SECURITIES AND EXCHANGE COMMISSION
In the Matter of the Application of
EDWARD JOHN MCCARTHY
For Review of Disciplinary Action Taken by the
NEW YORK STOCK EXCHANGE, INC.
OPINION OF THE COMMISSION
NATIONAL SECURITIES EXCHANGE -- REVIEW OF DISCIPLINARY PROCEEDING
Conduct Inconsistent with Just and Equitable Principles of Trade
Acts Detrimental to the Interest or Welfare of the Exchange
Trading for Member's Own Account and Account Over Which Member Exercised Discretion
Trading so as to Accord Own Account Preferential Treatment
Member of national securities exchange effected trades for an account in which the member had an interest and over which he exercised discretion; traded in a manner that accorded this account preferential treatment over accounts of member's customers; and failed to make and preserve required records. Held, exchange disciplinary action sustained.
George Brunelle, and Suzanne E. Auletta, of Brunelle & Hadjikow, P.C., for Edward John McCarthy.
Rex W. Mixon, Jr., Nancy Reich Jenkins, David Steiner, Laura A. Cooper, and Steven M. Tanner, for the New York Stock Exchange, Inc.
Appeal filed: December 18, 2002
Last brief received: April 8, 2003
Edward John McCarthy, a member of the New York Stock Exchange, Inc. ("NYSE" or "Exchange") and since March 1994 an independent floor broker, appeals from the NYSE's disciplinary action against him. The NYSE determined that, between June 1995 and March 1996, McCarthy engaged in conduct inconsistent with just and equitable principles of trade, in violation of NYSE Rule 476(a)(6), and engaged in acts detrimental to the interest or welfare of the Exchange, in violation of NYSE Rule 476(a)(7). The NYSE found that McCarthy violated Section 11(a) of the Securities Exchange Act of 19341 and Exchange Act Rule 11a-12 by executing orders on the floor of the Exchange for an account maintained by Oakford Corporation ("Oakford"), a non-member firm, in which he had an interest and over which he exercised investment discretion. The NYSE found that McCarthy alsoviolated NYSE Rule 95(a)3 by executing trades for an account as to which he had investment discretion.
The NYSE further determined that McCarthy violated NYSE Rule 914 by crossing orders without first ensuring that the order had an opportunity for an improved price on the Exchange floor and without providing notification to, and obtaining acceptance of the trade from, the member who placed the trade; and that he violated NYSE Rule 925 by trading in front of, or along with, customer orders. Finally, the NYSE determined that McCarthy violated NYSE Rules 123 and 440 and Exchange Act Rules 17a-3 and 17a-4 by failing to make and preserve required records.6
The Exchange's Board of Directors censured McCarthy, imposed a $75,000 fine, and barred McCarthy for two years from membership and employment in any capacity on the floor of the Exchange. McCarthy appeals the NYSE's findings as well as the sanctions against him. We base our findings upon an independent review of the record.
Edward John McCarthy entered the securities industry in 1986 as a specialist clerk on the floor of the Exchange. In or about March 1994, McCarthy became a lessee member of the Exchange and began work as an independent floor broker. Since approximately January 1995, McCarthy has worked as an independent floor broker operating as a sole proprietor.
In June 1995, McCarthy began to execute orders for an account at Oakford. According to McCarthy, during the first two or three months that he traded for the Oakford account he calculated what he believed to be the net profit of his trades for the account. McCarthy testified that, "I billed [Oakford] 70 percent of the profit." McCarthy's billing for the Oakford account for June 1995 is illustrative of this practice. McCarthy determined that the net profits for his trades for the Oakford account for June 1995 were $1700. McCarthy sent Oakford a bill for $1190, which was 70 percent of the net profit that he had calculated.
After "the first month or two . . . that [he] billed 70 percent of the profit," McCarthy became aware that Oakford "wasn't paying me that figure." McCarthy elaborated further that in August or early September he called Bill Killeen, a principal of Oakford, "when I realized I wasn't getting paid what I thought I would be getting paid." Although McCarthy was not aware of this at the time, the shortfall in payment resulted from clearing fees and other incidental fees being subtracted from Oakford's profit before Oakford calculated McCarthy's 70 percent share of the profit.
McCarthy testified that Killeen told him to calculate the profit for the trades he made for the account and record this amount on the bill, rather than recording 70 percent of the profit as he had been doing. Although McCarthy stated that after receiving these instructions, he believed that Oakford "was going to pay me whatever [it] wanted," he testified further that he believed that Oakford "was going to pay me based on the profit being some sort of factor of what I would get paid." After this conversation, McCarthy sent a bill to Oakford each month for an amount equal to the net profit from his trading. The first such bill that McCarthy sent to Oakford was for September 1995. He continued to bill Oakford in this manner until his trading for the account ended in March 1996.
