The Securities and Exchange Commission has sanctioned the National Stock Exchange (NSX) for failing to enforce its investor-protection rules from 1997 through 2003. As a result, the SEC said NSX failed to detect hundreds of thousands of transactions in which NSX dealers cheated their clients.
The SEC also settled its civil action against NSXs president and chief executive officer, David Colker, for his failure to enforce compliance with an NSX rule.
Specifically, the SEC found that NSX violated Section 19(g) of the Securities Exchange Act of 1934 (Exchange Act) by failing until 2004 to conduct surveillance for violations of its customer priority rule, an important investor protection that prohibited NSX dealers from trading securities for their own accounts ahead of marketable customer orders.
The SEC also found that NSX and Colker did not enforce NSXs market order exposure (MOE) rule in a manner consistent with the rules language. The rule required NSX dealers to provide customer market orders with the opportunity for price improvement whenever the spread between the national best bid and offer was greater than the minimum price variation.
In 1997, when the minimum price variation decreased from 1/8 to 1/16 of a point, NSX continued enforcing the rule at spreads of 1/4 point or greater instead of at 1/8 point or greater. At Colkers direction, NSX did not file a proposed rule amendment with the SEC seeking approval for its limited enforcement of the MOE rule, although NSX was required to do so.
Colker made this decision, in part, because he wanted to avoid exposing a proposed rule amendment to a public notice-and-comment process. Consequently, public customers lost opportunities for potential price improvement on thousands of market orders executed on NSX from 1997 to 2003.
Self-regulatory organizations must vigorously enforce their own rules and the federal securities laws. This settlement will further safeguard investors by strengthening NSXs regulatory functions, said Linda Chatman Thomsen, Director of the SECs Division of Enforcement.
As part of the settlement, NSX agreed to separate its regulatory functions from its business functions by, among other things, appointing an independent chief regulatory officer to supervise NSXs day-to-day regulatory affairs. NSX also agreed to implement automated daily surveillance for potential violations of several NSX and Exchange Act order-handling rules, and to earmark $1 million for two separate regulatory audits of NSXs surveillance, examination, investigation, and disciplinary programs over a three-year period.
Colker consented, without admitting or denying the findings in the SECs Order and Complaint, to the imposition of a censure and, subject to court approval, to the entry of a final judgment in the U.S. District Court for the Northern District of Illinois ordering him to pay a $100,000 civil penalty. Under the terms of the SECs Order, Colker and his successors will have no future role in NSXs regulatory functions.
