What did Knight Trading Group do to incur a $1.5 million fine for violating trading rules?

By Andrew Beattie AAA
A:

The dotcom boom accelerated many deceitful business practices that first became apparent during the '80s and '90s. Many of these had to do with analyst recommendations being tied with investment banking divisions' interests and other basic conflict of interest problems. One of the clearest examples of a firm putting its own interests above those of its clients was the conduct of the Knight Trading Group.

The Knight Trading Group acted as a market maker for brokerage firms, buying and selling the securities that made up client orders. In this capacity, Knight was handling up to 11% of all buy and sell orders on the Nasdaq during the dotcom boom. The trading group was supposed to facilitate more efficient execution of orders, allowing clients to buy and sell at as close to the current price quotes as possible. At the height of the bubble, Knight Group was often off the posted quotes and frequently late in executing trades, meaning that clients often lost money on trades while waiting for the orders to go through.

This tardiness was more sinister than mere incompetence or network difficulties. A NASD investigation revealed that the company was front running on client orders. The traders at the company would receive large client orders, often institutional, and execute the order in a company or personal portfolio before putting through the client's order. As large orders can push stocks sharply up in a volatile market like the dotcom boom, Knight was profiting from privileged information.

Such a revelation and an investigation took an immediate toll on the company's shares, sending the stock down close to 30%. Because market makers' worth is tied to their reputation, the company's shareholders also launched a lawsuit because the traders' actions and management's lack of oversight destroyed the shareholders' investment. Knight Trading Group was assessed a $1.5 million fine on January 7, 2002, but it continued to face ongoing litigation and damage to its reputation.

For more, see The Biggest Stock Scams Of All Time.

This question was answered by Andrew Beattie.

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