McCarthy testified that he employed a clerk to prepare bills for other accounts, but that he himself prepared the bills submitted to Oakford. McCarthy noted that he prepared the Oakford bills because they involved a calculation of the trading profits for the account; his other bills involved a commission that was calculated on a per-share basis. An expert witness offered by the Exchange testified that the understanding and practice of floor brokers was that they were to bill customers by trade on a per-share basis and not based on the profits earned for a trading account. From September 1995 until he stopped trading for the Oakford account in March 1996, the only information that McCarthy put on the bills he submitted to Oakford was the ticker symbol of the stock he had traded and the amount of the daily and monthly net profit. The bills contained no information commonly found in commission invoices such as the number of shares traded, the price, and whether the transactions were purchases or sales.
In preparing the bills he sent to Oakford, McCarthy subtracted losses for individual trades and, when applicable, net losses incurred over entire days. McCarthy did not bill Oakford for trades resulting in neither profit nor loss. For example, McCarthy calculated the net profit for trades he made for the Oakford account on January 29, 1996, by subtracting the loss incurred as a result of one trade from the profit that resulted from the remaining trades on that day. In determining the amount to bill Oakford for June 1995, McCarthy deducted the loss incurred by the account on June 21, 1995, from the profit that resulted from trades on the remaining days in June to arrive at the net profit. McCarthy executed two trades for the Oakford account on March 4, 1996, but did not bill Oakford for these trades because they did not result in a profit or loss.
McCarthy provided records for only 21 trading days in response to Exchange requests for documents for the period from June 1995 through March 1996. Eleven out of the 62 Oakford order tickets that McCarthy produced for those 21 trading days were not time-stamped. McCarthy's trading records showed that, on numerous occasions during those 21 trading days, McCarthy entered the floor with two order tickets for the Oakford account; one to buy on a minus or zero-minus tick and the other to sell on a plus or zero-plus tick.7 On four occasions while holding suchorders for Oakford, McCarthy executed a trade contrary to the instructions on the order ticket. In three of those trades, McCarthy bought stock on a plus tick. On one occasion, McCarthy executed a short sale on a minus tick.8 Oakford rejected none of these trades despite the fact they were contrary to Oakford's orders. In addition, McCarthy effected seven trades on three separate days prior to the time reflected in the time-stamp on the corresponding Oakford order tickets.
McCarthy's trades with respect to KMart Corporation ("KM") on the morning of March 18, 1996, are illustrative of his general trading pattern with respect to the Oakford account. On March 18, McCarthy held an Oakford order to buy 10,000 KM shares on a zero-minus tick and an Oakford order to sell 10,000 KM shares on a zero-plus tick. McCarthy also had a sell-short order from a customer for 10,000 KM shares at a price of 10 5/8. The date and time-stamps were missing from all three orders. McCarthy crossed the customer's short sale with the Oakford buy order at 10 5/8 on a plus tick contrary to the instructions on the Oakford order. McCarthy then executed the 10,000 KM share Oakford sell order in two transactions at 10 7/8, consistent with the zero-plus tick instruction. These trades resulted in a $2500 profit for the Oakford account and McCarthy billed Oakford for the entire amount, consistent with Kileen's general billing directive.
During the time that McCarthy traded for the Oakford account, the account generated a total net profit, exclusive of clearing fees and other incidental fees, of approximately $56,615. McCarthy received payments from Oakford totaling approximately $39,416, which constituted 69.6 percent of the account's net profits.
Procedural History of NYSE Disciplinary Action Against McCarthy
On February 27, 2001, an Exchange Hearing Panel (the "Hearing Panel") commenced a disciplinary hearing to consider allegations that McCarthy's trading for the Oakford account violated NYSE rules and the federal securities laws. The Hearing Panel was comprised of an Exchange hearing officer and two floor brokers. In a decision dated September 10, 2001, the Hearing Panel determined by a majority vote that the Exchange's Division of Enforcement had failed to establish that McCarthy had an "impermissible interest" in the Oakford account and had failed to establish that McCarthy exercised investment discretion with respect to that account or had traded so as to accord the Oakford account preferential treatment over the accounts of his customers. The Hearing Panel determined by a unanimous vote that McCarthy had failed to make and preserve required records.9
The Exchange's Division of Enforcement filed a request for review with the NYSE's Board of Directors (the "Board") seeking reversal of the Hearing Panel's findings with respect to McCarthy's interest in and discretion over the Oakford account and his trading so as to accord that account preferential treatment over the accounts of his customers. The Division also sought an appropriate sanction for these additional asserted violations. The Division contended to the Board that the HearingPanel's findings of fact were correct and supported by the evidence, but that the Hearing Panel had erred when it failed to conclude, on the basis of its findings, that McCarthy had violated applicable federal securities laws and NYSE rules based on this conduct.
The Board's Committee for Review received briefs and heard oral argument on the Division of Enforcement's appeal. In a decision dated April 4, 2002, the Board affirmed the Hearing Panel's factual findings, but held, "in view of the factual findings that the Hearing Panel made in its decision, the majority of the Hearing Panel erred in concluding that McCarthy was not guilty" of the violations charged and appealed by the Division of Enforcement. The Board affirmed the Hearing Panel's findings of violation with respect to McCarthy's failure to make and preserve required records.10 In light of its additional findings of violation, the Board remanded the case to the Hearing Panel with instructions to impose a "penalty appropriate in light of Exchange precedent and the particular facts and circumstances of this case evident from the record in this matter."
