SEC Says Amex Had `Serious Failure' in Enforcing Regulations
Sept. 29 (Bloomberg) -- The American Stock Exchange failed
to police options trading in violation of an order mandating
stricter enforcement -- and then lied to regulators to cover up
its lack of supervision, according to Securities and Exchange
Commission inspectors.
The Amex, the third-biggest U.S. stock exchange, is accused
of breaking a September 2000 agreement to improve surveillance
with a ``deliberate attempt to conceal serious deficiencies'' in
its oversight procedures, SEC staff examiners charged in a 32-
page report, which was obtained by Bloomberg News.
``The staff is seriously concerned'' violations in the
Amex's handling of customer options trades ``are continuing to go
undetected, unreviewed and unsanctioned,'' SEC compliance
director Lori Richards informed Amex Chairman and Chief Executive
Officer Salvatore Sodano in a cover letter to the report.
The SEC's charges surfaced amid a clamor by regulators and
institutional investors for changes in the role of exchanges in
self-regulation following the New York Stock Exchange's approval
of a $188 million pay-and-benefits package for former Chairman
Richard Grasso. Six of nine directors who were on the NYSE's
compensation committee run securities firms regulated by the Big
Board.
``There's increasing skepticism that the industry is able to
regulate itself,'' said Alan Bromberg, a law professor at
Southern Methodist University in Dallas. ``Pressure is building
for change in the way the markets function and who regulates
them.''
Surveillance Review
Amex CEO Sodano earned $22 million in pay and benefits this
year. Compensation of Peter Quick, Amex's president, wasn't
disclosed. Quick's brother Christopher is on the NYSE board.
The report was sent June 16 to the Amex -- two weeks after
its parent, NASD Inc., announced a preliminary agreement to sell
the exchange for about $110 million to GTCR Golder Rauner LLC, a
Chicago private equity firm. Amex spokesman Robert Rendine said
GTCR is aware of the investigation and that it hasn't affected
negotiations. Calls to GTCR's Constantine Mihas, who is
negotiating the Amex purchase, weren't returned.
``The exchange has been cooperating fully with the SEC,''
Rendine said. Amex also hired law firm Davis, Polk & Wardwell to
conduct ``a comprehensive review'' of its surveillance of trading
and is carrying out the firm's recommendations, he said.
The probe focuses on allegations that Amex specialists who
coordinate stock and option trading ignored orders from
professional day-traders or filled these orders at prices worse
than advertised.
Shortcomings
Reviewing Amex's surveillance procedures, the SEC's office
of compliance inspections and examinations found these alleged
shortcomings:
``Amex staff provided a false document'' in an attempt to
``mislead'' the SEC that the exchange had a robust regulatory
program in place.
The Amex's 15-member board of governors ``failed to
adequately ensure'' the exchange was complying with its promise
in September 2000 to improve surveillance.
The exchange failed to file timely annual progress reports
as required by the September 2000 order, illustrating ``Amex's
lack of commitment toward its regulatory obligations.''
In one week in October 2001, Amex specialists completed just
62 percent of orders from so-called direct-access brokers who
communicate directly with their customers from the exchange
floor, the SEC report found. In contrast, the traders ``filled''
95 percent of orders from customers who transmitted their orders
through traditional brokerage firms.
Violations
Amex regulators ignored ``strong evidence of discriminatory
handling of certain customer orders'' and failed to enforce
specialists' obligations to make good on their ``firm quotes,''
according to Richards's cover letter. She declined to comment on
the report.
``Direct-access customers are perceived as being more
knowledgeable than traditional retail customers about options
trading'' and take advantage of small price discrepancies in
quotes displayed among market-makers of the same options on
different exchanges, the SEC report said. Amex's three principal
direct-access firms are Goldman Sachs Group Inc.-owned Spear,
Leeds and Kellogg, Interactive Brokers and Preferred Capital
Markets.
The report criticized Amex and its board on three main
fronts. The exchange's surveillance failed to detect ``large
numbers of potential firm quote violations'' and used ``illogical
procedures and indefensible rule interpretations'' to understate
the violations.
When violations were discovered, Amex failed to refer most
for disciplinary action. When referrals were made, ``Amex's
disciplinary committee routinely took no action against Amex
specialists,'' the SEC letter said.
The inquiry began in early 2001 after direct-access firms
complained to the SEC.
`Fabricated Document'
The SEC report said the ``false document'' that Amex's
surveillance staff submitted during the investigation may lead to
criminal charges by federal authorities. The compliance unit
referred the report to the SEC's enforcement division.
``The fabricated document falsely indicated that Amex
investigators had referred over 300 violations of the firm quote
rule to the Amex's disciplinary committee for disciplinary action
during 2002, when in fact only a few referrals had been made,''
according to the report.
``Once senior Amex officials became aware that Amex staff
members had provided a false document,'' the report added, ``they
immediately notified the staff that the document was not truthful
and took other remedial actions.''
Remedial Action
Amex put two staff members on administrative leave on March
21 for providing false information to the SEC, according to the
report.
The SEC report said several direct-access customers have
brought civil actions against Amex and three other options
exchanges over their members' failure to meet SEC-mandated quote
obligations.
Stock options give holders the right, but not the
obligation, to buy or sell underlying securities at a set price
within a set period of time.
In finding that Amex's board of governors failed to ensure
compliance with enforcement procedures, the SEC cited the minutes
of 12 board meetings since its agreement in 2000 with the
exchange. There'd been ``no discussion'' of efforts to improve
Amex surveillance, investigative and enforcement processes since
then, the SEC said.
--Jed Horowitz in the New York newsroom, with reporting by Philip Boroff in New York and Robert Schmidt in Washington. Editors: Kessler, Urban, Wolfson, Siler. |
