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United States v. Mahaffy

August 2, 2006

UNITED STATES OF AMERICA,
v.
KENNETH E. MAHAFFY, JR., TIMOTHY J. O'CONNELL, DAVID G. GHYSELS, JR., ROBERT F. MALIN, LINUS NWAIGWE, MICHAEL A. PICONE, AND KEEVIN H. LEONARD, DEFENDANTS.



The opinion of the court was delivered by: Glasser, United States Senior District Judge

MEMORANDUM AND ORDER

INTRODUCTION

In this prosecution, defendants Kenneth E. Mahaffy, Jr. ("Mahaffy"), Timothy J. O'Connell ("O'Connell"), David G. Ghysels, Jr. ("Ghysels"), Robert F. Malin ("Malin"), Linus Nwaigwe ("Nwaigwe"), Michael A. Picone ("Picone"), and Keevin H. Leonard ("Leonard"), have been charged in an Indictment alleging securities fraud offenses pursuant to 18 U.S.C. §§ 1348 and 1349; and conspiracy to violate and violation of the Travel Act, 18 U.S.C. §§ 371, 1952(a)(3). O'Connell is also charged with conspiracy to commit witness tampering and witness tampering, 18 U.S.C. § 1512. O'Connell, Mahaffy, Nwaigwe, and Picone are charged with the making of false statements in violation of 18 U.S.C. § 1001. Before the Court are defendants' motions to dismiss for insufficiency of the Indictment and lack of venue.

BACKGROUND ALLEGATIONS

The charges in this case stem from an alleged operation in which day trading defendants made payments to defendant stockbrokers for access to non-public information. The non-public information concerned pending orders, from institutional clients of the brokerage firms, for the purchase or sale of large blocks of securities. The day trading defendants, and others, used that information to purchase or sell the subject securities prior to the brokerage firms' execution of their clients' orders. The Indictment describes this operation as a "front-running" scheme, which: harms a brokerage firm's customers because it allows the stock trader to take advantage of limited opportunities to purchase and sell the same securities in which the firm's customers are interested before the customers are able to do so. As a result, the firm's customers may not obtain as favorable a price as they would have absent the front-running.

(Id., ¶ 15).

I. The Defendants and Other Relevant Persons

A. A.B. Watley and Related Day Traders

The A.B. Watley Group ("Watley"), which operated primarily as a day trading firm, was a broker-dealer of securities registered with the United States Securities and Exchange Commission ("SEC") and the National Association of Securities Dealers ("NASD") and maintained its principal office at 40 Wall Street, New York, New York. Watley also maintained several branch offices, including offices in Forest Hills, New York and Melville, New York.

Defendant Robert F. Malin was Vice-Chairman of the Board of Directors and President of Watley. He worked at Watley's principal office, managed Watley's business activities and supervised its day traders. Defendant Linus Nwaigwe was Watley's Director of Compliance, responsible for ensuring that Watley's employees complied with federal securities laws and followed SEC rules and regulations. In December 2002,*fn1 Defendant Michael Picone was Chief Operating Officer of Watley. In August 2003, Picone entered into a consulting agreement with Watley. Between August 2003 and July 2005, Picone provided various financial and accounting services to Watley pursuant to this agreement. Defendant Keevin Leonard managed, supervised and trained Watley's day traders. He was also licensed by the NASD to act as a stockbroker and a General Securities Principal.

Millennium Brokerage, LLC ("Millennium") was a broker-dealer of securities registered with the SEC and NASD, and maintained its principal office in Woodcliff, New Jersey. Millennium also maintained a branch office at 3 Park Avenue, New York, New York. Millennium was a day trading firm. In March, 2003, a group of former Watley day traders began working at Millennium's Park Avenue branch.

E*Trade Professional Trading, LLC ("E*Trade") was also a registered broker-dealer and maintained its principal office at 135 East 57th Street, New York, New York. E*Trade also sold an electronic trading platform that was marketed to professional stock traders. In October 2003, a group of former Watley traders began day trading on behalf of a hedge fund called Ellis Island Trading ("Ellis Island"), which used E*Trade's trading platform. Ellis Island was located in the Amex Building in New York, New York. In December 2003, the same group of day traders terminated their relationship and became employed at E*Trade's principal office. The day traders continued to be employed at E*Trade until at least February 2004.

B. The Stockbrokers

Defendant Kenneth Mahaffy, Jr. was a stockbroker licensed by the NASD. Between 1997 and February 2003, Mahaffy was employed as a stockbroker at a branch office of Merrill Lynch & Co., Inc. ("Merrill Lynch") located at 1325 Franklin Avenue, Garden City, New York. Between February 2003 and June 2005, Mahaffy was employed as a stockbroker by Smith Barney, a division of Citigroup Global Markets, Inc. ("Citigroup"). Mahaffy was employed at a branch office of Citigroup located at 401 Broad Hollow Road, Melville, New York. Merrill Lynch and Citigroup were both broker-dealers of securities registered with the SEC and the NASD.

Defendant Timothy J. O'Connell was a stockbroker licensed by the NASD. Between 1997 and February 2005, O'Connell was employed as a stockbroker at Merrill Lynch's Garden City branch. Between 2001 and February 2003, O'Connell and Mahaffy shared client commissions and worked together as partners at Merrill Lynch's Garden City branch.

