UNITED STATES DISTRICT COURT
Plaintiff Securities and Exchange Commission (the "Commission") alleges for its Complaint against defendant Joshua M. Levine, as follows:
NATURE OF THE ACTION
1. Joshua M. Levine, with the assistance of others, developed software programs used by Datek Securities Corporation ("Datek Securities") to conceal improper trading on the Nasdaq Stock Market's Small Order Execution System ("SOES"). From at least 1993 through March 1998, National Association of Securities Dealers ("NASD") rules restricted use of the SOES system to retail customer orders and prohibited broker-dealers from using SOES to trade for their own accounts. During this period, Datek Securities used specialized day-trading software to execute millions of proprietary trades on SOES. To conceal its misconduct, and create the appearance of compliance with federal securities laws and NASD rules, Datek Securities allocated its unlawful proprietary trades among dozens of nominee accounts and created fictitious books and records.
2. From 1993 to 1994, Datek Securities manually allocated its trades among dozens of nominee accounts at the end of each day to conceal its proprietary SOES trading activity. In 1994, Levine and others developed software that automated this unlawful allocation process. Ultimately,Levine refined the software so that it allocated the trades as they took place. As a result of Datek Securities' use of Levine's software, Datek Securities' books and records were false and inaccurate. Accordingly, Levine aided and abetted Datek Securities' violations of certain broker-dealer books and records provisions of the federal securities laws: Section 17(a)(1) of the Securities Exchange Act of 1934 ("Exchange Act") and Rules 17a-3(a)(1), 17a-3(a)(2), 17a-3(a)(3), and 17a-3(a)(7) promulgated thereunder [15 U.S.C. § 78q(a)(1) and 17 C.F.R. §§ 240.17a-3(a)(1), 240.17a-3(a)(2), 240.17a-3(a)(3), and 240.17a-3(a)(7)].
JURISDICTION AND VENUE
3. This Court has jurisdiction over this action pursuant to Sections 21(d)(1), 21(d)(3), 21(e), and 27 of the Exchange Act [15 U.S.C. §§ 78u(d)(1) and (d)(3), 78u(e), 78u-1 and 78aa].
4. Levine, directly or indirectly, made use of the means and instrumentalities of interstate commerce, or of the mails, or of the facilities of a national securities exchange in connection with the transactions, acts, practices and courses of business alleged herein.
5. This Court properly has venue over this action because the conduct at issue occurred in the Southern District of New York.
6. The Commission seeks to enjoin Levine from engaging in the transactions, acts, practices, and courses of conduct alleged in this Complaint and transactions, acts, practices, and courses of conduct of similar purport and object, for other equitable relief, for payment of civil penalties by the defendant, and for such other and further relief as the Court may deem appropriate.
7. Joshua M. Levine, 34, is a resident of New York. Between 1992 and 1998, Levine was the primary software developer for Datek Securities. From November 1992 through December1994, Levine was registered at Christian Klein & Cogburn, Inc. ("Christian Klein"), a broker-dealer registered with the Commission, where he was both a vice president and the chief financial officer. From 1993 to 1997, Levine was associated with another broker-dealer registered with the Commission.
OTHER RELEVANT ENTITIES
8. Datek Securities originally registered as a broker-dealer with the Commission pursuant to Section 15(b) of the Exchange Act in May 1979. In February 1998, Datek Securities reorganized under a holding company, Datek Online Holdings, with six wholly-owned subsidiaries. As part of this corporate restructuring, Datek Securities changed its name to Datek Online Brokerage Services ("DOBS") on March 16, 1998. On March 30, 1998, Datek Securities sold the assets of its day-trading business, subject to all liabilities, to Heartland Securities Corporation ("Heartland") for a promissory note of $3.5 million. Recently, DOBS was renamed iCapital Markets, which continues the firm's execution and proprietary trading business, and will also provide other firms with order routing and execution services and connections to market centers.
DATEK SECURITIES' SOES TRADING
9. The NASD established the Small Order Execution System ("SOES") in 1984. SOES was an automated trading system intended to benefit small investors by providing immediate execution of small orders entered into the Nasdaq system at the best available price. During the relevant period, SOES was the only Nasdaq trading system that allowed for automatic execution, and it offered faster execution than any other system.
