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December 1, 1998

Trader Sanctioned for Harassment of Market Maker

By Jeffrey L. Winograd

What happens when a trader is upset because a competing market maker narrows the spread in a Nasdaq security? Generally, most traders will take their lumps.

Besides, traders are accustomed to forces at work limit-order display rules and quotations in sixteenths among them that tend to naturally narrow spreads.

But suppose an unhappy trader engages in behavior that is deemed anti-competitive by the regulatory arm of the National Association of Securities Dealers? Most likely, the trader will be sanctioned, if not severely penalized.

In the recent past, allegations of anti-competitive behavior by market makers were at the root of a bruising investigation of Nasdaq by the Securities and Exchange Commission and the U.S. Justice Department.

Isolated Case

A later case of anti-competitive behavior that recently came to light, shows once again how seriously regulators view the practice. The isolated offense was perpetrated by a trader on Oct. 7, 1996 when he sold a competiting Nasdaq market maker 2,000 shares of stock in Oak Technology. The market maker in question was quoting a narrower market than the trader's desk.

An NASD hearing panel concluded that the trader broke up the order, selling only 100 shares of the stock in 20 separate fills, instead of executing two trades of 1,000 shares, which was the buyer's displayed size.That resulted in an unusually longer period executing, reporting and confirming the trades.

During a 93-minute time span, between 2:25 p.m. and 3:58 p.m., the trader telephoned the competing market maker 20 times to execute the 2,000 shares in order "to harass [the market maker] for narrowing the spread."

The trader was censured by NASD Regulation, fined $15,000, and ordered to take and pass the NASD's Series 55 examination for equity traders before December 9.

Furthermore, the trader's employer was fined $20,000 and censured "for failing to establish, maintain, and enforce adequate written supervisory procedures to prevent anti-competitive activities," according to an NASD Regulation press release in November.

An NASD Regulation official described the episode as being an isolated case of a trader running amok.

"This is not a trend at all, it's kind of a bizarre little event," Stephen Lupurello, vice president of market regulation for NASD Regulation, told Traders Magazine during a telephone interview. "When we see it, we hit it hard."

The case was brought to the attention of regulators by the market-making firm that narrowed its spread. Nonetheless, Lupurello stressed that NASD Regulation is quite capable of spotting patterns of anti-competitive practices.

"NASD Regulation has a system looking for patterns of conduct that may indicate evidence of harassment," he said.

An action by NASD Regulation is irrevocable after 45 days, unless the case is appealed or is subjected to a review.