(The news featured below is a selection from the news covered in the Federal Securities Report Letter, which is distributed to subscribers of the Federal Securities Law Reports.)

Specialist Firms to Pay More Than $5 Million in Disgorgement, Penalties

The SEC and the New York Stock Exchange announced the initiation and settlement of enforcement actions against two NYSE specialist firms. Under the settlement agreement, the firms will pay a total of $5.2 million in penalties and disgorgement. The remedies include $1.7 million in civil money penalties and $3.5 million in disgorgement. Improvements to the firm's compliance procedures and systems are also required. The two settling specialist firms are SIG Specialists, Inc. and Performance Specialist Group LLC.

In a joint investigation, the NYSE and SEC found that between 1999 and 2003, the two firms, through particular transactions by certain of their registered specialists, violated federal securities laws and exchange rules by executing orders for their dealer accounts ahead of executable public customer or agency orders. Through these transactions, the firms allegedly violated their basic obligation to match executable public customer buy and sell orders and not to fill customer orders through trades from the firm's own account when those customer orders could be matched with other customer orders.

The SEC and the NYSE concluded that the firms improperly profited from trading opportunities and disadvantaged customer orders, which either received inferior prices or went unexecuted. The investigation also indicated that the firms breached their duty to serve as agents to public customer orders. In the settlements, the firms have neither admitted nor denied the findings.

The settlement provides that the firms' $5.2 million payment will go to a distribution fund for the benefit of injured customers. This includes the $1.7 million in civil money penalties, which, under the Sarbanes-Oxley Act, may be distributedto victims in SEC enforcement actions. The firms also consented to charges that they 1) willfully violated Exchange Act Section 11(b) and Rule 11b-1 by failing to maintain a fair and orderly market through their improper proprietary trading, 2) violatedNYSE rules and 3) failed to adequately supervise certain of their individual specialists who allegedly engaged in fraud through that proprietary trading in certain interpositioning transactions.

The NYSE and SEC found that the improper proprietary trading took various forms. In some cases, certain of the firms' specialists interpositioned the firms' dealer accounts between customer orders by trading into both of them in succession. Thetraders would buy into a customer market sell order first and then sell at a higher price into the opposite market buy order, allowing the firm dealer account to profit from the spread on these trades. The regulators also found that the specialists traded for their dealer accounts ahead of executable agency orders on the same side of the market, with customer orders executed later at prices inferior to the prices of dealer account trades. At other times, the specialists traded ahead ofmarketable limit orders, which then went unexecuted and ultimately were cancelled by the customers.

The NYSE and SEC found that the interpositioning transactions were heavily concentrated in a few stocks overseen by a small number of specialists at each firm. With certain interpositioning transactions in six stocks at each firm, the NYSE and SEC found that individual specialists engaged in fraud by violating their implied representations to public customers that they were limiting dealer transactions to those reasonably necessary to maintain a fair and orderly market. Neither of the specialist firms, according the findings, had in place reasonable systems or procedures to monitor, detect or prevent those violations. The regulators stated that the investigation is continuing.