In a decision dated July 9, 2002, issued after hearing oral presentations by the parties solely on the issue of the penalty, the Hearing Panel imposed a censure and a $75,000 fine. The Exchange's Division of Enforcement then filed a request for Board review of the penalty determination. The Division asserted that the sanction imposed by the Hearing Panel should be modified to include a suspension or bar in addition to the censure and fine. The Board's Committee for Review received written submissions and heard oral argument on this request. In a decision dated December 5, 2002, the Board modified the penalty by barring McCarthy for two years from Exchange membership and from employment in any capacity on the floor of the Exchange.
A. McCarthy Had An Interest in the Oakford Account
The undisputed evidence in the record establishes that McCarthy's compensation was calculated based on a percentage of the net profits generated by his trades for the Oakford account. He received approximately 70 percent of the net trading profits for the account -- that is, losses were offset against profitsbefore Oakford paid McCarthy. McCarthy himself testified that he understood Oakford would "pay me based on the profit being some sort of factor of what I would get paid." Because McCarthy shared with Oakford in the economic risk of the trades, McCarthy had an interest in the Oakford account, and the account was McCarthy's own account. His trades for the Oakford account, therefore, violated Exchange Act Section 11(a) and Exchange Act Rule 11a-1.11
Further supporting the Exchange's finding that McCarthy had an interest in the Oakford account is his special approach to billing for that account. McCarthy charged, and billed, his non-Oakford accounts a commission that was calculated on a per-share basis. However, he billed Oakford based on the trading profits for the account. McCarthy employed a clerk to prepare bills for his other accounts, but he personally prepared the bills submitted to Oakford. These facts support the Exchange's findings that McCarthy knew he was being compensated on the basis of the profits generated by his trades for the Oakford account and that he sought to keep the arrangement confidential.
The September 1995 through March 1996 Oakford bills themselves support the Exchange's finding that McCarthy was compensated based on the profits generated by the Oakford account. These bills contained only the amount of daily and monthly net profit from his trading for the account. Information normally provided for billing purposes such as the number of shares traded, the price of those shares, and whether the transactions were purchases or sales, was not included on those bills. Thus, the only information McCarthy provided to Oakford on which payment could be based was the net profits that resulted from his trades for the Oakford account. Furthermore, it was McCarthy's practice to omit from the invoices he submitted to Oakford information about trades for the Oakford account that resulted in no net profit or loss. This is further evidence thatnet profit -- not the number of shares traded -- was the basis for his compensation.12
Despite the evidence to the contrary, McCarthy maintains that he did not have an interest in the Oakford account. He alleges that a number of facts are inconsistent with, and undermine, the Exchange's finding that he had an interest in the account. For example, McCarthy argues that the Exchange did not establish the existence of an agreement between McCarthy and Oakford to share in the profits generated by the trading account or establish his clear intention to share in those profits. He maintains that he "simply complied with a customer's request to calculate the customer's profits, and he did so believing that the customer's profits would be, at most, one factor in the customer's unilateral decision about how much to pay." According to McCarthy, although he billed Oakford based on the profits generated by his trading for the account, he believed he would be paid whatever Oakford wanted to pay. McCarthy would have us find that Oakford determined unilaterally that it would share with McCarthy trading profits and would have us exonerate McCarthy on this basis.
While the Exchange did not adduce direct proof that McCarthy and Oakford had a specific agreement to share profits, it established that McCarthy shared with Oakford in the economic risk of the trades he made for the Oakford account. The Exchange further established, through McCarthy's own testimony, McCarthy's expectation -- evidenced further by McCarthy's personal billing of Oakford on a net-profit basis -- that Oakford would compensate him based on profits earned from his trading. Thus, McCarthy was integrally involved in the payment arrangement.
