U.S. Securities & Exchange Commission
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U.S. Securities and Exchange Commission

before the

Securities Exchange Act of 1934
Release No. 46226 / July 18, 2002

Administrative Proceeding
File No. 3-10839

In the Matter of






The Securities and Exchange Commission deems it appropriate and in the public interest that administrative proceedings be, and hereby are, instituted pursuant to Section 15(b)(4) to determine whether Knight Securities, L.P. ("Knight") willfully1 violated Securities Exchange Act of 1934 ("Exchange Act") Rule11Ac1-4.


In anticipation of the institution of these administrative proceedings, Knight has submitted an offer of settlement ("Offer"). The Commission has determined it is appropriate and in the public interest to accept Knight's Offer and accordingly is issuing this Order. Solely for the purposes of these proceedings, and any other proceedings brought by or on behalf of the Commission or to which the Commission is a party, and without admitting or denying the findings set forth herein, except as to the jurisdiction of the Commission over it and the subject matter of these proceedings, which Knight admits, Knight consents to the entry of this Order Instituting Proceedings, Making Findings, and Imposing Remedial Sanctions.


Based on the foregoing, the Commission finds that:


A. Knight

Knight Securities, a wholly-owned subsidiary of Knight Trading Group, Inc., is a broker-dealer registered with the Commission pursuant to Section 15 of the Exchange Act since 1995. Knight, which does no retail business, is the largest market maker in the over-the-counter market, making a market in over 4,000 Nasdaq Stock Market ("NASDAQ") securities. Knight currently handles approximately 5.5% of the NASDAQ trading volume. The orders Knight receives predominantly are those orders transmitted by other broker-dealers on behalf of their customers.

B. The Limit Order Display Rule

The Limit Order Display Rule, Rule 11Ac1-4, which became effective in January 1997, and was fully implemented by August 1997, generally requires market makers to display customer limit orders that: (1) are priced better than the market-maker's quote, or (2) add to the size of a market maker's quote when the market maker is at the best price in the market, known as the National Best Bid or Offer ("NBBO").2 A market maker does not have to display any limit orders that it immediately executes or sends to another market maker or a qualified ECN (electronic communication network) for handling.3 The improving limit order must continue to be displayed until it is executed, rerouted or a new improving quote is displayed.

The purpose of the Limit Order Display Rule is to provide transparency by allowing the market to see improving customer limit orders and consequently, enhancing execution quality, and encouraging liquidity.4

C. Automated Compliance with the Limit Order Display Rule

Knight employs a widely used automated order routing and execution system ("Automated Compliance System") licensed from a third party to automate certain order handling, execution reporting and quote management functions. During the period from 1997 through 1999, the Automated Compliance System was the most-used trading system on the NASDAQ market, employed by over 160 market makers to process an estimated 50% of all NASDAQ order flow.

After adoption of Rule 11Ac1-4, the vendor of the Automated Compliance System distributed an updated version of the software that modified the system's automated order handling protocols so that limit orders eligible for display under the Rule were supposed to be automatically reflected in the market maker's quote unless the order was executed or routed to another market maker or ECN. However, there were design limitations in this Automated Compliance System. In particular, the Automated Compliance System was incapable of redisplaying eligible limit orders that had been previously displayed in a market maker's quote, and then removed from its quote by a movement in the price or size of that quote. Instead, the Automated Compliance System was programmed to require manual redisplay of those orders.5

As a result, Knight was required to supplement the Automated Compliance System in an attempt to ensure compliance with the limit order display rule. Initially, Knight relied on manual oversight of limit order display rule compliance - a dedicated person was responsible for continually surveying the market maker's limit order book for eligible orders that the system had failed to redisplay automatically and manually updating quotes to reflect such orders. Knight's manual oversight did not adequately ensure compliance with the limit order display rule. Ultimately, Knight independently modified the vendor software and designed a fix to the Automated Compliance System that would ensure the automatic redisplay of the orders.

