U.S. v. Finnerty - In the Eye of the Beholder: 'Interpositioning' As a Crime, Violation, or Nuisance

U.S. v. Finnerty - In the Eye of the Beholder: 'Interpositioning' As a Crime, Violation, or Nuisance

 
"Interpositioning" and related practices by trading floor Specialists have been directly or indirectly acknowledged by the S.E.C. for decades and are prohibited by application of specific provisions within stock exchange disciplinary rules. J. Scott Colesanti, Special Professor at the Hofstra University School of Law, teaching securities regulation and broker-dealer regulation, analyzes this case which provides a telling reminder that there are some securities offenses for which the broadly worded and expansively applied S.E.C. Rule 10b-5 nonetheless proves a difficult fit.
 
Professor Colesanti writes: For over 100 years, the storied stock exchange “trading floor” has been made possible by the Specialist, a liquidity provider obligated to the dual roles of matching customer orders and alternatively fulfilling such orders from a proprietary inventory. These dual roles have consistently posed a conflict of interest; in recent years, the Specialist has increasingly been alleged to have yielded to the conflict and profited by filling orders from his inventory while viable customer orders were pending or forthcoming (a practice known in industry jargon as “interpositioning” or, alternatively, “trading ahead”).
 
Interpositioning and related practices have been directly or indirectly acknowledged by the S.E.C. for decades and are prohibited by application of specific provisions within stock exchange disciplinary rules. Yet the attempted criminalization of the offense in 2005 was somewhat novel and a likely result of the federal government’s publicized offensive against business misbehavior. Specifically, in the wake of the scandals prompting the adoption of the Sarbanes-Oxley Act of 2002, the White House formally announced the President’s 10-point plan to return corporate responsibility and “to improve oversight of corporate America;” that plan included the goal that “each investor should have prompt access to critical information” as well as the encouragement of the Corporate Fraud Task Force within the Department of Justice to heed the “call to action” and further the goal of real-time enforcement. By the time of U.S. v. Finnerty, 13 criminal cases had been brought by the DOJ against individual Specialists, with the disappointing results including two acquittals and seven cases in which charges were dropped. Against this backdrop, Finnerty provides a telling reminder that there are some securities offenses for which the broadly worded and expansively applied S.E.C. Rule 10b-5 nonetheless proves a difficult fit.
 
In 1963, the S.E.C. released a special study of the stock markets, which concluded in relevant part that many Specialists traded excessively in their own accounts. The study prompted Rule 11b-1, which called upon the stock exchanges to adopt rules delineating the Specialists’ roles. In response thereto, the NYSE adopted Rule 104, which indirectly addresses, among other things, interpositioning where it prohibited Specialists purchases and sales for his own account “unless such dealings are reasonably necessary to permit such specialist to maintain a fair and orderly market.” [footnotes omitted]