10. NASD rules placed several restrictions on the use of SOES. Under NASD rules, only individual retail customers were permitted to use SOES, and broker-dealers were prohibited fromusing SOES to trade for their own accounts. NASD rules also set a maximum order size for SOES trades and prohibited the division of orders in excess of the maximum order size into smaller parts for purposes of complying with the maximum order size requirement.
11. Datek Securities registered as a SOES Order Entry Firm on August 4, 1987, which allowed it to place trades through the SOES system.
12. In the early 1990's, a day-trading software known as "Watcher" was developed for Datek Securities. Watcher was designed to run Nasdaq data through Datek Securities computers, which were far faster than the traditional Nasdaq Workstation II. The Watcher system gave Datek Securities traders a significant time advantage because they received last sale and quotation update information before other market participants. The Watcher system also analyzed the data to highlight trading opportunities. Those features enabled Datek Securities traders to react more quickly to market activity and to enter and receive execution on their orders more quickly than other market participants. While other means of executing securities transactions were available --namely, the telephone or SelectNet - only SOES offered automatic execution, increasing the timing advantage offered by Watcher.
13. Watcher's superior technology combined with SOES automatic execution gave Datek Securities traders an advantage. However, that advantage was limited by SOES rules: SOES could not be used for proprietary trading and there were limits on the number of shares per trade. To maximize profitability and comply with the SOES rules, Datek Securities traders would have had to execute a large number of trades in accounts held by numerous individual retail customers. The firm only would have collected commissions on such trades.
14. Instead of using the SOES system for its intended and lawful purpose -- to place orders for the accounts of retail customers -- Datek Securities used the system for its own proprietary trading. From 1995 through March 1998, the firm executed approximately 12 million SOES trades, over 30 percent of all SOES trades.
15. Datek Securities concealed its use of SOES for proprietary trading by allocating trades to numerous nominee accounts, cross trading with its proprietary account, and creating false books and records.
16. Datek Securities used numerous nominee accounts to hide its proprietary trading. The firm promised to pay the nominees a guaranteed and fixed rate of return in exchange for complete discretionary trading authority.
17. Datek Securities assigned and allocated proprietary trades to the nominee accounts in an unlawful post-transaction process. The firm made sure that each account achieved the guaranteed rate of return by several means, including allocation of profitable trades to underperforming accounts and manipulation of commission rates. Nominee accounts never earned more than the guaranteed return -- if accounts earned more, Datek Securities kept the excess by adjusting commission charges and reassigning trades to other accounts.
18. The post-trading allocation of trades was possible because the SOES system did not require an Order Entry Firm to identify a particular account to enter an order. For example, Datek Securities merely had to identify itself as an Order Entry Firm when placing a trade on the SOES system. Datek Securities traders executed SOES trades without regard to any particular account androutinely violated the rules regarding maximum size orders. Those traders did not create or fill out contemporaneous order tickets.
19. From 1993 to 1994, Datek Securities employees manually allocated all of Datek Securities' trades among accounts after the close of the market. Datek Securities clerks reviewed a Nasdaq print-out of the day's trades and matched the closest chronological SOES buys and sells of the same security to free up the greatest amount of "buying power," the amount that could be purchased in a particular account, based on margin requirements and the equity in the account. After these trades had been matched, the clerks gave the list to back-office employees who decided which trades would be assigned to each account. Trades were allocated to particular accounts in a manner that gave the firm's records the appearance of compliance with NASD rules governing SOES. Other factors in the allocation process included the margin requirement for the account and the rate of return guaranteed to the account. In addition, Datek Securities employees assigned numerous profitable trades to certain favored accounts. Levine understood the mechanics of the manual allocation process.
20. After the trades had been allocated, they were entered into a computer system and the resulting computer file was transferred to Datek Securities' Brooklyn office, where the information was used to generate blotters, trial balances, and customer account statements. The proprietary trades were unlawfully executed and falsely recorded as those of individual retail customers. Consequently, Datek Securities' books and records were false and inaccurate.