Defendant David G. Ghysels, Jr. was a stock broker licensed by the NASD. Between March 2001 and April 2003, Ghysels was employed as a stock broker at a branch office of Lehman Brothers ("Lehman"), located in Palm Beach, Florida.

Ralph Casbarro was a stockbroker licensed by the NASD. Between 1998 and March 2005, Casbarro was employed as a stockbroker at a branch office of Citigroup located at 1345 Avenue of the Americas, New York, NY.

Defendant Paul Coughlin was a stockbroker licensed by the NASD. Between 1995 and December 2005, Coughlin was employed by Merrill Lynch as a stockbroker at a Merrill Lynch branch office located at 1251 Avenue of the Americas, New York, NY.

As stockbrokers at Merrill Lynch, Citigroup and Lehman (collectively, the "Brokerage Firms"), Mahaffy, O'Connell, and Coughlin each owed fiduciary and other duties of trust and confidentiality to their respective Brokerage Firms and the clients of their respective firms.

II. The "Front-Running" Scheme

According to the Indictment, between January 2002 and February 2004, Mahaffy, O'Connell, Ghysels, Malin, Nwaigwe, Picone and Leonard, with others, participated in a fraudulent "front-running" scheme. Stockbrokers Mahaffy, O'Connell and Ghysels, in violation of their fiduciary and other duties of trust and confidence owed to their employers and their Brokerage Firms' clients, provided day traders at Watley, Millennium, Ellis Island and E*Trade (the "Day Traders") with customer order information by permitting the Day Traders to secretly listen to their Brokerage Firms' internal speaker systems known as "squawk boxes." The information broadcast through the squawk boxes included material, non-public information concerning large orders to purchase and sell securities that had been placed with the Brokerage Firms by their institutional clients. The large orders involved quantities of securities that were sufficiently large that the transactions could be expected to influence the market price for the securities in question.

The Day Traders then used the information disseminated through the squawk boxes to purchase and sell those securities prior to the Brokerage Firms' execution of their clients' orders. Thus, for example, when the squawk boxes disseminated information concerning a large order to buy a particular stock, the Day Traders would purchase shares of the same stock before the larger buy order was executed, expecting that the imminent execution of the large buy order would cause the market price of the particular stock to rise. Conversely, when the squawk boxes disseminated information concerning a large order to sell a particular stock, the Day Traders would short sell the same securities before the larger sell order was executed, expecting that the imminent execution of the large sell order would cause the market price of the particular stock to fall. The Watley Day traders engaged in this illegal trading activity at the direction and under the supervision of Malin, Nwaigwe, Picone, and Leonard.

In exchange for access to the Brokerage Firms' squawk boxes, the Day Traders paid bribes in the form of cash, commissions and other things of value to Mahaffy, O'Connell and Ghysels. One method by which the Day Traders bribed the brokers was by generating commissions through the execution of "wash trades." The "wash trades" consisted of prearranged pairs of trades of the same securities between different accounts that the Day Traders maintained at various firms, including the Brokerage Firms. Typically, the Day Traders executed the wash trades by simultaneously placing orders to (1) purchase a block of stock at a particular price through one Brokerage Firm account; and (2) sell a similarly sized block of the same stock at the same price through a different Brokerage Firm account.

The wash trades involved no net change in beneficial ownership of stock and had no legitimate investment purpose, and were executed solely as a means of generating commissions for Mahaffy, O'Connell, Ghysels and others. Between January 2002 and September 2003, Leonard coordinated the execution of wash trades through Watley's accounts at the Brokerage Firms. During this period, he also regularly collected cash from the Watley Day Traders for "desk fees," the purpose of which was to, among other things, reimburse Watley for the cash and commissions paid to the brokers in exchange for access to the squawk boxes.

In the fall of 2003, Malin and Picone tried to find new sources of squawk box access for A.B. Watley. Between September 2003 and February 2004, Malin, Picone and others agreed to pay secret bribes to Coughlin in exchange for access to Merrill Lynch's squawk box. During this period, Malin and Picone caused a Watley Day Trader to deliver cash bribes to Coughlin of approximately $1,000 per month. They provided the trader with the cash to make the bribe payments by causing Watley to issue reimbursement checks to the trader for bogus business expenses.

III. The Cover Up, Obstruction and False Statements

A. Efforts to Hide Squawk Box Access from NASD

Between January 2002 and February 2004, Watley typically provided its Day Traders with squawk box access using a system of external speakers and speaker phones that had been installed throughout the firm's trading floor. At various times during this period, NASD examiners visited Watley's New York City office to conduct compliance examinations.

Malin, Nwaigwe, Leonard and others concealed Watley's squawk box access from the NASD by, among other things, causing the Watley Day Traders to listen to the squawk boxes through headsets, rather than the external speaker systems, while the NASD examiners were present at Watley's New York City office. Furthermore, in approximately January 2004, a NASD examiner questioned Nwaigwe about the squawk boxes after hearing them being broadcast over a speaker phone near the trading floor. Nwaigwe falsely told the NASD examiner, in substance and in part, ...


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