Commentary

Tim Quast
Traders Magazine Online News

We're All HFTs Now

In this guest commentary, author Tim Quast looks back at the history of HFT and how the market has evolved to where many firms now fit the definition of high-frequency trader.

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September 17, 2008

Not Guilty

Former Knight Get Vindication

By Peter Chapman

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In a federal court in Trenton, N.J., this June, Kenny Pasternak, former chief executive of Knight Trading Group, now Knight Capital Group, and John Leighton, Knight's former head of institutional sales, recently won a big victory against the Securities and Exchange Commission. The ruling brings some closure to a legal drama surrounding allegations of fraud at Knight that has dragged on for years, cost Knight $79 million, and ended the securities industry careers of three former Knight executives.

"I feel vindicated," Pasternak told Traders Magazine. "But it's unfortunate it takes five years and millions of dollars in legal bills to deal with the strong-arm tactics of the SEC."

Nine years ago, Pasternak was riding high. His wholesaling firm was benefiting from an Internet stock-trading boom fueled by retail investors chasing the next big technology thing. Volume was up. Profits were up. Hiring was up.

Some of that hiring was done to boost Knight's institutional business. Pasternak brought in John Hewitt from Goldman Sachs as president to broaden Knight's reach overseas and into other products. Hewitt, in turn, hired a 30-year sales veteran from Goldman named Bob Stellato to run institutional sales.

That's when the problems started. Within days of his hire, Stellato accused Knight's most successful sales trader, Joe Leighton, of front-running customer orders. He also accused Joe Leighton's brother John, in charge of the sales trading desk, of failing to do anything about it.

Nothing Wrong

Both men maintained they were doing nothing wrong, so Stellato took his charges to Knight's legal department and to Hewitt. Knight's chief counsel, Michael Dorsey, denied there was any wrongdoing, and so did Pasternak.

Within a year of his hire, Stellato was let go from Knight. Hewitt left the same month. Stellato decided his firing was a "wrongful termination" and took his case to NASD arbitration. Included in his charges was a "whistle-blower" charge of front-running directed against Knight.

That brought the regulators in. The NASD, now the Financial Industry Regulatory Authority, or FINRA, and the SEC began an investigation into Stellato's claims that eventually resulted in charges against Knight, Joe Leighton, John Leighton and Pasternak.

By that time, in early 2002, Pasternak had been forced out of Knight because of the firm's financial losses that accompanied the bursting of the Internet bubble. Tom Joyce, a Merrill Lynch veteran, took over as Knight's CEO in May 2002.

For Pasternak, the troubles were just beginning. The regulators' investigations culminated in charges against Pasternak and John Leighton. In early 2004, just before Knight would pay $79 million to settle SEC and NASD charges of trading misconduct, Pasternak and John Leighton received Wells Notices from the NASD and SEC, informing them of possible charges.

In March 2005, the NASD pounced, charging Pasternak and John Leighton with supervisory violations related to the alleged fraud. In August of that year, the SEC followed suit, charging the two men with complicity in the fraud, as well as supervisory violations. The SEC maintained that sales trader Joe Leighton had extracted excessively high profits from his trades with money managers.

The NASD hearing took place last year. A NASD hearing panel found the two men guilty. The SEC trial took place in federal court this spring, resulting in a decision of not guilty.