LEVINE AIDED AND ABETTED DATEK SECURITIES'
21. By early 1994, Levine had developed a software program, known as "Wire," that automated Datek Securities' unlawful trade allocation process and thus dramatically enhanced DatekSecurities' ability to conceal its proprietary SOES trading from regulators. Levine programmed Wire to allocate trades to particular accounts to achieve their guaranteed rates of return, and to give Datek Securities' books and records the appearance that they complied with federal securities laws and NASD rules. Wire was run at the end of each trading day and, as refined by Levine, at several different points during the day. By automating the allocation process, the Wire software made it more difficult for securities regulators to detect the scheme, because no pre-allocation documents were generated to permit comparison.
22. Levine continually made refinements to Wire that allowed Datek Securities to conceal its unlawful proprietary trading more efficiently and effectively. By 1995, Levine had developed "Real Time Wire," which, as its name suggests, allocated trades as they took place. In addition, Levine's Real Time Wire program was used by Datek Securities to assign profitable trades, including trades executed on SOES, to its proprietary account. The software automatically generated thousands of cross trades between the proprietary account and the nominee accounts, and this huge volume of cross trades each day allowed the firm to profit enormously. Datek Securities utilized Real Time Wire's allocation capabilities to conceal its proprietary trading from 1995 until early 1997, when it was gradually replaced by a practice in which specific traders were assigned to specific accounts.
FIRST CLAIM FOR RELIEF
23. Paragraphs 1 through 22 are hereby realleged and incorporated by reference.
24. Datek Securities failed to make and keep certain books and records current and accurate. Datek Securities, among other things, falsely recorded in its blotters, ledgers, ledger accounts, and other records, including records of original entry, that its proprietary trades were customer transactions conducted in non-proprietary customer accounts.
25. As a result, Datek Securities violated Section 17(a)(1) of the Exchange Act and Rules 17a-3(a)(1), 17a-3(a)(2), and 17a-3(a)(3) promulgated thereunder [15 U.S.C. § 78q(a)(1) and 17 C.F.R. §§ 240.17a-3(a)(1), 240.17a-3(a)(2), and 240.17a-3(a)(3)].
26. Defendant Levine knowingly developed, implemented, and refined software programs that substantially assisted Datek Securities in the falsification and fabrication of its books and records. Levine created and continually refined software programs for Datek Securities that falsely recorded proprietary securities transactions as customer transactions. As a result, Levine aided and abetted Datek Securities' violations of Section 17(a)(1) of the Exchange Act and Rules 17a-3(a)(1), 17a-3(a)(2), and 17a-3(a)(3) promulgated thereunder [15 U.S.C. § 78q(a)(1) and 17 C.F.R. §§ 240.17a-3(a)(1), 240.17a-3(a)(2), and 240.17a-3(a)(3)] .
SECOND CLAIM FOR RELIEF
27. Paragraphs 1 through 26 are hereby realleged and incorporated by reference.
28. Datek Securities failed to make and keep accurate records of each purchase and sale of securities, including order and sales tickets prepared prior to the execution of trading transactions.
29. As a result, Datek Securities violated Section 17(a)(1) of the Exchange Act and Rule 17a-3(a)(7) promulgated thereunder [15 U.S.C. § 78q(a)(1) and 17 C.F.R. § 240.17a-3(a)(7)].
30. Defendant Levine knowingly developed, implemented, and refined software programs that substantially assisted Datek Securities in the falsification of its sales records. Accordingly, Levine aided and abetted Datek Securities' violations of Section 17(a)(1) of the Exchange Act and Rule 17a-3(a)(7) promulgated thereunder [15 U.S.C. § 78q(a)(1) and 17 C.F.R. § 240.17a-3(a)(7)].
PRAYER FOR RELIEF
WHEREFORE, Plaintiff Securities and Exchange Commission respectfully requests that this Court enter a judgment:
(i) permanently enjoining Levine from aiding and abetting violations of Section 17(a)(1) of the Exchange Act and Rules 17a-3(a)(1), 17a-3(a)(2), 17a-3(a)(3), and 17a-3(a)(7) promulgated thereunder [15 U.S.C. § 78q(a)(1) and 17 C.F.R. §§ 240.17a-3(a)(1), 240.17a-3(a)(2), 240.17a-3(a)(3), and 240.17a-3(a)(7)].
(ii) ordering Levine to pay civil monetary penalties under Section 21(d)(3) of the Exchange Act [15 U.S.C. § 78u(d)(3)]; and
(iii) granting such other relief as this Court may deem just and appropriate.
Dated: January __, 2003 Washington, D.C.