D. Knight's Violations of the Limit Order Display Rule

Between October 1997 and August 1999, certain eligible limit orders were not promptly redisplayed, executed, or re-routed in contravention of the limit order display rule. An examination by the staff of all trading through Knight on the single trading day of May 5, 1999, revealed that Knight failed to redisplay promptly eligible limit orders 6,082 times.6

Of the eligible limit orders Knight failed to redisplay promptly on May 5, 1999, 1,350 improved the NBBO. Thus, the NBBO reflected an inferior quote and a wider spread between the bid and the ask. Of the undisplayed limit orders that affected the NBBO, 1,144 were executed or re-displayed within a minute. 146 of the NBBO improving customer limit orders remained in Knight's trading system without display, execution, or re-routing for over a minute. The remaining orders that were not redisplayed promptly on May 5, 1999 did not affect the NBBO.

As described above, the Limit Order Display Rule, Rule 11Ac1-4 in relevant part, requires market makers to display customer limit orders that: (1) are priced better than the market-maker's quote, or (2) add to the size of a market maker's quote, unless the market maker immediately executes the limit order or routes it to another market maker or ECN. As described above, by failing to redisplay promptly certain improving limit orders Knight violated the Limit Order Display Rule.

Based on the above, the Commission finds that Knight willfully violated Exchange Act Rule 11Ac1-4.



Accordingly, IT IS HEREBY ORDERED that Knight,

1. be, and hereby is, censured; and

2. pay a $75,000 civil money penalty within ten (10) days of the entry of the Order. Payment is to be made by U.S. Postal money order, certified check, bank cashier's check, or bank money order, made payable to the Securities and Exchange Commission and shall be hand-delivered or mailed to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312, under cover of a letter that identifies the respondent and the name and file number of this proceeding. A copy of the cover letter and of the form of payment shall be simultaneously transmitted to Linda Chatman Thomsen, Esq., Securities and Exchange Commission, Division of Enforcement, 450 Fifth Street, NW, Washington, DC 20549.

By the Commission.

Jonathan G. Katz

1 "Willfully" as used in this order means intentionally committing the act which constitutes the violation, see Wonsover v. SEC, 205 F.3d 408, 414 (D.C. Cir. 2000); Tager v. SEC, 344 F.2d 5, 8 (2d Cir. 1965). There is no requirement that the actor also be aware that he is violating one of the Rules or Acts.
2 However, if a customer's limit order is of de minimis size in comparison to the market maker's displayed quote size, the market maker does not have to update its quote to reflect the size of the limit order. A limit order (or an aggregation of limit orders) is considered de minimis relative to a market maker's quote if it is less that or equal to 10 percent of the market maker's displayed size. Additionally, if a market maker receives a customer limit order priced at its quote and the quote is not at the NBBO, it is not obligated to reflect the limit order in its quote size.
3 Additionally, market makers are not required to display the following customer limit orders: orders that the customer has requested not be displayed; odd-lot orders; block-size orders; and all-or-none limit orders.
4 See Adopting Release 34-37619A, September 6, 1996. See also Office of Compliance Inspections and Examinations, Office of Economic Analysis, U.S. Securities and Exchange Commission, Report Concerning Display of Customer Limit Orders (May 4, 2000), at http://www.sec.gov/news/studies/limitorder.htm (summarizing the impact of the display rule since its inception).
5 For example, a market maker's quoted ask price of $10 for 500 shares of security WXYZ, might include a limit order to sell 100 shares of WXYZ at $10 that the Automated Compliance System had automatically included in the market maker's quote in accordance with the limit order display rule. If the market maker then moved its ask price to, for example, $10 ¼ for 400 shares of WXYZ, the Automated Compliance System, as originally programmed, failed to redisplay automatically the 100 shares limit order at the superior price of $10. Instead, the limit order was routed to a "pending" file by the Automated Compliance System and thereafter would require manual intervention to be redisplayed.
6 Some limit orders were not redisplayed more than once. For purposes of quantifying violations, a violation occurred each time an eligible limit order was not redisplayed.


Modified: 07/18/2002