BUSINESSWEEK ONLINE : AUGUST 9, 1999 ISSUE
FINANCE

The NYSE: A Street Scandal That May Not Die
What did it know about illegal trading?

In recent days, word has emerged from the New York Stock Exchange about plans for a possible initial public offering of stock. There are plenty of obstacles to an IPO, but one seems to have been surmounted: The NYSE's floor broker trading scandal is at an end. Ten floor brokers--part of the army of people who execute large trades on the NYSE floor--were accused of abusing their positions by carrying out trades for their own profit. Nine of the 10, all trading at an obscure brokerage called Oakford Corp., have pleaded guilty. And on June 29, the NYSE emerged mostly unscathed from a Securities & Exchange Commission enforcement action. The NYSE pledged to beef up its oversight of floor brokers--which, the SEC maintained, has been woefully deficient for years.

But in fact, reverberations from the floor-trading scandal may not be over for the nation's most prestigious stock exchange. In announcing the NYSE settlement, the SEC disclosed that federal prosecutors have ''probable cause'' to believe that 64 floor brokers illegally traded for their own profit in recent years. The U.S. Attorney's office in Manhattan is continuing its probe into trading-floor chicanery. And prosecutors have received explosive allegations from a central figure in the scandal: Oakford President William S. Killeen.

FULLY AWARE. Killeen, who pleaded guilty to two felony charges, has made grave allegations against major Wall Street firms and personalities--including NYSE Chairman Richard A. Grasso, who Killeen insists was aware of improper trading by floor brokers. He also maintains that floor brokers for Goldman, Sachs & Co. (GS) and other firms engaged in improper trading and that the largest specialist firm on the NYSE, the white-shoe brokerage Spear, Leeds & Kellogg, was fully aware of Oakford's illegal use of floor brokers to trade stocks. That is denied by Spear.

Killeen disclosed these allegations in hours of recent conversations with former American Stock Exchange trader-turned-whistle-blower Edward Manfredonia. Manfredonia, who has alleged that Amex traders have engaged in extensive misconduct (BW--Apr. 26), was introduced to Killeen by a friend of Killeen's. Manfredonia says he released tapes of the talks to business week because he believes Killeen was unfairly singled out. Beyond confirming portions of his conversations with Manfredonia used in preparation of this article, Killeen declined to be interviewed, citing his upcoming sentencing.

To be sure, Killeen's allegations are, to a large extent, self-serving. Moreover, they apparently were part of an unsuccessful effort to obtain lenient treatment from prosecutors. On May 20, Killeen pleaded guilty to one count of income-tax evasion and one count of securities fraud, and he will be sentenced on Sept. 21. Killeen has maintained that in his meetings with the U.S. Attorney's office in Manhattan before the plea, prosecutors rebuffed his efforts to provide information. ''They only want to hear [about] Oakford. They don't want to hear [about] other firms,'' Killeen bitterly told Manfredonia.

Oakford, Killeen maintains, was not alone in profiting from trading by floor brokers, which the government says violates the securities laws. That point, indeed, is repeated by Killeen throughout his conversations with Manfredonia. He noted that he ''did business'' with 150 floor brokers over a six-year period, and asserted that ''there are 60 different firms, broker-dealers as my own, that do this kind of business day in and day out with the floor brokers on the floor.''

According to the February, 1998, indictment and subsequent SEC charges, Killeen oversaw a scheme in which 10 independent floor brokers engaged in short-term trading on the NYSE floor, splitting the profits from the trades with Oakford. Floor brokers execute trades--usually large, institutional orders--at the various specialist booths on the exchange floor. (Specialists are brokerage firms that buy and sell particular stocks and are required to maintain an orderly market in those shares.) Traditionally, floor brokers get a small commission for each trade, even as little as $2--hence their nickname ''two-dollar brokers.''

