(Below re-published with permission from MarketsMuse.com)– Broker Rebates, Payment-for-Order-Flow and “Pay-to-Play” have become synonymous with new world order in which exchanges, dark-pool operators and high-frequency trading (“HFT”) firms, (the so-called “flashboys”) dominate the world of stock trading. While many Wall Street geniuses will argue “the genie is out of the bottle” when it comes to payment-for-order-flow, it doesn’t mean this practice is right-minded, no less legal-and it hasn’t stopped naysayers from arguing that customers’ best interests are clearly not part of the equation. A Federal judge in Nebraska seems to agree, based on his ruling last week that allows a class action lawsuit aimed at TD Ameritrade in connection with their receiving payment-for-order-flow rebates from high-frequency trading (“HFT”) (and not even sharing those rebates with customers!) to proceed. The plaintiff argument is that TD has violated best execution guidelines. Should anyone be shocked?! After all, the topic of payment-for-order-flow and barely-disclosed rebates paid to brokerages by exchanges and electronic market-making firms in consideration for routing orders to them has been a topic of spirited debate for more than several years.

Here’s the excerpt from WSJ reporting by Cezary Podkul:

Mom-and-pop investors who think their brokers are prioritizing high-frequency traders over them may soon have a chance to try to prove their case in court.

A federal judge in Nebraska this month ruled a class-action lawsuit could proceed against TD Ameritrade Holding Corp. AMTD -1.09% , one of the nation’s largest discount brokerages. In his ruling, the judge cited “serious and credible allegations of securities fraud” stemming from the company’s order routing practices.

Plaintiffs allege the discount brokerage prioritized its profits over their best interest on stock transactions

The TD Ameritrade customers who brought the suit alleged the company, which provides investing and trading services for 11 million client accounts, prioritized its profits over their best interests. They claim it did so by accepting incentives from stock exchanges and large electronic trading firms to route customer orders to them without ensuring the customers would get the best prices available – an obligation that along with related factors is known as “best execution.”

A spokeswoman for TD Ameritrade said the company disagrees with the judge and will appeal his ruling.

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The Securities and Exchange Commission announced today that Noah L. Myers of Lyme, Connecticut and the former owner of MiddleCove Capital, LLC, an investment adviser formerly registered with the SEC, was sentenced to 40 months in prison followed by three years of supervised release following his conviction on one count of securities fraud. On October, 20, 2014, Myers waived his right to indictment and pleaded guilty to one count of security fraud.

On January 16, 2013, the SEC accepted offers of settlement from Myers and MiddleCove and instituted a cease-and-desist order against them. The SEC order found that from approximately October 2008 to February 2011, Myers engaged in fraudulent trade allocation – “cherry-picking” – at MiddleCove. Myers executed his cherry-picking scheme by unfairly allocating trades that had appreciated in value during the course of the day to his personal and business accounts and allocating trades that had depreciated in value during the day to the accounts of his advisory clients. Myers did this by purchasing securities in an omnibus account and delaying allocation of the purchases until later in the day (and sometimes the next day), after he saw whether the securities appreciated in value. When a security appreciated in value on the day of purchase, Myers would often sell the security and disproportionately allocate the purchase and the realized day-trading profit to his own accounts or to accounts benefiting himself or his family members. In contrast, for securities that did not appreciate on the day of purchase, Myers would disproportionately allocate these purchases to his clients’ accounts and his clients would hold the position for more than one day. Myers carried out his cherry-picking scheme with regard to several securities, but was most active with an inverse and leveraged exchange traded fund (ETF). Myers finally ceased these practices in February 2011 when one of his employees threatened to contact the Commission.

The SEC’s January 16, 2014 order found that Myers and MiddleCove willfully violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder and Sections 206(1), 206(2) and 207 of the Investment Advisers Act of 1940. The SEC order revoked the registration of MiddleCove as an investment adviser, barred Myers from the securities industry, and ordered Myers and Middlecove to pay disgorgement of $462,022, prejudgment interest of $26,096, and a civil money penalty of $300,000.

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“..The Securities and Exchange Commission is unfortunately pursuing a fundamentally flawed strategy to police the capital markets and protect investors.

Last year, SEC Chairwoman Mary Jo White disclosed she intends on pursuing a “broken windows” strategy for securities enforcement. The SEC intends on prosecuting even minor violations of the federal securities laws in order to prevent wrongdoers from engaging in even more egregious conduct.

The theory is that when a window is broken and someone fixes it, it is a sign that disorder will not be tolerated. When a broken window is not fixed, it is a signal that no one cares, and so breaking more windows, and more serious crime, will follow. This approach is the one taken in the 1990s by New York City’s then-Mayor Rudy Giuliani and Police Commissioner Bill Bratton back when Ms. White was the U.S. attorney for the Southern District of New York, which includes Manhattan.

Unfortunately, the “broken windows” strategy championed by Ms. White is fundamentally flawed. By going after minor offenses, it artificially inflates the SEC’s enforcement actions and gives the appearance of being tough on bad actors. In reality, it is a mirage.

For example, in October, the SEC commenced 34 cease-and-desist actions against public companies and their insiders, alleging violations under Sections 13 and 16 of the Securities Exchange Act of 1934, for failing to timely report information about holdings and transactions in company stock. While this action created a nice headline for the SEC and inflated its yearly statistics, it likely did little to prevent more serious violations of the federal securities laws.

Filing more cases involving smaller infractions simply does not lead to greater compliance by companies like banks and brokerage firms with thousands of employees. The flawed assumption underlying the “broken windows” approach is that the message of deterrence will be heard before violations escalate. But it is rare in white-collar crimes that someone moves gradually from skipping a few filings, the classic small case, to perpetrating significant accounting fraud, defrauding thousands of investors or an insider-trading scheme. Typically, Wall Street brokerage firms engage in large-scale violations without working their way up the ladder of criminality. So the deterrent message is less likely to be heard.

The strategy also provides cover for the SEC to avoid going after the big banks and brokerage firms that are responsible for most of the serious securities fraud-related carnage. The level of financial chicanery engaged in by banks and brokerage firms leading up to the 2008 market crash was extraordinary. Virtually every major bank and financial company on Wall Street engaged in criminal scandals that impoverished millions and collectively destroyed hundreds of billions, in fact, trillions of dollars of the world’s wealth —and nobody went to jail. The SEC’s passive approach to punishing banks and brokerage firms that engaged in this activity led to blistering criticism that the SEC was simply too soft on major market players. An unwillingness to go after the large corporations that engage in most of the serious misconduct cannot be hidden under an avalanche of small actions against fringe wrongdoers.

Even current SEC Commissioner Michael S. Piwowar took aim at the strategy in a speech Oct. 14 when he stated, “A “broken windows’ approach to enforcement may not achieve the desired result.” He argued the idea was flawed because the ultimate goal of regulation is to achieve resilient markets, not regulatory compliance. “If you create an environment in which regulatory compliance is the most important objective for market participants, then we will have lost sight of the underlying purpose for having regulation in the first place,” Mr. Piwowar said.

For the full article from P&I, please click here

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