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NYSE Fines Firms for Trade-Ahead Audit Trail Violations

  • May 8, 2008
  • John Hintze

NYSE Regulation said Wednesday that it has fined a handful of Wall Street’s largest firms for not providing data about orders sent to and executed on the New York Stock Exchange floor. The information allows regulators to scan for brokers trading ahead of customers.

Bear Stearns, Citigroup Global Markets, Credit Suisse Securities, Goldman Sachs and Morgan Stanley each consented to censure and a $100,000 fine for allegedly failing to comply with NYSE Rule 123. On thousands of occasions, the firms “failed to provide certain required data needed to link the entry of orders with reports of execution in the Front End Systemic Capture (FESC) system,” according to the NYSE hearing board’s disciplinary decision.

While Rule 123 has been in place for several years, said NYSE Regulation chief of enforcement Robert Marchman, a March 2005 memo informed members about new requirements to address evolving technical issues. Another memo was issued in September 2006. “Firms were informed on at least two recent occasions about data requirements the exchange expected them to comply with,” Marchman said.

According to the decision, the regulator’s enforcement division on Nov. 26, 2006 notified Bear Stearns that it was investigating Rule 123 violations and followed up with correspondence and discussions. Nevertheless, NYSE says the firm continued to violate the rule through December 2007. “The violations resulted from systemic data-coding issues and were mostly attributable to the fact that the order management system Bear Stearns was using was not programmed in accordance with NYSE technical specifications,” says the decision.

Rule 123 was prompted by a long-running scheme by floor brokers at trading firm Oakford Corp. who allegedly held customer orders while they traded ahead of them. Eight brokers were charged in 1998 with making more than $11 million in illegal trading profits.

The FESC system was designed to provide an audit trail to prevent such manipulations, and detect when floor brokers execute orders without customer orders in position. “When an order is sent to the floor, it has to be entered into the FESC system and the execution time also has to be noted,” said Marchman.

NYSE Regulation began to investigate firms for Rule 123 violations after receiving referrals from the exchange’s division of market surveillance, said Marchman. Though he declined to say whether his division has received any more referrals, Marchman noted that because of the “significance of capturing this information to assist us in surveying the market, to prevent actions like trading ahead of customers, it’s not unusual for us to receive referrals from the market surveillance division in this area.”

While the fines are relatively small, regulators’ initial penalties are often intended to induce quicker industry compliance with a rule. Under Regulation SHO, for example, NYSE imposed fines ranging between $250,000 and $400,000 against several of the same large brokerages. An NYSE official said at the time that there was no finding of intent and described the penalties as a “warning shot to other brokers that shorting without locates will not be tolerated.” A year later, NYSE levied a $2.5 million penalty against Philadelphia-based Janney Montgomery Scott for Reg SHO violations, although some of its missteps were allegedly more egregious.

Marchman said a number of firms have already taken steps to comply with Rule 123 and, subject to the actions, have worked with the regulators to develop technology to ensure industrywide compliance. “A six-figure fine does send a message to the industry about the importance of firms adhering to their reporting obligations in the self-regulatory structure,” he said.

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