Federal securities laws and NYSE rules bar floor brokers from trading for their own personal profit. That is because floor brokers get information on buy and sell orders, and other information on the flow of orders. This is not publicly available and would give them an unfair advantage over other investors.

But defense lawyers in the Oakford case have argued that personal trading by floor brokers has been such an accepted practice in recent years that their clients did not have criminal intent and thus did not commit a crime. And they asserted that arrangements in which brokers share in the profits of trades, without necessarily having their names on the accounts, had been sanctioned for many years by the exchange, and were explicitly banned only last October. There is no dispute, however, that it has always been illegal for floor brokers to initiate trades for their own profit. NYSE officials declined comment on assertions regarding widespread improprieties, saying doing so would conflict with their SEC settlement.

In his wide-ranging conversations with Manfredonia, which took place during the week of July 19, Killeen expanded considerably on these assertions. Killeen says that as many as half the 500 floor brokers on the exchange floor--250, vs. the 64 suspected by the government--have been involved in illegal trading and that Oakford's trading practices were common knowledge. ''There's nobody that didn't know,'' he told Manfredonia. ''And anybody that tells you they didn't know is a liar.''

''LUDICROUS.'' Killeen says he has provided prosecutors with the names of more than 100 floor brokers who have traded illegally, for their own profit. The U.S. Attorney's office declined comment, while an NYSE spokesman describes Killeen's assertion that 250 brokers traded illegally is ''ludicrous.''

Still, Killeen's contentions regarding the breadth of the scandal dovetail with the public record and flesh out defense assertions that the practices alleged by the government are widespread at the NYSE. In its settlement with the NYSE, the SEC found that from 1993 to 1998 ''groups of independent floor brokers'' engaged in illegal trading schemes, and the NYSE ''failed to take appropriate action'' to root out such activity.

Defense lawyers for the 10 accused floor brokers--nine of whom pleaded guilty--cited even higher numbers than the 64 noted in the consent decree. In a letter to Judge Jed S. Rakoff on Apr. 30, on behalf of all the defendants, defense lawyer Victor J. Rocco noted that an NYSE survey in 1993 found that 230 floor brokers and 10 of the 40 specialist units ''engaged in intraday trading in over 200 stocks'' for personal profit. This, he asserted, supported the defense's view that improper trading was widespread. However, some of the intraday trading cited in the survey-- aimed at capturing bid-ask spreads--was legal for brokers at the time. NYSE officials would not release the survey.

Some of Killeen's most serious allegations concern the firm that cleared trades for Oakford from 1992 to 1998--Spear Leeds. He says Spear Leeds was intimately involved in the operations of Oakford. His firm, he notes, had a ''joint back office'' arrangement with Spear that gave Spear a particularly intimate role in the oversight of Oakford. Joint back offices or ''jbos'' are an arrangement that's becoming more commonplace on Wall Street, in which large clearing firms become partners with small day-trading firms, allowing smaller firms to obtain far greater leverage than they could on their own. But the trade-off for this leverage is oversight--because the larger firms can take on, if they choose, substantial credit risk.

Killeen says that Spear lent his firm up to $30 million a day and that Oakford was thus a large and valued customer. Carl H. Hewitt, Spear's general counsel, says he is not aware of the volume of business Oakford conducted.

Killeen repeatedly insisted, in conversations with Manfredonia, that Spear became intimately acquainted with its jbo partner Oakford--including its use of floor brokers to trade for their own profit. To say otherwise, Killeen asserts, is ''ridiculous.'' He has maintained that ''every trader that came on my desk, they [Spear Leeds] approved,'' and that a Spear managing director named Randy W. Frankel personally approved the often-sizable checks issued to floor brokers as their piece of the profits, as much as $100,000 at a time. Frankel was on sabbatical from Spear Leeds and unavailable for comment.

