15 Specialists from Big Board are Indicted
By Jenny Anderson
The New York Times
Federal prosecutors announced the indictment yesterday of 15 former New York Stock Exchange floor traders, who are charged with cheating customers by mishandling trades to enrich their firms.
The Securities and Exchange Commission also filed securities fraud complaints against the 15 and against 5 other traders, saying they had made thousands of illicit trades from 1999 through 2003. The 20 were specialists - traders on the floor of the exchange who manage activity in particular stocks. The Big Board also settled S.E.C. accusations that it failed to regulate its traders properly.
The joint enforcement action is another black eye for the New York Stock Exchange, which has had scandals in recent years, and comes at a pivotal moment in the exchange's evolution. While the S.E.C. recently endorsed its floor-based system as part of an overhaul of how stocks are traded in the United States, the Big Board was still forced to make some radical changes. A hybrid system allows more electronic trading while maintaining the core floor-based operations.
But a backbone of the New York Stock Exchange is the specialist, a trader who has the obligation to create an orderly market in the stocks he or she supervises.
Critics of the system, often proponents of purely electronic markets, say the human element slows the process, creates conflicts of interest - all the traders buy and sell for their company's account as well as for customer accounts - and is unnecessary, given the technology that is available.
Defenders of the exchange say that because of the large volume of stock that is traded there, it offers better prices with fewer fluctuations while providing the opportunity for human judgment when such judgment is needed. About 1.6 billion shares a day, worth $56 billion, are currently traded on the Big Board.
At its heart, the case again raises the question of whether self-regulatory organizations like the New York Stock Exchange can successfully police themselves. Yesterday's indictments represented the second big floor-trading scandal in recent years. In 1999, the S.E.C. found that the Big Board failed to uncover and halt illegal proprietary trading by a ring of independent floor brokers.
While the Big Board uncovered the original instances of improper trading in this latest case, it failed to follow through, leading to S.E.C. supervision of the investigation. Last year, the S.E.C. brought enforcement actions against seven specialist firms. The firms paid more than $243 million without admitting wrongdoing. The S.E.C. is considering whether to change the self-regulatory model.
Federal regulators say the specialists engaged in two illegal trading schemes: using knowledge of a trade to deal in front of it, and "interpositioning," which occurs when a specialist intervenes in a trade rather than matching buy and sell orders.
The 15 specialists indicted, all but two of whom have left their firms, were members of the New York Stock Exchange's five major specialist trading companies. They are accused of making illegal trading profits from interpositioning of $13.4 million and costing investors more than $19 million from trading for their firms' accounts ahead of customers.
In some instances where, prosecutors said, the traders were cheating customers, they referred to the exchange's electronic order system with an obscenity. Mark Schonfeld, director of the S.E.C.'s Northeast Region office, said the specialists' disregard for their obligations was "profound, and at times profane."
In one case, at 9:41 a.m. on Oct. 2, 2002, the computer of a specialist in General Electric stock indicated that at a price of $25.85, there were orders to buy 39,500 shares and orders to sell 35,000 shares. The specialist, David A. Finnerty of Fleet Specialist, should have matched the 35,000, prosecutors say. Instead he bought 22,700 shares for Fleet's own account at $25.85, then raised the price to $25.95. Just after 9:42, he sold 12,800 shares from the same account, making $1,280 in about 14 seconds.
Regulators say he made $4.3 million in illegal profit and caused $5 million in customer harm.
But Mr. Finnerty's lawyer, Frederick P. Hafetz, said of his client: "His conduct was consistent with his obligations to the New York Stock Exchange. He is fully confident that he will be vindicated at trial."
David N. Kelley, the United States attorney in Manhattan, said at a news conference that the specialists put "their own interests and the interests of their firms before the interests of the unwitting investors."
"Over time," Mr. Kelley continued, "these small thefts accumulate into large profits that translate into higher compensation and bonuses for specialists who execute the trades." He added that the investigation was continuing and that other indictments could follow.
If convicted, the accused face prison terms as long as 10 to 20 years and fines of $1 million to $5 million, or twice the gross gain or loss resulting from the improper trades, prosecutors said.
Fourteen traders who were indicted have been arrested (the 15th is thought to be in the Netherlands.) All 14 pleaded not guilty late yesterday.
As part of its settlement with the S.E.C., the stock exchange agreed to finance an outside monitor to conduct audits of its regulatory program every two years through 2011. In addition, it will set up a pilot program of video and audio surveillance on its trading floor for at least 18 months in a group of 20 highly liquid stocks.
The Big Board had instituted a number of measures to curb abuse. In December 2003, it created a chief regulatory officer and formally separated its regulatory arm from the business side. Regulatory management has been almost entirely replaced, and the size of the group has increased markedly. A specialist surveillance unit and a risk assessment unit have been created.
The 15 people indicted yesterday include, in addition to Mr. Finnerty, Donald R. Foley II, Scott G. Hunt and Thomas J. Murphy Jr., all former employees of Fleet Specialist, now part of Bank of America; Kevin M. Fee, former specialist at Bear Wagner; Freddy DeBoer, a former Labranche & Company specialist; Robert A. Johnson, of Spear, Leeds Kellogg Specialists; and Patrick J. McGagh, Joseph Bongiorno, Michael J. Hayward, Richard P. Volpe, Michael F. Stern, Gerard T. Hayes and Robert A. Scavone, of Van der Moolen Specialists USA.
At the arraignment yesterday, Barry H. Berke, who represents Mr. Bongiorno, called the charges "an unprecedented attempt to transform industrywide issues into a criminal case" against individuals.
The S.E.C.'s case names five other specialists. They include two former Spear Leeds chiefs, Todd Christie and Robert Lucklow. Neither continues to work at Goldman Sachs, which acquired Spear, Leeds in 2000. James Parolisi and Patrick E. Murphy also worked at Spear Leeds.
"Patrick Murphy has long enjoyed a sterling reputation for his skill and his integrity as a specialist at the N.Y.S.E.," Mr. Murphy's lawyer, Robert F. Katzberg, said.Robert J Giuffra Jr., a lawyer for Van der Moolen, said, "Van der Moolen specialists continue to cooperate with all government investigations, and the N.Y.S.E. and has taken remedial steps to put these past matters behind the firm."
Representatives of the other firms declined to comment.
In calls to homes of 12 of the 15 former executives, either the executives refused to comment or the calls were not returned. Thomas Murphy, Mr. DeBoer and Mr. Volpe could not be reached.
**This article has been edited in part since its original publication in the Wall Street Journal.