McCarthy also claims that the Exchange's finding that he had an interest in the Oakford account is undermined by the fact that he did not receive a uniform 70 percent of Oakford's profits each month but rather received each month a different and random percentage of Oakford's profits. McCarthy asserts that this factis inconsistent with an agreement to share in profits. The alleged discrepancies between the percentage of profits that McCarthy believed he was paid and Oakford's calculation resulted from the fact that Oakford based its payments to McCarthy on 70 percent of the net profits as shown in the account statements provided by its clearing broker. The clearing broker subtracted items such as clearing fees from its calculation of net profits. McCarthy did not subtract such fees in his own calculations, although he testified that he was aware of their existence. In any event, any small monthly difference in the percentage of profits that Oakford paid McCarthy does not contradict the record evidence that net profits were the basis for McCarthy's compensation for his trades for the Oakford account.13
B. McCarthy Exercised Discretion Over the Trading Activity of the Oakford Account
McCarthy violated Exchange Act Section 11(a), Exchange Act Rule 11a-1, and NYSE Rule 95(a) when he traded for the Oakford account while at the same time exercising discretion over that account's trading activity. On a number of occasions, McCarthy had discretion with respect to whether to execute trades for the Oakford account and whether the trades would be purchases or sales. On four occasions established on this record, McCarthy executed an order for the Oakford account contrary to the instructions on the order ticket. In three of these trades, McCarthy executed a buy on a plus tick even though the order instructed him to sell on a plus or zero-plus tick. In one trade he executed a short sale on a minus tick even though the order instructed him to buy on a minus or zero-minus tick. In thesetrades McCarthy ignored Oakford's order instructions and used his discretion to trade for the Oakford account.14
On seven other occasions established on this record, McCarthy executed trades prior to the time-stamp on the corresponding order tickets. This indicates that McCarthy had discretion as to whether to execute a trade and that only after executing the trade did he create and time-stamp an order ticket. On one of these occasions, McCarthy executed buy and sell orders in the same stock for the same number of shares one-half hour apart, but the order tickets for both trades were time-stamped six minutes after the second trade occurred. These two trades generated a $500 profit for the Oakford account. In addition, eleven of the 62 order tickets that McCarthy provided to the Exchange were not time-stamped. This evidence indicates that McCarthy used the time and place advantages available to him as a floor broker to determine the most advantageous times to execute profitable trades for the Oakford account.
McCarthy claims that missing or incorrect time-stamps on order tickets are circumstantial evidence that do not establish that he engaged in discretionary trading but rather are the result of simple errors or oversights. McCarthy was a clerk on the floor of the Exchange for eight years before he became a floor broker, and he testified that he was aware of the requirement that order tickets be time-stamped when the order is received on the floor of the Exchange. McCarthy further testified that he informed his clerks of this requirement and that they were diligent in following it. His attempt to justify his misconduct on the basis of errors and oversight does not withstand scrutiny.
C. McCarthy Accorded the Oakford Account Preferential Treatment
The Exchange has established that, in violation of NYSE Rules 91 and 92, McCarthy accorded preferential treatment to the Oakford account over the other accounts for which he traded. In 21 instances established on this record, McCarthy executed a trade for the Oakford account ahead of or along with a customerorder in violation of NYSE Rule 92. McCarthy was able to time the execution of these trades for the Oakford account with customer trades in such a way as to maximize the potential profit for, and minimize potential loss in, the Oakford account. This pattern of trading allowed McCarthy to use the time and place advantages available to him as a floor broker to provide a safety net for the Oakford account.
On 14 occasions, McCarthy crossed trades for the Oakford account with trades for his customers without following the requirements of NYSE Rule 91.15 By doing so, McCarthy traded as principal with his customers, in violation of his duty to act in the best interests of his customers and in violation of the fundamental principles of agency law embodied in NYSE Rule 91.
McCarthy's only defense to what he describes as these "derivative allegations" is to repeat his arguments that he did not have an interest in, or discretion over, the Oakford account and, therefore, treated the Oakford account as he would have treated any customer account. As discussed supra, we have rejected McCarthy's arguments regarding his interest in, and discretion over, the Oakford account and, accordingly, they fail to support his claim that he that he did not violate NYSE Rule 91 and 92. We find, as did the Exchange, that McCarthy violated NYSE Rules 91 and 92 by trading for the Oakford account ahead of, along with, and crossed with his customer orders.
D. McCarthy Failed to Make and Preserve Required Records
McCarthy admits that he failed to make and preserve required records relating to his trades for the Oakford account inviolation of Exchange Act Rules 17a-3 and 17a-4 and NYSE Rules 123 and 440. Exchange members are required to preserve for at least three years a record of every order originated or received by that member.16 The record must include the name and amount of the security, the terms of the order, and the time when such order was received.17
McCarthy admitted in testimony that his records "were sometimes inaccurate and incomplete." As indicated above, McCarthy produced only 62 order tickets for trading occurring on 21 trading days during January and March 1996. Eleven of these 62 order tickets were not time-stamped. The Exchange also has established that commission bills that McCarthy submitted to Oakford for September 1995 through March 1996 were incomplete and inaccurate. They contained only the symbol for the stock trade and the daily net profit and did not contain information as to the number of shares traded, the price, whether the transactions were purchases or sales, or the amount that McCarthy believed was due as commission. We conclude that McCarthy's failure to make and preserve these records constitutes a violation of the recordkeeping requirements of Exchange Act Rules 17a-3 and 17a-4 and NYSE Rules 123 and 440.
We conclude, as did the Exchange, that McCarthy violated Exchange Act Section 11(a), Exchange Act Rule 11a-1, and NYSE Rules 91, 92, and 95(a) in the course of trading as a floor broker on the floor of the Exchange and violated Exchange Act Rules 17a-3 and 17a-4 and NYSE Rules 123 and 440 by failing to make and preserve required records.
McCarthy makes a number of arguments that this disciplinary proceeding was deficient on procedural and due process grounds.
