The pact with the company, now known as Knight Equity Markets, covers charges both from the US Securities and Exchange Commission and the NASD, according to an SEC statement .
The settlement also censures Knight for its failure to reasonably supervise its institutional sales traders. Knight has also voluntarily agreed to retain an Independent Compliance Consultant to review:
- Knight’s policies and procedures on its best execution obligations
- trade reporting requirements
- limit order requirements and books and records requirements
- Knight’s supervisory and compliance structure.
The $79-million value of the settlement pact includes more than $41 million in disgorgement, over $13 million in prejudgment interest and $12.5 million in civil penalties. Knight will also pay an additional $12.5 million in NASD fines.
“Customers have a right to expect they are getting fair treatment when they entrust their broker with orders to buy and sell securities,” said Stephen Cutler, Director of the SEC’s Division of Enforcement, in the statement. “That expectation is betrayed when the broker handling the orders puts its own financial interests ahead of its customers’ interests.”
“Every firm has a fundamental obligation to trade honestly and fairly with its customers, regardless of the customers’ level of sophistication,” said NASD Vice Chairman Mary Schapiro, in a NASD statement. “Knight’s fraudulent trading, extracting millions of dollars of excess profits from its institutional customers for two years, requires the strong sanctions imposed here.”
According to the SEC between January 1999 and November 2000, Knight – which was, at the time, one of the largest market-makers on the NASDAQ – earned over $41 million in illegal profits by failing to provide best execution to its institutional customers.
Regulators said that Knight, upon receipt of an institutional customer order, would acquire a substantial position in the firm’s proprietary account. Rather than fill the order promptly on terms most favorable to the customer, Knight would wait to see if its proprietary position increased in value during the trading day. When the prevailing market price for the stock moved significantly away from Knight’s acquisition cost, Knight then filled the customer’s order and pocketed the difference as its profit on the transaction, according to the SEC.
For example, according to the SEC, on April 4, 2000, Knight received a customer market not-held order to purchase 250,000 shares of Applied Micro Circuits Corporation (AMCC). Over the next 18 minutes, Knight acquired 147,000 shares of AMCC at an average cost of $91.00 per share. Rather than promptly selling the stock to the institutional customer at Knight’s cost (plus a reasonable profit), Knight sold the AMCC stock to the customer over a period of time at an average profit of approximately $2 per share. On the entire AMCC order, Knight realized a profit of over $1.1 million (or an average of $3.94 per share), regulators alleged.
By engaging in these trading practices, Knight extracted enormous profits – as high as $9.per share – by executing transactions that involved effectively no risk to Knight. During the same period, Knight failed reasonably to supervise Knight’s former leading sales trader who was primarily responsible for Knight’s fraudulent trading, the SEC said.
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