The NYSE investigation regarding specialist firms that is the source of the dispute between the NYSE and LaBranche is in the news again. The WSJ reports (subscription required) that Fleet Specialist has settled a NYSE disciplinary matter by consenting to accept a censure and a fine of $150,000. One of Fleet's former individual specialist traders also settled for a fine of $25,000. The action arose in part for failure, on one or more occasions between July 2001 and September 2002, to immediately bid or offer customer orders that would have improved the market in GM stock.
The NYSE found that Fleet's individual specialists relied excessively on "quote assist," an automated feature in the order book that publishes within 30 seconds of receipt any quotes that better the current bid or offer. The NYSE noted that the specialist still has an obligation to manually quote the better bid or offer.
The NFA has announced that it is in the process of developing guidelines to assist CTAs in complying with a newly-adopted CFTC rule for disclosing past performance in notional accounts (accounts which are not fully-funded, but which are traded as though fully-funded). New Rule 4.35(a)(7) is great, requiring only that performance in notional accounts be presented in a balanced manner and not violate anti-fraud requirements. This is a huge step forward from the previous rules and interps, which really did micro-manage how such performance could be presented. NFA guidelines tend to be pretty well done and hopefully the coming guidelines regarding notional accounts will not just outline restrictions and diktats regarding performance presentation but will instead describe what "balanced" means (or could mean) under a variety of different scenarios.
Reuters reports that First Options of Chicago, a CBOE clearing firm, is being sued for $70 million by investors in a hedge fund. The fund, Strategic Income Fund LLC, was run by Edward Jung, who was a CBOE market maker. Jung had a personal market maker account in addition to running the fund account and, after large losses, apparently freely moved transactions and funds between the accounts. Jung has been the subject of disciplinary action by the CBOE, the SEC and was recently criminally indicted.
According to the Reuters story, the suit alleges that First Options improperly used assets of the fund to offset losses in Jung's personal account. Interestingly, the investors are represented by Corboy & Demetrio, a Chicago law firm famous for its torts lawsuits but not ever before, at least to my knowledge, involved in securities litigation.
The email problems between the NYSE and LaBranche & Co., one of the NYSE's largest specialist firms, continue. The NYSE is conducting an ongoing investigation of potential violations by its specialist firms and has requested production of emails by LaBranche. LaBranche has produced all emails that it believes are relevant to the NYSE investigation and is refusing to produce what it describes as personal email of employees. Originally reported last week by the WSJ (subscription required), no resolution has been reached. A Reuters article this week quotes Richard Grasso, president of the NYSE as having said in April that:
In my system, (of self-regulation) you cannot raise your hand and elect your Fifth Amendment privilege. Any question my prosecutors ask you, you either answer, or you are a former member of the New York Stock Exchange that moment. There is no such thing as constitutional rights.
Two thoughts arise. First, expect more of these tussles in the future. Regulators have embraced email as a rich source of incriminating statements. Email evidence was an important part of the $1.4 billion Global Settlement and the SEC fined five firms a total of $8.25 million last December over failure to retain email as mandated by the SEC. The NASD just last month released a notice to members requiring that instant messaging be retained in a manner similar to emails. Regulators, having broadened what must be retained, now have an interest in being able to look at everything. Firms, of course, dislike producing emails because of the expense (which is due in large part to pre-production review of the emails) and also because, in any large group of emails, there will be several that, taken out of context, make the sender, recipient and/or firm look bad, foolish, criminal and/or obsessed.
Second, Grasso's statement is, unfortunately, typical of thinking at some SROs. The arrogance of such "my way or the highway" attitude can be aggravating to deal with. As a legal matter, though, it is correct. The NYSE and other SROs are private entities that should not have to comply with the Fifth Amendment. Membership is voluntary but one condition of joining every exchange or other SRO is agreeing to comply with its rules. The problem is that SROs want to have it both ways -- private entity when prosecuting, but quasi-governmental entity (and thus immune) when on the receiving end of a suit. For example, following a NYSE enforcement action against a floor broker named John D'Alessio, D'Alessio sued the NYSE on various grounds. The Second Circuit held that the NYSE and its senior officials enjoyed absolute immunity in the performance of regulatory functions delegated to them under the Exchange Act. It hardly seems fair that the NYSE enjoys the same immunity as the SEC while having no similar due process obligations.