A. McCarthy objects to the Board's decision (1) to find violations based on the Hearing Panel's factual findings, and (2) to add a two-year suspension to the sanctions imposed on remand by the Hearing Panel. According to McCarthy, the "double appeal" of the Hearing Panel's determinations and the resulting Board rulings, which occurred on two separate occasions, constitute an unprecedented attempt by the Board to substituteits judgment for that of the Hearing Panel and were based on improper motives rather than record evidence.
McCarthy contends that the Board must affirm a decision of an NYSE hearing panel unless that decision is "arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law." This standard, which McCarthy takes from the Administrative Procedure Act, applies to judicial review of an administrative agency's action.18 It is not the standard applicable to the Board's review of a decision by an Exchange hearing panel. Rather, NYSE Rule 476(f) sets forth the applicable standard, authorizing the Board to modify or reverse any hearing panel determination and to increase the sanction imposed by the hearing panel "as it deems appropriate."19 Contrary to McCarthy's insistence, this provision does not require the Board to defer to the hearing panel's conclusion as to whether the allegations have been proven or to the Hearing Panel's choice of sanction.20
McCarthy also complains that the Board's decisions lack "specific explanation." McCarthy speculates that the Board simply concluded that he committed the alleged violations based upon the argument of the NYSE's Division of Enforcement that Oakford had entered into violative profit-sharing arrangements with other floor brokers. The record is to the contrary, however -- the NYSE's Enforcement Division did not argue and the Board did not base its rulings on an argument of "guilt-by-association." The Board explained in its first decision that the violations at issue were in fact established on the extensive record developed by the Hearing Panel, written submissions by the parties, and oral argument. The Board made clear that it accepted the Hearing Panel's factual findings but concluded thatthe majority of the Hearing Panel "erred" in concluding, from those findings, that McCarthy was "not guilty" of the specified charges. As indicated above, we agree with the Board's conclusion and independently have found that the record supports the violations as found by the Board.
Furthermore, with regard to the sanction, the Board explained in its second decision that, acting pursuant to NYSE Rule 476(f), and after "consideration of the record in this matter, which included the penalty decision issued by the Hearing Panel on remand, written submissions filed by the parties and oral argument," it was modifying the decision of the Hearing Panel by including a two-year bar from membership and employment in any capacity on the floor of the Exchange. The Board concluded that "this penalty is appropriate in light of Exchange precedent and the particular facts and circumstances of this case." Indeed, as we explain in greater detail, infra, the modified sanctions imposed by the Board are more consistent with the Exchange's obligation to hold its floor brokers to the highest standards of honesty and integrity than those imposed by the Hearing Panel.21
McCarthy also alleges that the Board erred when it reversed the Hearing Panel's findings of violation and sanctions determination. McCarthy asserts that the Hearing Panel found him to be a credible witness, believed his testimony that his violations were the result of his inexperience as a floor broker and because McCarthy's clerk time-stamped certain relevant orders in rapid succession, and "[a]pparently, the Hearing Panel also found credible the testimony of the two character witnesses who testified for McCarthy at the hearing." McCarthy further argues that the penalty imposed by the Hearing Panel "for the most part, was determined by assessment of witness credibility." According to McCarthy, therefore, the Board had an "obligation to give substantial deference" to the Hearing Panel's findings of violation and its sanction determination.
McCarthy's argument in this regard misses the point. His asserted lack of experience as a floor broker and his asserted good character did not relieve him from the requirements of the federal securities laws and NYSE rules. This is especially true here, where his violations go to the heart of the duties a floorbroker owes a customer. The Board's findings of violation and its sanctions determination are fully supported by the record evidence.
B. McCarthy next contends that he is being sanctioned on the basis of regulatory interpretations and prohibitions that were promulgated subsequent to the events in question and, therefore, that he lacked fair and timely notice that his arrangement with Oakford was prohibited.22 McCarthy makes this argument despite his own testimony that he knew, at the time that he was trading for the Oakford account, that it was a violation of NYSE rules to receive compensation based on a percentage of the profit generated by his trades for an account. Given this testimony, we are at a loss to understand how McCarthy can claim that he lacked fair notice that his conduct was prohibited.
McCarthy rests his claim of lack of fair notice on United States v. Oakford Corp.23 He argues that the district court determined that the Exchange adopted a flexible interpretation of the ban on a floor broker's trading for an account in which the broker has an interest and argues that this interpretation did not provide him with notice that his Oakford compensation violated Section 11(a) and Rule 11a-1. In so doing, McCarthy ignores the district court's conclusion in Oakford Corp. that, while the Exchange interpreted the ban on trading for one's own account "somewhat more flexibly"24 than the bright-line rule subsequently articulated by the Commission,25 floor brokersnonetheless long have been aware of the potential for violating Section 11(a) and Rule 11a-1 if they share in a customer's profits.26 The court based this conclusion in part on a 1992 report of a study on the practice of flipping that the Exchange had commissioned. That report noted that the Exchange viewed trades by a floor broker for an account in which the broker was a partner as a violation of Section 11(a).27 In any event, we find, as we did in another NYSE appeal recently before us, that Section 11(a), Exchange Act Rule 11a-1, and the related NYSE rules are sufficiently specific to put McCarthy on notice that he was prohibited from trading for the Oakford account because he was sharing in the profits and losses of that account.28
C. McCarthy argues that the Exchange unfairly and unreasonably delayed taking disciplinary action against him. The Exchange issued its charges in June 2000, approximately two years after it learned that McCarthy was one of the floor brokers with whom Oakford maintained a trading account. This does not, as McCarthy would have it, constitute an "inordinate time delay" that could render disciplinary action "inherently unfair."29 Furthermore, McCarthy makes no claim that any witnesses or documents were unavailable as a result of the alleged delay on the part of the Exchange and, therefore, has failed to establish that he was prejudiced as a result.
