The U.S. Securities and Exchange Commission today charged four brokers and a day trader with using squawk boxes to eavesdrop on the confidential order flow of major brokerages so they could front run their large orders at better prices.

The day trader, John Amore, is charged with paying brokers at Citigroup, Lehman Brothers and Merrill Lynch to provide live audio access to those firms’ internal communications, or squawk box, systems. It alleges that he directed traders working for him to listen to the pirated squawk boxes and trade ahead of the institutional orders in order to profit from price movements that resulted from execution of the large customer order. The SEC charged one former broker from Citigroup Global Markets, one from Lehman Brothers, one from Merrill Lynch, and one who was at both Merrill Lynch and Citigroup. None of the allegations have been proven.

The commission alleges that the brokers placed their telephone receivers next to the squawk boxes and left open phone connections to the day trader’s office in place for virtually entire trading days. Amore and the proprietary traders listened for indications on the squawk boxes that firms had received large customer orders and then “traded ahead” in the same securities, betting that the prices of the securities would move in response to the subsequent filling of the customer orders.

The SEC says that between at least June 2002 and September 2003, the day traders traded ahead of orders they heard on the Citigroup, Merrill, and Lehman squawk boxes on more than 400 occasions, making gross profits of at least US$650,000. The commission alleges that, in exchange for live audio access to the squawk boxes the traders compensated the brokers with commission-generating trades. Additionally, two of the brokers allegedly received cash payments.

“By divulging confidential information concerning customer orders, the brokers breached duties of confidentiality and trust they owed to their employers and to their employers’ customers. These brokers also violated their firm’s written policies requiring confidential treatment of customer information,” the SEC says.

The commission’s complaint, which was filed in the US District Court for the Eastern District of New York in Brooklyn, charges the defendants with securities fraud and seeks disgorgement of illegal profits, penalties, and an injunction against future violations.

“These brokers sold day traders real-time access to their firms’ confidential information on institutional orders to enable the day traders to profit from the information. Our joint action with the U.S. Attorney’s Office sends a clear message that such abuses will not be tolerated,” said Linda Chatman Thomsen, director of the SEC’s Division of Enforcement.

http://www.sec.gov/news/press/2005-114.htm