The NASDR enforcement staff's puzzling pursuit of a small-order execution system (SOES) firm for more than a year over one small trade has refueled allegations that the NASD treats small firms unfairly.
Last August, the NASD National Business Conduct Committee (NBCC, now the National Adjudicatory Council), called for review of a District Business Conduct Committee's (DBCC) dismissal of a November 1996 NASDR complaint against HMS, a so-called SOES firm based in Montvale, N.J.
Harassment and unfair treatment of SOES firms by the NASD was cited by the SEC in its 1996 settlement with the SRO. SOES firms are detested by large Nasdaq trading firms because of some SOES' traders rapid-fire trading via the automated system whereby they attempt to take advantage of stale market maker quotes. SOES abuses have been frequently cited by the NASD itself as causing wide spreads in Nasdaq stocks.
Calling the HMS case up for review was a startling move: Parties to an enforcement complaint sometimes appeal DBCC decisions, but rarely does the NBCC itself ask to take another look.
In a December hearing, the NBCC affirmed the DBCC decision.
"In my 16 years in the industry, this is the first such case I've been involved in that has been called for review, especially after the respondent won, and especially pertaining to such a minor matter," says Bill Singer, a New York City attorney who represented HMS in the case.
The NASDR complaint involved a single agency sale ticket of 1,000 shares of Intuit that had been marked long and executed through the SOES system. Short sales are not permitted on SOES.
Within a few minutes of execution, HMS put the trade in the firm's error account, indicating the customer account wasn't long. HMS covered its short position the next day, April 28, 1995. The firm took in a $9,000 profit.
According to the NASDR complaint, HMS was one of 17 firms, both large and small, under investigation for possible short selling in Intuit stock on that day. The NASD had halted trading in the stock the day before, after the announcement that the U.S. Department of Justice had rejected Microsoft's proposed acquisition of Intuit.
HMS promptly responded to the investigation, NASD documents show, by submitting the trade with the explanation it had been executed in error as a short sale. Over a year and a half after the trade, HMS was charged with violating four rules involving short selling and books and records.
The DBCC dismissed the complaint, even as HMS presented no witnesses in its defense. In a lengthy decision, the DBCC also took NASDR enforcement staff to task for its prosecution of the case. No one had questioned either the customer or HMS to determine why HMS had marked the sale long, the DBCC decision says. No one asked about the circumstances that caused HMS to discover the mistake.
"Despite the complete lack of evidence to prove that HMS knew, or should have known, that the customer account was short, NASD Regulation staff argued that HMS had the burden to prove that it made a good-faith determination that the customer account was long," says the decision. "But this argument impermissibly shifts to HMS the burden of proving compliance with the Short-Sale Rule." The firm had had no prior violations of the rules in question.
In its call for review, the NBCC gave as its reasons "to make further inquiry into the factual circumstances surrounding the alleged violation," according to an Aug. 6, 1997, letter to Singer from an NASDR associate general counsel.Brian Rubin, an NASDR enforcement department attorney, argues (in transcripts of the Oct. 15, 1997, NBCC hearing) that HMS should be held liable even if it accidentally made the short sale and followed NASD procedures of placing the trade in an error account. The DBCC misinterpreted the rules, Rubin argues.
In its Dec. 23 decision, the NBCC again faulted NASDR enforcement staff for its prosecution. Yet, the NBCC rejected HMS' argument that it was a victim of selective prosecution.
"Given all the facts of this case, the SOES connection, the isolated-one-trade fact pattern, the admission of error, the legal precedent in our favor, and the [NASD] staff's failure to properly develop and present its case, this case should never have been called for review," says Singer.
"Additionally, if the NASDR is going to put smaller members through this regulatory ordeal of winning and then having to incur additional expenses to fly to Washington for 'review,' then the member should be compensated in full for its costs and expenses," he adds. Singer claims HMS was not reimbursed for expenses.
The NASDR did not comment by press time.