We return today to a topic discussed in a previous post, regarding the importance of listing standards as a source of corporate governance; and the need for proper enforcement of these standards.  Recent action by the SEC against the Boston Stock Exchange and it's former president further demonstrates that the need for enforcement is not limited to the national exchanges, but applies to the smaller regional exchanges as well.

On September 5, 2007, the Securities and Exchange Commission (Commission) initiated a settled inforcement action against the Boston Stock Exchange (BSE), and its former president, James B. Crofwell (Crofwell), for violation of Section 19(g) of the Exchange Act – failure to enforce Exchange rules to prevent specialists from trading for their own accounts, ahead of marketable customer orders.  

According to the Commission, from 1999 to 2004, the BSE and Crofwell failed to enforce Exchange Rules Ch. 2 §§ 6 & 11, and Ch. 15 § 2(b), which prevent specialists from trading securities from their own propriety accounts, and benefiting from the spread between their cost and the price quoted to their customer, when other customer market orders could be matched at the same or better price.

Specifically, the Commission contends that the BSE did not adequately monitor specialists to detect and prevent violations of the customer priority rules – pointing to problems with BEACON (Boston Exchange Automated Communication and Order-Posting Network), the BSE’s propriety trading platform, and the adoption of a competing specialist initiative during 1996.  The Commission asserts further, that both the BSE and Crofwell where aware of the fact that these procedures were inadequate, and that despite repeated warnings from the Commission neither took appropriate action to correct the problem.  

As part of the settlement agreement, the BSE and Crofwell both consented to a censure and an order to cease and desist from future violations of Section 19(g) of the Exchange Act.  Furthermore, the BSE has agreed to the expenditure of at least $1 million to retain an outside consultant/auditor to help the BSE improve its surveillance, examination, investigation and disciplinary programs relating to trading.

In a related civil action, Crofwell consented to the entry of a final judgment ordering him to pay a $75,000 penalty for aiding and abetting the Exchange’s violations of the Section 19(g) of the Exchange Act.

In other news, Nasdaq announced its plans to purchase the Boston Stock Exchange and its key assets in early October.  The  acquisition, which is  valued at  nearly $61 million, has been approved by the BSE board of directors, and is set for completion in the first quarter of 2008. 

The primary materials for this case may be found on the DU Corporate Governance website.