ROSLYNN R. MAUSKOPF, United States Attorney for the Eastern District of New York, and RON WALKER, Inspector-in-Charge, New York Division, United States Postal Inspection Service, today announced the unsealing of an indictment against KENNETH E. MAHAFFY, JR., a stock broker formerly employed by Merrill Lynch & Co., Inc. ("Merrill") and Citigroup Global Markets, Inc. ("Citigroup"), TIMOTHY J. O'CONNELL, a stock broker formerly employed by Merrill, RALPH D. CASBARRO, a stock broker formerly employed by Citigroup, and DAVID G. GHYSELS, JR., a stock broker formerly employed by Lehman Brothers ("Lehman"). The defendants are charged with crimes arising from their participation in a "front-running" securities fraud scheme that generated over $600,000 in illegal trading profits between January 2002 and December 2003.¹

MAHAFFY, O'CONNELL, CASBARRO and GHYSELS will be arraigned this afternoon before United States Magistrate Judge Kiyo A. Matsumoto at the United States Courthouse in Brooklyn, New York. The case has been assigned to United States District Judge I. Leo Glasser. The investigation resulting in the defendants' arrests was conducted with the assistance of the United States Securities and Exchange Commission ("SEC"). The SEC filed a civil complaint today against the defendants in the United States District Court for the Eastern District of New York.

According to the indictment, the defendants participated in a securities fraud scheme involving "front-running." Front-running occurs when stock brokers inform traders outside the brokerage firm, such as day traders, that a customer of the brokerage firm has placed a large order to buy or sell a particular stock. This information enables the day traders to trade in the same stock before the customer's order is executed, in anticipation of the movement in price that the customer's order is likely to cause. As a result, the firm's customers may not obtain as favorable a price for the stock as they would have absent the front-running. The stock brokers provided the information in violation of fiduciary and other duties owed to their brokerage firms and customers of the brokerage firms.

As alleged in the indictment, between January 2002 and December 2003, the defendants routinely provided day traders at two New York City based day trading firms, A.B. Watley, Inc. ("A.B. Watley") and Millennium Brokerage, LLC ("Millennium"), with material, non-public customer order information, which was disseminated through internal speaker systems at Merrill, Citigroup and Lehman known as "squawk boxes." Specifically, the defendants placed telephone calls to the day traders and left the telephones off the hook next to squawk boxes at their respective brokerage firms so that the day traders were able to hear the customer orders that were being broadcast. In exchange for access to the squawk box information, the day traders paid substantial amounts of money to the defendants in the form commissions from "wash trades" (simultaneously buying and selling the same amount of a security at the same price for the sole purpose of generating commissions) that were generated through brokerage accounts that the day traders opened with the defendants at Merrill, Citigroup and Lehman. Some of the defendants also accepted cash bribes from the day traders in exchange for squawk box access.

The indictment alleges that the day traders profited from the scheme by trading in front of the large orders that were broadcast through the squawk boxes. For example, when the squawk boxes disseminated information concerning a large buy order for a particular stock, the day traders would purchase shares of the same stock before the larger order was executed. Alternatively, when the squawk boxes disseminated information concerning a large sell order for a particular stock, the day traders would "short sell" the same securities before the larger order was executed. In either circumstance, the day traders profited from the subsequent movement in price that the large customer order caused. The day traders generated profits of over $600,000 by engaging in this illicit trading activity through proprietary accounts at A.B. Watley and Millenium.

The indictment also alleges that O'CONNELL attempted to conceal his illegal conduct by lying to federal agents and tampering with a witness who testified before a federal grand jury in the Eastern District of New York. Specifically, on June 7, 2004, O'CONNELL falsely told a United States Postal Inspector that he never provided anyone with access to a Merrill Lynch squawk box, when he had, in fact, routinely provided the day traders with access throughout 2002 and 2003. The indictment and a criminal complaint previously filed against O'CONNELL further allege that between November 2004 and March 2005, he instructed his assistant at Merrill to lie to federal investigators and testify falsely before the grand jury concerning the assistant's knowledge of O'CONNELL's use of the Merrill squawk box.

"The defendants put their own interests ahead of their firms and their firms' clients by stealing valuable, confidential information and selling it to unscrupulous day traders. As a result, the defendants received thousands of dollars in kickbacks and bribes, and the day traders reaped hundreds of thousands of dollars in illegal profits, all at the expense of the brokerage firms' clients," stated United States Attorney MAUSKOPF. "Today's case demonstrates that securities professionals who exploit their clients for personal gain by engaging in fraudulent trading practices such as 'front-running' will be prosecuted to the full extent of the law."

New York Postal Inspector-in-Charge WALKER stated, "Using their knowledge of the system and positions within reputable companies, the defendants netted huge profits at the expense of their clients. They even tried to muffle a witness from testifying about their use of squawk boxes. Today's indictment illustrates the commitment of the U.S. Attorney's Office and the U.S. Postal Inspectors to identify, arrest and prosecute those who practice securities fraud."

The indictment charges all of the defendants with securities fraud and conspiracy to commit securities fraud, receiving commercial bribes in violation of the Travel Act, and conspiracy to receive commercial bribes in violation of the Travel Act. The indictment also charges O'CONNELL with making false statements to federal agents, witness tampering and conspiracy to commit witness tampering. The charges carry the following maximum sentences: as to each securities fraud count and conspiracy to commit securities fraud count, 25 years imprisonment, five years supervised release, a $250,000 fine (or twice the gross gain or loss as a result of the offense) and an order of restitution; as to each Travel Act count and conspiracy to violate the Travel Act count, five years imprisonment, three years supervised release, a $250,000 fine (or twice the gross gain or loss) and an order of restitution; as to the false statement count, five years imprisonment, three years supervised release and a $250,000 fine; and as to the witness tampering and conspiracy to commit witness tampering counts, ten years imprisonment, three years supervised release, and a $250,000 fine.

The government's case is being prosecuted by Assistant United States Attorneys Michael A. Asaro and Sean Casey.

 

The Defendants:

Name: KENNETH E. MAHAFFY, JR.
DOB: 5/27/55

Name: TIMOTHY J. O'CONNELL
DOB: 10/13/64

Name: RALPH D. CASBARRO
DOB: 1/5/62

Name: DAVID G. GHYSELS, JR.
DOB: 2/18/58

 

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¹ The charges announced today are merely allegations, and the defendants are presumed innocent unless and until proven guilty.

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