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April 1, 2010

Former Knight Execs Exonerated

By Peter Chapman

The top sales trader at the firm then known as Knight Trading Group did not rip off his customers, nor did his superiors fail to properly police his activities.

Ken Pasternak

That was the conclusion of FINRA's National Adjudicatory Council last month when it reversed a decision by a FINRA lower court against Ken Pasternak and John Leighton.

In 2006, FINRA found that the two former Knight Trading Group (now Knight Capital Group) officials failed to properly supervise their top sales trader, Joseph Leighton, who, the court concluded, had bilked his institutional customers.

At the time, FINRA fined Pasternak and John Leighton $100,000 each, barred John Leighton from all supervisory capacities and suspended Pasternak from all supervisory capacities for two years. The new ruling vacates those sanctions.

Pasternak was a co-founder and chief executive of Knight from 1995 to 2002; John Leighton was head of institutional sales at Knight from the firm's inception until 2000; Joseph Leighton, his brother, was Knight's top sales trader from 1996 to 2000.

John Leighton

In 2005, Joseph Leighton settled charges brought by FINRA and the Securities and Exchange Commission that he engaged in deceptive trading practices. He paid a $4 million fine. Half the money was distributed to money management firms he was alleged to have cheated.

Pasternak and John Leighton chose to fight FINRA and the SEC over the charges of poor supervision. They lost the FINRA case, but immediately appealed. They beat the SEC's charges in a federal court in 2008.

The logic behind FINRA's latest ruling was similar to that of the federal judge in the SEC case: Joseph Leighton did nothing wrong. Neither did Pasternak nor John Leighton.

Joseph Leighton's conduct was at the heart of the matter. FINRA and the SEC accused him of filling customer orders at prices that generated outsize profits for Knight. The regulators alleged that his method of filling orders diverged from standard industry practice, which was to make no more than a sixteenth or an eighth per share.

Pasternak and John Leighton successfully argued that Knight acted as a market maker when dealing with institutional customers; it was not an agent with some sort of fiduciary duty. The firm filled orders on a net basis, which meant prints occurred at the prevailing market price.

Joseph Leighton was not obligated to take into account the price Knight paid or received.

Both a federal judge and FINRA's NAC agreed, stating that there was no rule limiting the amount of profit a market maker, risking its capital, could make.

"I am relieved that this matter has finally been resolved and my name cleared after so many years," Pasternak said in a statement. "I look forward to re-engaging fully with the industry and carrying on my career uninhibited by these false and unwarranted accusations."

Pasternak has run hedge fund Chestnut Ridge Capital since 2003.

 

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