FREQUENT VISITS. Killeen maintained that Spear Leeds ''knew who was trading for us, how much they were trading, what stocks they were trading, when they were paid, [and] how much they were paid.'' Among the Spear officials who were aware of floor brokers trading for Oakford, he maintains, were four of the nine members of the firm's executive committee--Harvey Silverman, Gary Goldring, Robert Luckow, and Frankel. Killeen says that Silverman frequently visited Oakford offices and twice offered to make Oakford a unit of Spear Leeds. Silverman and Goldring did not return phone calls, and Luckow was out of the office and unavailable for comment. But Hewitt says he ''spoke to everyone involved and can confirm to you that the allegations are untrue.''

By Killeen's account, his relationship with Grasso was also close. He maintains that he has told prosecutors that Grasso and he were friends, and that the Big Board chairman was familiar with his method of doing business and aware of trading by Oakford's floor brokers--who constituted the majority of Oakford's traders. He observed to Manfredonia that he and Grasso had breakfast meetings ''seven or eight'' times, including a January, 1997, meeting with Grasso, which he says was attended by Edward J. Mueger, one of the 10 floor brokers indicted with Killeen, who is described by Killeen as an old friend of Grasso. An NYSE spokesman says that while Grasso has met Killeen, he was never told by Killeen about trading by floor brokers. Mueger, whose Long Island phone is disconnected, could not be reached for comment. An NYSE spokesman declined to comment on Grasso's relationship with Mueger.

Defense lawyers in the Oakford case had argued that the NYSE sanctioned the conduct of their clients. Indeed, New York lawyer Dominic F. Amorosa, who won dismissal of charges against floor broker John R. D'Alessio, supports Killeen's assertions about Grasso. While saying that he doesn't know of the meetings referred to by Killeen, he asserts that ''Grasso and the people at the New York Stock Exchange were aware of what these guys were doing.'' Amorosa describes as an ''interesting issue'' whether ''that puts Grasso in the middle of criminal conduct.'' An NYSE spokesman says Grasso cannot comment on Amorosa's comments because D'Alessio remains an NYSE member, albeit suspended, and thus ''is subject to the regulatory jurisdiction of the NYSE.'' He says Grasso denies knowing of ''violative or illegal activity'' among floor brokers.

Killeen maintains that many major brokerages profit from trading by the floor brokers on their payrolls. ''If they [floor brokers] see something good on the floor, they just go over to tell their desk 'clock a buy' [or] 'clock a sell,' whatever they're going to do, and they execute the trade.'' According to Killeen, Goldman floor brokers have a separate, segregated trading account, ''and they get their bonus based on their account.''

Killeen says he saw a Goldman Sachs broker initiating a trade for the firm in 1997, during one of his frequent visits to the floor. ''He [the Goldman floor broker] did it while we were together on the floor, right in front of me.''

The stock involved in the trade, he says, was Dayton Hudson Corp. ''He just saw the stock was getting very active and he says: 'The stock's going to break here. It's going to go up.' He says: 'I'm going to buy some for my account.''' A Goldman spokesperson released a statement saying: ''We have not been contacted by any regulatory authority regarding these allegations and are unaware of any such activity.''

An official of the U.S. Attorney's office in Manhattan declined comment on any of Killeen's assertions, citing the investigation under way. But whatever information Killeen may or may not have tried to provide the feds, it seems the current federal probe may be limited in scope. An NYSE spokesman says the exchange itself, ''to the best of our knowledge,'' is not under investigation. Likewise, Hewitt, Spear's general counsel, says he is not aware of any probes directed at Spear stemming from the floor-trading scandal at the NYSE.

The 39-year-old Killeen is, of course, hardly a choirboy himself. Prosecutors maintained that he rode herd over a scheme to flagrantly violate the law on the floor of the nation's leading stock market. But had the NYSE floor already been sullied--by indifferent enforcement of the rules, profiteering floor brokers, and firms whose size and clout has discouraged prosecutors? It's a troubling question. And it deserves an answer.

By Gary Weiss in New York

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