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15 Big Board Floor Traders Indicted on Fraud Charges

Times Staff Writer

NEW YORK -- The federal government indicted 15 current and former New York Stock Exchange traders Tuesday for allegedly cheating investors, and penalized the exchange itself for failing to crack down on the alleged wrongdoing.

The U.S. attorney’s office brought criminal securities fraud charges accusing the traders of enriching themselves at the expense of their customers. The indictment cited $32.5 million in illegal trading profits and losses to customers in connection with the charges, but authorities said total losses to customers from 1999 to early 2003 exceeded $158 million.

The traders were all registered specialists at the NYSE. Specialists work among the throng of traders wearing colorful jackets on the exchange floor, matching buy and sell orders for specific stocks. When there is an imbalance, they buy or sell shares using their firm’s own account to ensure an orderly market and to prevent wild price swings.

Authorities allege that the specialists stepped in and traded for their own accounts when there were customer orders to be executed -- giving the specialists a risk-free profit on the spread between the buy and sell prices, and leaving customer orders to be traded at an inferior price.

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In a parallel action, the NYSE agreed to a settlement with the Securities and Exchange Commission that requires the Big Board to strengthen its oversight of the trading floor, including spending $20 million for outside audits every two years through 2011.

In addition, the NYSE has agreed to an 18-month pilot program for video and audio surveillance of floor trading in at least 20 stocks. At the end of the trial period, the exchange will consider expanding surveillance to all stocks.

The SEC also brought civil charges against the 15 specialists who were charged criminally, plus five other specialists.

The episode is a black eye for the Big Board, which is working to restore its reputation after public outrage over the $139.5-million pay package of Richard Grasso, its former chairman.

The SEC said the NYSE “routinely ignored scores of likely violations.” After it did find problems, the exchange “routinely failed to take disciplinary action or imposed only the most minor of sanctions,” the SEC said.

“When they found it, they didn’t investigate it -- and when they investigated it, they didn’t punish it,” said Mark Schonfeld, head of the SEC’s New York office.

Richard Ketchum, head of the NYSE’s regulatory unit, acknowledged in an interview that the exchange wasn’t as effective as it should have been.

“We take this settlement very seriously,” Ketchum said. “We are determined as an organization never to be in this position again.”

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The NYSE has overhauled its regulatory functions since the trading abuses were first disclosed in 2003.

After Grasso was ousted in the flap over his pay, the exchange divided itself into a market unit headed by John Thain and a regulatory unit overseen by Ketchum. Ketchum has beefed up staff and technology, and installed new chiefs of market surveillance and enforcement.

The charges grew out of a civil settlement last year in which major NYSE trading firms agreed to pay $247 million to resolve investigations that their traders routinely cheated customers.

In Tuesday’s action, regulators accused the traders of two types of improper activity -- “interpositioning” and “trading ahead.”

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Interpositioning occurs when a specialist ignores customer orders to make his own trade, such as buying shares from a seller and then selling those same shares to a buyer at a higher price.

In trading ahead, specialists with knowledge of pending customer orders take positions in the stock before executing their customers’ orders. Specialists get a price advantage, authorities say, and customers get stuck with higher costs.

Dave Humphreville, president of the Specialist Assn., noted that the suspect trading represented well under 1% of total trading activity over the four-year period.

“We regret any inappropriate behavior on the part of specialists,” Humphreville said. “We believe it was very limited in nature.”

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The abuses occurred during Grasso’s tenure as chairman. Grasso spokesman Eric Starkman defended the former chairman, noting that “it was under Dick Grasso’s leadership that the investigation into the floor traders began.”

But others questioned Grasso’s commitment to rooting out rogue traders.

“His concern was the exchange’s competitors,” said John Coffee, a Columbia University law professor. “And aggressive enforcement could backfire by creating a politically embarrassing scandal that could erode the exchange’s reputation.”

Four traders -- David Finnerty, Donald R. Foley II, Frank A. Delaney IV and Thomas J. Murphy Jr. -- pleaded not guilty to securities-fraud charges in federal court and were released on bail. Ten others were awaiting arraignment, while the 15th was believed to be in Europe. If convicted, they each face up to 20 years in prison and fines of up to $5 million.

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Finnerty’s attorney said his client had “done nothing wrong.” Lawyers for Foley, Delaney and Murphy declined to comment.

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Associated Press was used in compiling this report.


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