The NYSE censured McCarthy, imposed a $75,000 fine, and barred him for two years from Exchange membership or employment in any capacity on the floor of the Exchange. We review sanctions imposed by the NYSE to determine whether those sanctions are excessive or oppressive, or whether they impose an unnecessary or inappropriate burden on competition.30 We see no basis for reducing the sanctions. As we have consistently held, the appropriate sanction depends on the facts and circumstances of each particular case.31
McCarthy argues that the sanctions imposed are unduly severe.32 McCarthy violated the principles of commercial honor and trust that are the hallmark of the exchange auction market system. His violations go to the heart of the duties a floor broker owes a customer. He used the time and place advantages available to him in his position as a floor broker to advantage the Oakford account, an account in which he had an interest and over which he exercised investment discretion. He placed his own interests above the interests of his customers.
McCarthy's conduct was not an isolated incident but rather involved ongoing, numerous improper trades that occurred over the course of nearly a year. As McCarthy admitted, he knew that it was a violation of NYSE Rules to receive compensation based on the profitability of trades. His violative conduct stopped not because of any recognition that his conduct was improper, but only because he determined, according to his own testimony, that such conduct was not "economically feasible" because it resulted in too little profit given the amount of time McCarthy spent trading for the Oakford account.
McCarthy asserts that the Exchange failed to consider a number of mitigating factors in its sanctions determination, such as his youth, inexperience, and otherwise unblemished record. The Exchange argues in its brief to the Commission that the suspension imposed by the Board, limited as it is in scope and duration, is evidence that the Board took into account such mitigating factors. The NYSE notes in its brief that the two-year bar on membership and employment on the floor of the Exchange is not a plenary bar and that it allows McCarthy to work in the securities industry. In light of these considerations and
the serious misconduct established by the NYSE, we find that the sanctions imposed by the NYSE are fully warranted. An appropriate order will issue.33
By the Commission (Commissioners GLASSMAN, GOLDSCHMID and ATKINS); Chairman DONALDSON and Commissioner CAMPOS, not participating.
Admin. Proc. File No. 3-10999
In the Matter of the Application of
EDWARD JOHN MCCARTHY
For Review of Disciplinary Action Taken by the
NEW YORK STOCK EXCHANGE, INC.
ORDER SUSTAINING DISCIPLINARY ACTION TAKEN
BY NATIONAL SECURITIES EXCHANGE
On the basis of the Commission's opinion issued this day, it is
ORDERED that the disciplinary action taken by the New York Stock Exchange, Inc. against Edward John McCarthy, be, and it hereby is, sustained.
By the Commission.
Jonathan G. Katz
1 15 U.S.C. § 78k(a). Section 11(a), subject to certain exemptions not relevant here, makes it "unlawful for any member of a national securities exchange to effect any transaction on such exchange for its own account, the account of an associated person, or an account with respect to which it or an associated person thereof exercises investment discretion." For a discussion of the regulatory framework governing floor brokers and their trading for accounts in which they have an interest or over which they exercise discretion, see John R. D'Alessio and D'Alessio Securities, Inc. , Exchange Act Rel. No. 47627 (Apr. 3, 2003), 79 SEC Docket 3627, appeal pending, No. 03-4883 (2d Cir.).
2 17 C.F.R. § 240.11a-1. Rule 11a-1, with certain exceptions not relevant here, prohibits an exchange member, while on the trading floor, from initiating any transaction in any security traded on the exchange for any account "in which such member has an interest, or for any such account with respect to which such member has discretion."
3 NYSE Rule 95(a) provides that "[n]o member while on the Floor shall execute or cause to be executed on the Exchange, . . . any transaction for the purchase or sale of any stock with respect to which transaction such member is vested with discretion as to (1) the choice of security to be bought or sold, (2) the total amount of any security to be bought or sold, or (3) whether any such transaction shall be one of purchase or sale."
4 NYSE Rule 91 prohibits a member from crossing trades of a customer with an account in which the member or its member organization, among others, "is directly or indirectly interested," without first ensuring that the order has an opportunity for an improved price on the Exchange floor and providing notification to, and obtaining acceptance of the trade from, the member who placed the trade.
