8/3/2019 SEC Fraud Charge Against Knight Trading

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SEC and NASD File Fraud Case Against Knight Securities, L.P.

FOR IMMEDIATE RELEASE

Knight Settles and Agrees to Pay $79 Million in Disgorgement and Penalties

Washington, D.C. - The Securities and Exchange Commission today announced thesettlement of civil fraud charges against Knight Securities, L.P. The Commission issued anOrder that found that Knight defrauded its institutional customers by extracting excessiveprofits out of its customers' orders while failing to meet the firm's duty to provide "bestexecution" to the institutions that placed those orders. Without admitting or denying theSEC's findings, Knight, now known as Knight Equity Markets, L.P., agreed to pay more than$41 million in disgorgement of illegal profits, over $13 million in prejudgment interest and$12.5 million in civil penalties. Knight will also pay an additional $12.5 million in fines tosettle a parallel NASD proceeding.

In addition to the payment of over $79 million, the Order requires Knight to cease anddesist from committing or causing any future violations of the broker-dealer anti-fraud andbooks and records provisions of the Exchange Act, and censures Knight for its failure toreasonably supervise its institutional sales traders. Knight has also voluntarily agreed toretain an Independent Compliance Consultant to conduct a comprehensive review of (i)Knight's policies and procedures with respect to best execution obligations, trade reportingrequirements, limit order requirements and books and records requirements, and (ii)Knight's supervisory and compliance structure.

"Customers have a right to expect they are getting fair treatment when they entrust theirbroker with orders to buy and sell securities," said Stephen M. Cutler, Director of the SEC'sDivision of Enforcement. "That expectation is betrayed when the broker handling the orders

puts its own financial interests ahead of its customers' interests."

Paul R. Berger, Associate Director of Enforcement said, "Broker-dealers have aresponsibility to build a supervisory system that protects investors, rather than one that isdesigned to fail. Broker-dealers cannot turn a blind eye to the fraudulent activities of theiremployees and expect to avoid the consequences."

The SEC's Order found that:

Knight -- which was, at the time, one of the largest market-makers on the NASDAQ --earned over $41 million in illegal profits by failing to provide best execution to itsinstitutional customers. Specifically, Knight defrauded its institutional customers by

extracting excessive profits out of its customers' not-held orders while failing to meet thefirm's duty to provide best execution to the institutions that placed those orders. During therelevant time period, Knight, upon receipt of an institutional customer order, would acquirea substantial position in the firm's proprietary account. Rather than fill the order promptlyon terms most favorable to the customer, Knight would wait to see if its proprietaryposition increased in value during the trading day. When the prevailing market price for thestock moved significantly away from Knight's acquisition cost, Knight then filled thecustomer's order and pocketed the difference as its profit on the transaction.

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For example, Knight received a customer market not-held order to purchase 250,000shares of Applied Micro Circuits Corporation (AMCC). Over the next 18 minutes, Knightacquired 147,000 shares of AMCC at an average cost of $91.00 per share. Rather thanpromptly selling the stock to the institutional customer at Knight's cost (plus a reasonableprofit), Knight sold the AMCC stock to the customer over a period of time at an averageprofit of approximately $2.00 per share. On the entire AMCC order, Knight realized a profit

of over $1.1 million (or an average of $3.94 per share).

When the market moved unfavorably in relation to the position Knight had established tofill the institutional customer's order, Knight executed its remaining position in the order tothe customer at prices that still generated a profit for Knight. By engaging in these tradingpractices, Knight extracted enormous profits - as high as $9.00 per share - by executingtransactions that involved effectively no risk to Knight. Consequently, Knight improperlyrealized tens of millions of dollars in excessive per share profits from its institutionalcustomers.

During the same period, Knight failed reasonably to supervise Knight's former leading salestrader who was primarily responsible for Knight's fraudulent trading (Leading Sales Trader).

Knight's senior management not only allowed the Leading Sales Trader to be directlysupervised by his brother but also permitted the two to evenly split the profits generatedby the Leading Sales Trader's trading with institutional customers. The two brothers'relationship, their positions and responsibilities within the firm, and their profit-sharingarrangement created an inherent conflict of interest that contributed to a substantialbreakdown in the supervision over the Leading Sales Trader.

Knight failed reasonably to supervise Knight's institutional sales traders while they weresystematically misusing Automated Confirmation Transaction Service (ACT) trade modifiers.Knight had no written procedures, no adequate systems in place and no supervisorypersonnel to prevent Knight's sales traders from consistently misusing the modifiers over atwo-year period.

The misuse of ACT modifiers led to the sales traders' recording inaccurate execution timeson the firm's trading blotters, in violation of the books and records provisions of the federalsecurities laws. By misusing the ACT trade modifiers, Knight sales traders were able toimproperly input trades into Knight's trading system at prices that were different from theinside market at the time the trades were reported. The repeated misuse of the ACTmodifiers also limited the ability of Knight's institutional customers to detect the fact thatKnight was extracting excessive profits at their expense. By misusing ACT trade modifiers,Knight's sales traders avoided limit order protection protocols and filled more profitableinstitutional "not held" orders before certain resting limit orders placed by Knight'scustomers.

Additionally, Knight violated the books and records provisions of the federal securities laws

by failing to (i) retain email communications relating to its business, (ii) maintain apurchase and sales blotter that contained accurate information concerning the time of execution of certain trades, and (iii) include required information on some order tickets andmaintain certain order tickets for the time period required by the federal securities laws.

Accordingly, Knight willfully violated the broker-dealer antifraud provisions of the SecuritiesExchange Act of 1934 (Section 15(c)(1)(A)). Knight willfully violated multiple provisions of the books and records provisions of the Exchange Act (Exchange Act Section 17(a) andRules 17a-3(a)(1), 17a-3(a)(7), 17a-4(b)(1) and 17a-4(b)(4) thereunder). Knight failed

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reasonably to supervise pursuant to Section 15(b)(4)(E) of the Exchange Act with a view topreventing violations of Sections 15(c)(1) and 17(a) of the Exchange Act and Rule 17a-3(a)(1) thereunder.

In the NASD proceeding, the NASD found that Knight violated the broker-dealer antifraudprovisions of the Exchange Act. The NASD also found that Knight failed to supervise (i) the

Leading Sales Trader's institutional trading, (ii) the use of ACT modifiers by Knight'sinstitutional sales traders, and (iii) the use of proprietary "back book" accounts used bysome Knight employees. In addition, the NASD found that Knight (i) improperly reportedtrades to ACT, (ii) failed to file accurate U5 terminations for the Leading Sales Trader andhis brother, the supervisor of the institutional sales desk, and (iii) failed to providedocuments to the NASD in a timely manner. Knight agreed to settle the NASD's parallelproceeding without admitting or denying the NASD's findings or allegations.

The SEC's investigation is continuing as to others.