SEC Charges Four Brokers With Defrauding Customers in $18.7 Million Scheme

The Securities and Exchange Commission announced on October 5, 2012 that it has charged four stockbrokers with illegally overcharging customers $18.7 million. According to the SEC, the brokers, who worked on the cash desk at a New York-based broker-dealer, used hidden markups and markdowns and secretly kept portions of profitable customer trades. This is yet another example of securities fraud and stockbroker misconduct that continues to undermine investors' trust adn confidence in Wall Street.

The SEC alleges that the brokers purported to charge customers very low commissions, typically pennies or fractions of pennies per transaction, but in reality were reporting false prices when executing trades on behalf of customers. The brokers made their scheme difficult to detect because they deceptively charged the markups and markdowns during times of market volatility in order to conceal the fraudulent nature of the prices that they reported to customers. The embedded markups and markdowns ranged from a few dollars to $228,000 and involved more than 36,000 transactions during a four-year period. Some fees were altered by more than 1000 percent of what was being told to customers.

The SEC further alleged that when a customer placed a limit order seeking to buy shares at a specified maximum price, the brokers filled the order at the customer's limit price but then sold a portion of that order back to the market to obtain a secret profit for the firm. The brokers then falsely reported to the customer that they could not fill the order at the limit price. Meanwhile, the brokers also were paid millions of dollars in performance bonuses based on the fraudulent earnings they generated for their firm.

According to an SEC spokesperson, the brokers apparently believed they would get away with their scheme because they thought the high trading volumes and price volatility of the stocks traded as part of their scheme would conceal their illicit pricing scheme.

The SEC alleges that the fraudulent scheme, which took place from 2005 to 2009, worked as follows:

  • The sales brokers received a customer and gave the order to the sales trader Condron, who executed the trade.
  • The sales trader recorded the actual execution price on the trade blotter and informed the sales brokers of the execution.
  • Shortly after the trade was executed, the sales brokers examined other market executions around the time of the actual execution to determine whether the stock price fluctuated.
  • If the stock price's fluctuation was favorable to the firm and sufficient to conceal the fraud from customers, the sales brokers instructed the sales trades to record a false execution price on their internal trade blotter.
  • The sales brokers or the sales trader then reported the false execution price and the commission to the customers.

The SEC alleges that the brokers further defrauded customers by stealing portions of their profitable trades and keeping them for the firm:

  • After receiving and executing a customer's limit order to buy shares, the sales brokers looked for an opportunity to sell that same stock at a higher price than the price at which the customer's trade was executed.
  • The sales brokers then instructed the sales trader to sell a portion of that customer execution back at the higher price.
  • Rather than properly recording the actual price and quantity of the order fill, the sales trader entered a partial fill into the trade blotter, keeping the secret profits for the firm.
  • The sales brokers or the sales trader then reported a partial fill to the customer, falsely stating that they were unable to fully execute the customer's limit order.

The SEC alleged that the four brokers received substantial performance bonuses totaling more than $15.6 million based, in part, on the fraudulent earnings generated by the cash desk.

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