5 NYSE Rule 92 prohibits a member from purchasing or selling a security for an account in which the member or its member organization, among others, "is directly or indirectly interested" while holding an unexecuted order for a customer on the same side of the market.
6 NYSE Rule 123, among other things, requires exchange members to preserve for at least three years a record of every order originated or received by the member. The record must include the name and amount of the security, the terms of the order and the time when such order was received.
NYSE Rule 440 requires brokers and dealers to make and preserve books and records prescribed by the NYSE and by Exchange Act Rules 17a-3 and 17a-4.
Exchange Act Rules 17a-3 and 17a-4 require brokers and dealers to make and preserve current books and records regarding executed securities transactions and customer accounts. 17 C.F.R. §§ 240.17a-3 and 240.17a-4.
7 A zero-minus tick securities trade takes place at the same price as the previous sale but at a lower price than the last different price. A zero-plus tick securities tradetakes place at the same price as the previous sale but at a higher price than the last different price.
8 A short sale on a minus tick also is a violation of NYSE Rule 440B(a)(1)(i), which specifies, in pertinent part, that:
[n]o person shall, for his own account or for the account of any other person, effect a short sale of any [registered] security . . . (A) below the price at which the last sale thereof, regular way, was reported pursuant to an effective transaction reporting plan; or (B) at such price unless such price is above the next preceding different price at which a sale of such security, regular way, was reported pursuant to an effective transaction reporting plan.
9 The Hearing Panel also determined by a unanimous vote that the Exchange's Division of Enforcement had failed to establish that McCarthy violated NYSE Rule 95(c) by representing market orders at the minimum variation on both sides of the market. NYSE Rule 95(c) states that:
If a Floor broker acquires a position for an account during a particular trading session while representing at the same time, on behalf of that account, market or limit orders at the minimum variation on both sides of the market, the broker may liquidate or cover the position established during that trading session only pursuant to a new order (a liquidating order) which must be time-recorded upstairs and upon receipt on the trading Floor.
The Hearing Panel concluded that Rule 95(c) applied to limit orders, not market orders, because market orders are by definition executable without regard to variations. Given this perceived ambiguity, the Hearing Panel found that McCarthy had not violated Rule 95(c).
10 The Board also affirmed the Hearing Panel's finding that the Exchange's Division of Enforcement failed to establish that McCarthy violated NYSE Rule 95(c).
11 As we recently stated in D'Alessio, "any compensation arrangement that results in the exchange member sharing in the trading performance of an account, however structured, makes the account that member's 'own account,' or constitutes an 'interest' in the account." John R. D'Alessio, 79 SEC Docket at 3637, citing New York Stock Exchange, Inc., Exchange Act Rel. No. 41574 (June 29, 1999), 70 SEC Docket 153, 156 (Order Instituting Public Proceedings Pursuant to Section 19(h)(1) of the Securities Exchange Act of 1934, Making Findings and Ordering Compliance With Undertakings).
12 The Exchange offered expert testimony that, during the period at issue, floor brokers knew that it was impermissible to be compensated on the basis of the profits accruing to the account for which they were trading. This expert witness was Kenneth Polcari, a member of the Exchange who has been working on the floor of the Exchange since 1985, has been a floor official since 1997 and, at the time of the hearing, was co-president of the Organization of Independent Brokers.
13 McCarthy also argues that two NYSE hearing panels have declined to find profit-sharing arrangements when faced with calculations showing inconsistent percentages of profit payments. These cases are distinguishable from McCarthy's case. In one case, the Exchange hearing panel dismissed the case because the Exchange's Division of Enforcement maintained that the floor broker consistently received 70 percent of the profits and the hearing panel determined that he had not received this percentage. In the other case, the hearing panel determined that the Exchange's Division of Enforcement had failed to establish that the floor broker was responsible for many of the trades made for the trading account in question.
14 This manner of executing trades contrary to Oakford's instructions and Oakford's failure to reject any of these unauthorized trades led the Exchange's expert witness to conclude that McCarthy's trades for the Oakford account were not executed for a "real customer," but were instead executed for an account in which McCarthy had an interest and over which he exercised investment discretion.
15 Rule 91 provides that, when crossing a customer order with the member's own account, a member may take securities for its own account, provided "(1) he shall have offered the same in the open market at a price which is higher than his bid by the minimum variation permitted in such securities, and (2) the price is justified by the condition of the market, and (3) the member who gave the order shall directly, or through a broker authorized to act for him, after prompt notification, accept the trade." A member may supply securities from its own account provided that he shall have "bid for the same in the open market at a price which is lower than his offer by the minimum variation permitted in such securities," and provided that he meets the second and third conditions for taking securities for his own account.
16 NYSE Rules 123 and 410.
18 5 U.S.C. § 706.
19 Specifically, NYSE Rule 476(f) provides that the Board:
may sustain any determination or penalty imposed, or both, may modify or reverse any such determination, and may increase, decrease or eliminate any such penalty, or impose any penalty permitted under the provisions of this Rule, as it deems appropriate.