The WSJ reports (subscription required) that the Pentagon's Defense Advanced Research Projects Agency (DARPA) is involved in building a futures-style electronic marketplace that will focus on the Middle East. The twist is that the contracts will not be commodities, but will represent events. The marketplace will have three types of contracts:
Quarterly contracts based on data indices that track economic health, civil stability, military disposition, and U.S. economic & military involvement in Egypt, Iran, Iraq, Israel, Jordan, Saudi Arabia, Syria, and Turkey;Quarterly contracts that track global economic and conflict indicators; and
Specific possible events (e.g., U.S. recognition of Palestine in the first quarter of 2005)
Creating a futures marketplace to predict political issues is not new; the University of Iowa has run the Iowa Electronic Market on U.S. elections for years. In theory, since participating in such a market costs real money (with the possibility of winning or losing additional money), the marketplace avoids many of the factors that cause inaccuracies in polls. (After all, what is a futures market or stock market except a kind of poll on where prices are going?)
The WSJ article noted that two senators are objecting to the marketplace and want it shut down before it begins registering traders next week. I hope that the marketplace is able to go live; just seeing what contracts get listed would be interesting.
UPDATE: The WSJ is now reporting that plans for the marketplace have been cancelled in response to criticism.
On July 22, 2003, the NASD issued the Joint NASD/Industry Task Force Report on Breakpoints, which recommends a number of operational enhancements, disclosure requirements, and regulatory changes in response to problems in delivering breakpoint discounts to investors purchasing mutual fund shares with front-end loads. The NASD has been emphasizing that breakpoints will be a primary focus for its enforcement efforts, and breakpoint allegations have begun to filter into customer disputes, as well.
The SIA and TBMA have submitted a joint comment letter regarding NASD's proposal to require that the CEO and Chief Compliance Officer of each member firm annually certify to the adequacy of the firm's compliance and supervisory systems. The letter points out that the proposal, while well-intentioned, won't really accomplish its stated goal, which is increasing communications between compliance staff and senior management. Further, the SIA and TBMA believe that the certifications will lead to additional actions being taken against CEOs and CCOs, notwithstanding the NASD's statement that no additional personal liability will be created when the officers had a "reasonable basis" for certifying to the adequacy of systems.
The letter does an excellent job explaining the problems with the proposal. I hope the NASD listens.
The WSJ reports (subscription required) that the SEC
is working to resolve internal weaknesses in financial controls and hopes to get a clean opinion from outside auditors by 2005.
One can only imagine the SEC's reponse if a public company or BD were to inform the agency that it was hoping to have a clean audit by 2005.
The Washington Post editorializes today about a measure coming before the House Financial Services Committee that would prohibit state securities commissioners from setting requirements different than the SEC or SROs in certain areas while specifically preserving the right of the states to go after fraud. The Post is against the measure, stating:
And whatever the right balance may be between the SEC and the states, diminishing state officials' power in favor of such self-interested parties as stock exchanges is the wrong way to go, at the wrong time.
The Post does not, however, mention why it is the right way and the right time for states to be setting different (and presumably higher) requirements from the SEC. I think that the Post forgot one of the rationales behind the National Securities Market Improvement Act of 1996 which was that, for a national broker-dealer, having to comply with 50 sets of similar, but slightly different, requirements was incredibly expensive and inefficient. Too bad the Post thinks a return to those days would be a good idea.
UPDATE: Thursday's WSJ editorial page (subscription required) favors the bill, noting that the need for it is apparant
especially in a world where 50 state attorneys general have begun to see themselves as government profit centers via fine assessment.
The NYSE has published an information memo regarding the recently enacted final rule implementing the customer identification program (CIP) requirements under the PATRIOT Act. The memo does a nice job summarizing the requirements and just generally provides a more practical approach than last month's NASD notice to members on the same subject. Chalk one up for the NYSE.
The WSJ reports (subscription required) that the CME's earnings are up 66% in the second quarter. Since the CME went public last year, its shares have more than doubled in value. At the time of the IPO, there were lots of knowledgeable traders (including CME members) who wished they could short the stock. Since you can't short an IPO, they weren't able to, but it's another example of just how difficult it is to predict the future (and to trade). Even for the guys who know the most.
The SEC recently published a settlement order against Spear Leeds & Kellogg. SLK settled the matter by accepting a censure and agreeing to pay a $450,000 civil penalty, which the WSJ reports is a record amount (subscription required). The SEC asserted that two SLK employees aided and abetted a SLK client in marking the close in Southern Union Company, a NYSE stock. The SEC criticized SLK's procedures for monitoring for marking the close and noted in several instances that different SLK employees were "in effect, supervising himself." The lack of separate review by a supervisor has been a recurring theme in enforcement actions in the last few years and, given the size of the penalty here, it appears that will continue.
Late last week, the NASD announced a few changes to Forms U-4 and U-5. The changes were mostly minor, although some of the regulatory disclosure questions were reworded so that violations of the Sarbanes-Oxley Act would have to be disclosed. My favorite change, though, was the announcement that the hyphen between the "U" and the "4" or "5" was deleted. The old, stodgy U-4 is no more, now it's the sleek U4. Just goes to show, there's always something to modernize if you put your mind to it.