In the Matter of New York Stock Exchange, Inc.

The New York Stock Exchange (NYSE) (defendant) was registered with the Securities and Exchange Commission (SEC) (plaintiff) as a national securities exchange. The NYSE’s Regulatory Group, comprising the Market Surveillance, Member Firm Regulation, and Enforcement Divisions, was responsible for enforcing compliance with the securities laws and NYSE rules. Market Surveillance included Specialist Surveillance, which was responsible for reviewing automated alerts and referring possible trading violations for investigation; and Trading Investigations, which was tasked with investigating potential violations, imposing informal discipline, and referring serious violations to Enforcement. From 1999 through 2003, specialists in NYSE member firms engaged in unlawful interpositioning and trading ahead that caused over $158 million in customer harm. The NYSE’s automated surveillance system failed to detect trading-ahead activities because the time and price-spread parameters for generating alerts were unreasonably broad; the parameters were not reduced despite indications they were overbroad; only a fraction of trading-ahead alerts generated were reviewed; a smaller fraction were referred for further investigation; despite recommendations from the NYSE’s internal-audit group and others, the NYSE failed to increase the period for reviewing alerts from a single randomly chosen day to a week; an automated system to detect interpositioning violations was not established until late 2002; and Specialist Surveillance’s procedures manual de-emphasized interpositioning detection. Violations were not adequately investigated and disciplined because Specialist Surveillance routinely referred trading-ahead and interpositioning violations for investigation under the prohibition that did not require proof of intent, which avoided referrals to Enforcement for disciplinary action, and did not pursue violations that caused small amounts of customer harm or specialist gain; Trading Investigations did not investigate whether specialists referred for investigation had engaged in additional violations and made no effort to determine whether conduct was intentional and warranted referral to Enforcement for formal discipline; repeat violations were addressed with informal discipline; and the NYSE’s trading-correspondence unit, which received customer complaints about trading ahead, took no disciplinary action if the specialist firm agreed to repay the customer. Based on the NYSE’s settlement offer, the SEC entered an order instituting public administrative proceedings, making findings, and imposing a censure and cease-and-desist order.