Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Friday, December 18, 2009

SEC and Inter-Dealer Broker Settle Fraud Charges

The SEC and the U.S. subsidiary of the world's largest inter-dealer broker, U.K.-based ICAP plc,settled fraud charges that alleged deceptive activity and material misrepresentations to customers concerning its trading activities.  ICAP agreed to settle the SEC's charges by, among other things, paying $25 million in disgorgement and penalties. The SEC additionally charged five ICAP brokers for aiding and abetting the firm's fraudulent conduct and two senior executives for failing reasonably to supervise the brokers. The individuals have each agreed to pay penalties to settle the SEC's charges.

As an inter-dealer broker, ICAP Securities USA LLC (ICAP) matches buyers and sellers in over-the-counter markets for various securities, such as U.S. Treasuries and mortgage-backed securities, by posting trade information on computer screens accessed by its customers who make trading decisions based in part on such information. Inter-dealer brokers with greater trade activity on their screens often are better positioned to attract customer orders and earn more commissions than those whose screens reflect little or no trading activity.

The SEC's enforcement action finds that ICAP, through its brokers on its U.S. Treasuries (UST) desks, displayed fictitious flash trades also known as "bird" trades on ICAP's screens and disseminated false trade information into the marketplace in order to attract customer attention to its screens and encourage actual trading by these customers. ICAP's customers believed the displayed fake trades to be real and relied on the phony information to make trading decisions.

According to the SEC's order, ICAP's UST brokers displayed thousands of fictitious flash trades to ICAP's customers between December 2004 and December 2005. The SEC also finds that ICAP represented to its off-the-run UST customers that its electronic trading system would follow certain workup protocols in handling customer orders. Such ICAP customers therefore expected that their orders, once entered onto ICAP's screens, would be filled according to the workup protocols. However, ICAP's brokers on the UST desks used manual tickets to bypass such protocols and close out of thousands of positions in their ICAP house accounts, thereby rendering ICAP's representations concerning the workup protocols false and misleading. In some instances, ICAP's customers' orders received different treatment than the customers expected pursuant to the workup protocols.

The SEC's order further finds that ICAP held itself out as a firm that did not engage in trading that subjected its own capital to risk. ICAP's regulatory filings routinely made this point, noting specifically in one instance that the firm "does not engage in proprietary trading." During the relevant period, however, two former ICAP brokers on the voice-brokered collateral pass-through mortgage-backed securities (MBS) desk routinely engaged in profit-seeking proprietary trading that rendered ICAP's representations regarding proprietary trading false and misleading. The SEC's order also finds that ICAP failed to make and keep certain required books and records on the UST desks and the MBS desk.

Without admitting or denying the SEC's findings, ICAP has agreed to a censure, to cease and desist from committing or causing any violations of Section 17(a)(2) and 17(a)(3) of the Securities Act, Section 15C of the Exchange Act and 17 CFR Parts 404 and 405, and to pay $1 million in disgorgement and $24 million in penalties. ICAP also has agreed to retain an independent consultant to, among other things, review ICAP's current controls and compliance mechanisms; its trading activities on all desks to ensure that the violations described in the order are not occurring elsewhere at ICAP; and ICAP's books and records pertaining to trading records. Based on its review, the independent consultant will recommend any additional policies and procedures which are reasonably designed to ensure that ICAP complies with applicable provisions of the federal securities laws.

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