"14 Trading Firms Settle Charges for $69 Million
More than a dozen Wall Street trading firms systematically cheated their customers of millions of dollars by improperly slicing bits of profit from countless trades, federal regulators said on Wednesday.
The Securities and Exchange Commission disclosed the allegations after negotiating settlements. The firms did not admit or deny the charges but agreed to pay a total of more than $69 million in forfeited profits and penalties.
The 14 firms named in the complaints are all “specialists,” trading firms that have a specific duty to maintain orderly markets by matching buyers and sellers and standing ready to conduct trades when buyers or sellers are scarce. They include units or subsidiaries of well-known Wall Street names, including E*Trade Capital Markets, Goldman Sachs Execution and Clearing, Knight Financial Products and TD Options.
Regulators said the firms had engaged in various types of “front-running,” which involves trading ahead of customer orders or timing their own trades to seize profits. For instance, specialists that had a big order to buy a stock would first buy it from a seller themselves and then illegally bid up the price moments before selling it to profit on the transaction.
Regulators say specialist firms made a total of $58.4 million, which should have gone to their customers.
According to the S.E.C., the improper trading occurred from 1999 to 2005 on the American Stock Exchange, the Chicago Board Options Exchange, the Philadelphia Stock Exchange and the Chicago Stock Exchange.
In recent years, many customer orders have been routed to electronic trading networks, which automatically match buy and sell orders without human intervention. But specialist firms still play a role in securities trading at many exchanges, handling orders that cannot be filled electronically and maintaining reliable markets when trading becomes volatile.
The specialist business is lucrative because it has exclusive rights to oversee trades in particular stocks, and it was especially so before more automated trading became prevalent in the middle of the decade.
Firms are compensated for the risks and duties they take on as specialists, which makes the violations cited by the agency more shocking, said James Clarkson, acting director of the S.E.C.’s New York regional office.
“These firms violated the public trust by abusing the privileged position they had as specialists on the various exchanges,” Mr. Clarkson said.
Although smaller in scale, the allegations are similar in nature to those the commission filed in 2004 against five large specialist firms on the New York Stock Exchange, accusing them of collecting more than $150 million in improper profits. Those firms, without admitting or denying the allegations, paid $241.8 million to settle the cases.
In the individual complaints made public on Wednesday, the S.E.C. said that the improper profits collected by the 14 specialist firms had ranged from a few million dollars at some of the smaller organizations to more than $28 million at E*Trade.
E*Trade was one of six firms that settled cases that the agency had filed in federal court in Manhattan. Others named in those court cases, which all involved trading on the Chicago Stock Exchange, were Automated Trading Desk Specialists, now owned by Citigroup Derivatives Markets; Melvin & Company and its subsidiary, Melvin Specialists, which has been dissolved; Sydan LP; and TradeLink. Improper profits in those cases totaled $35.7 million, the S.E.C. said.
In those cases, the agreements are still subject to final approval by the court, said David Rosenfeld, the associate director in the S.E.C.’s New York office.
Lawyers for E*Trade, Automated Trading Desk, the Melvin units and Sydan did not respond to messages left at their offices on Wednesday. Lloyd Kadish of TradeLink declined to comment on the case.
The other eight of the 14 firms settled administrative “cease and desist” complaints, rather than formal court cases. They included Knight Financial Products, which sold its specialist operations to Citigroup in December 2004. A spokesman for Knight said that the firm “has previously disclosed this matter in its regulatory filings.”
The other firms settling administrative complaints were Goldman Sachs Execution and Clearing and SLK-Hull Derivatives, both owned by Goldman Sachs; TD Options; Botta Capital Management; Equitec Proprietary Markets; Group One Trading; and Susquehanna Investment Group.
Lawyers for the Goldman Sachs units, TD Options, Equitec and Group One did not respond to messages left at their offices on Wednesday. Eric Noll, with Susquehanna, and Mark Borelli, with Botta, both declined to comment on the settlements.
The trading involved in those administrative complaints occurred on the American Stock Exchange, the Chicago Board Options Exchange and the Philadelphia Stock Exchange, the S.E.C. said. Improper profits in those eight cases totaled $22.7 million, the S.E.C. said.
In addition, the agency assessed a total of $11 million in penalties against all 14 firms.
In bringing the charges, the S.E.C. said that specialist firms had an obligation to put orders from public customers ahead of their proprietary interests. Whenever possible, a specialist firm should fill a customer’s order to buy shares by matching it with another customer’s order to sell, giving those customers the best possible price.
According to regulators, the improper trading activity was detected through examinations by the S.E.C.’s compliance staff and investigated by its enforcement division, with the cooperation of the Financial Industry Regulatory Authority, the securities industry’s self-regulatory organization, and compliance staff members at the various exchanges."