johnson Jr. of Spear Leeds, which is part of Goldman Sachs; and Patrick J. McGagh Jr., Joseph Bongiorno, Richard P. Volpe, Michael F. Stern, Warren E. Turk, Gerard T. Hayes, and Robert A. Scavone of Van der Moolan Specialists USA.
The action from the U.S. Attorney's office and the SEC comes on the heels of $247 million civil settlement against the NYSE and its specialist firms last year.
The Specialist Association, a trade group for floor traders, downplayed the significance of the malfeasance in statement to Reuters. In a statement, the group said that while regrettable, the trades accounted for less than 1% of all trading activity. If convicted on the U.S. Attorney's allegations, 15 of the 20 specialists could face upwards of 20 years in jail and $5 million in fines.