20 See Daniel Turov, 51 S.E.C. 235, 239 (1992); see also Gary Roth, 52 S.E.C. 808, 811 n.7 (1996).
21 Cf. Turov, 51 S.E.C. at 239 (finding that the sanction imposed by the Exchange Board of Directors was based not on blind adherence to precedent but on the egregious nature of particular misconduct).
22 Due process requires that "laws give the person of ordinary intelligence a reasonable opportunity to know what is prohibited." Upton v. SEC, 75 F.3d 92, 98 (2d Cir. 1996).
23 79 F. Supp.2d 357 (S.D.N.Y. 1999).
24 Oakford, 79 F. Supp.2d at 366.
25 The court identified the source of this bright-line rule as New York Stock Exchange, Inc. , Exchange Act Rel. No. 41574 (June 29, 1999), 70 SEC Docket 153, 156 (Order Instituting Public Proceedings Pursuant to Section 19(h)(1) of the Securities Exchange Act of 1934, Making Findings and Ordering Compliance With Undertakings), our settled action in which we noted that "any compensation arrangement that results in the exchange member sharing in the trading performance of an account, however structured, makes the account that member's 'own account,' or constitutes an'interest' in the account."
26 Oakford, 79 F. Supp.2d at 366 (concluding that the NYSE did not hide from Exchange members that sharing in a customer's profits could violate Section 11(a) and Rule 11a-1).
27 Id.(citing New York Stock Exchange, Inc., 70 SEC Docket at 159. The report of the Exchange's Committee on Trading for Eighths noted that, if an independent floor broker "is compensated for his services based on the profitability of transactions in such a way that he becomes, in effect, a partner with his customer in the trade, such a broker may then become subject to the restrictions contained in Section 11(a).").
28 In that appeal, we rejected a similar argument that brokers operating on the floor of the Exchange during the period at issue here did not have fair notice that sharing in the profits and losses of an account gives the broker an interest in the account. John R. D'Alessio, 79 SEC Docket at 3644 n.44 (holding that D'Alessio, who traded for an account at Oakford from June 1994 until February 1998, had fair notice of the requirements of Section 11(a) and Exchange Act Rule 11a-1).
The October 7, 1998 letter sent to the Commission's Director of the Division of Enforcement by Richard Grasso, the Chairman and Chief Executive Officer of the Exchange, on which McCarthy also relies, lends no support to his claim of lack of fair notice. The letter, rather, reflects the Exchange's position that partnership relationships such as the arrangement that McCarthy had with Oakford in which heshared in not only the profits but the losses of each transaction -- a traditional indication of ownership -- were prohibited. For a detailed discussion of this letter see John R. D'Alessio, 79 SEC Docket at 3645.
29 William D. Hirsch, Exchange Act Rel. No. 43691 (Dec. 8, 2000), 73 SEC Docket 3597, 3605-06 (holding that the passage of approximately twenty months from the time that the Exchange learned of the misconduct until it issued charges did not result in an inherently unfair proceeding) (citing Jeffrey Ainley Hayden, Securities Exchange Act Rel. No. 42772 (May 11, 2000), 72 SEC Docket 1125, 1128).
30 Section 19(e)(2) of the Exchange Act, 15 U.S.C. § 78s(e)(2). McCarthy does not claim, and the record does not show, that the NYSE's action has imposed an undue burden on competition.
31 See Butz v. Glover Livestock Comm'n Co., 411 U.S. 182, 187 (1973); Jonathan Feins, Exchange Act Rel. No. 41943 (Sept. 29, 1999), 70 SEC Docket 2116, 2131 n.36; ChristopherJ. Benz, 52 S.E.C. 1280, 1285 (1997), petition denied, 168 F.3d 478 (3d Cir. 1998) (Table).
32 In his reply brief, McCarthy relies primarily on two NYSE cases in support of this argument. In Robert G. Puglisi, Exchange Hearing Panel Decision 03-7 (Jan. 24, 2003), the NYSE found that Puglisi executed orders for an account in which he had an interest, crossed orders for this account with those of his customers and failed to make and preserve required records. Puglisi consented to a one-month suspension and a $50,000 fine. In Anthony H. Soriano, Exchange Hearing Panel Decision 03-6 (Jan. 24, 2003), the NYSE found that Soriano committed similar violations as well as certain supervisory and net capital violations. Notably, neither of these cases involved trading ahead of or along with customer orders. In addition, in both cases, the disciplinary sanctions were consented to by the parties. As we have previously stated, "it is well established that respondents who offer to settle may properly receive lesser sanctions than they otherwise might have received based on pragmatic considerations such as the avoidance of time-and-manpower consuming adversary proceedings." Robert Sayegh, Exchange Act Rel. No. 41226 (Mar. 30, 1999), 69 SEC Docket 1307, 1315, citing Richard H. Puccio, 52 S.E.C. 1041, 1045 (1996) (citing cases).
33 We have considered all of the contentions advanced by the parties. We have rejected or sustained these contentions to the extent that they are inconsistent or in accord with the views expressed in this opinion.
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