The Vanishing NASD Governor

April 16, 2007

The 2005 NASD Pasternak Complaint

On March 7, 2005, the NASD issued a Press Release in which the self-regulator announced: NASD Charges Knight Securities' Kenneth Pasternak, John Leighton With Supervisory Violations in Fraudulent Sales to Institutional Customers Charges Against Former CEO, Head of Sales Desk Follow $79 Million Settlement with Knight.
In pertinent part, the 2005 NASD release stated:

NASD announced today that it has charged Kenneth Pasternak, former CEO of Knight Securities, L.P., and John Leighton, former head of the firm's Institutional Sales Desk, with supervisory violations in connection with fraudulent sales to institutional customers in 1999 and 2000.

In December 2004, Knight paid $79 million to settle NASD and Securities and Exchange Commission charges that it had defrauded institutional customers through the fraudulent and deceptive conduct of its leading institutional sales trader, who was John Leighton's brother. That sanction included $25 million in fines and a payment of $54 million in ill-gotten profits and interest into a Fair Fund established by the SEC for compensating harmed investors

Pasternak served on NASD's Board of Governors from May 30, 2000 to Sept. 17, 2001.

By way of background, Pasternak was nominated to the NASD Board of Governors by the NASD National Nominating Committee in February 2000. See, NASD Notice to Members 00-13 (February 28,2000. "

When Pasternak was elected to the NASD's Board of Governors in May 2000, the SEC and NASD allege that Knight was engaging in fraud and that he was personally engaging in misconduct. Guess the NASD sort of invited the proverbial fox into the henhouse. Just goes to show you - a year before he was nominated and during the year he was elected, even such a diligent regulator as the NASD just didn't have a clue as to the ongoing misconduct at one of its largest market makers. Wasn't a whiff of any problem. Nothing. Nada. Amazing how unaware a self-regulator can be when it comes to an 800 pound gorilla in its midst.

The 2005 SEC Pasternak Federal Court Action

A few months later, on August 8, 2005, the SEC issued a press release SEC FILES FRAUD CHARGES AGAINST KNIGHT SECURITIES' FORMER CEO AND INSTITUTIONAL SALES DESK MANAGER.,which stated that the SEC had filed a civil fraud action in the United States District Court for the District of New Jersey against Kenneth D. Pasternak, the former Chief Executive Officer and Head of the Trading Desk of Knight Securities, L.P and John P. Leighton, the former head of the Institutional Sales Desk at Knight, for their role in a best execution scheme that defrauded Knight's institutional customers. Securities and Exchange Commission v. Kenneth D. Pasternak and John P. Leighton, No. 05-3905 (D. N.J.) As the SEC noted in its complaint at paragraph 13, in "1999 and 2000, Knight was one of the largest market makers on the Nasdaq market."

Odd…I just can't seem to find any reference in the SEC's press release or Complaint to that fact that Pasternak was an NASD Governor from 2000 through 2001 (part of the relevant time period in the SEC's complaint). Given the typical background that the SEC includes in its releases, that omission seemed bizarre. After all, how many former NASD Governors get named in both NASD and SEC actions involving misconduct that occurred during their term of service? After all, the NASD thought it was an important enough disclosure to make in its press release only three months earlier.

The 2007 NASD Hearing Panel Decision

Okay, so now let's fast forward two years to April 11, 2007, when the NASD issues this press release: NASD Hearing Panel Sanctions Former Knight Securities Executives for Supervisory Failures in Connection with Fraudulent Sales. Former CEO Fined, Suspended; Former Sales Desk Head Fined, Barred as Supervisor.
In pertinent part, the 2007 NASD release states:

NASD Hearing Panel today issued $100,000 fines against Kenneth Pasternak, former CEO of Knight Securities, L.P. (now known as Knight Equity Markets, L.P.), and John Leighton, former head of the firm's Institutional Sales Desk, for supervisory violations in connection with fraudulent sales to institutional customers in 1999 and 2000.

Not exactly swift justice but after some seven or eight years of apparently intrepid investigation and prosecution, the NASD managed to suspend Pasternak in all supervisory capacities for two years, while Leighton was barred in all supervisory capacities. Of course, the Pasternak decision was ordered by a split Hearing Panel (2 to 1), so who knows how the matter will fare on appeal.

Tolstoy Anyone?

So here's an intriguing question: Why didn't NASD's 2007 press release state what was in its earlier 2005 release --- namely, that Pasternak had been nominated to, elected to, and served on its Board of Governors during a period of time when the NASD and the SEC alleged that his firm was engaging in fraud and that he was engaging in misconduct?

Maybe NASD is embarrassed by having to admit that it nominated and elected a person both the SEC and NASD have found to have engaged in serious misconduct. I can understand the self-regulator's chagrin. I mean, there is this NASD dissident/reform movement that is just so troublesome. These NASD detractors operating through the Financial Industry Association (FIA) have the audacity to contest all sorts of previously uncontested elections: at the district level, at the National Adjudicatory Council level, at the Board of Governors. And, oh my, those pesky dissidents/reformers actually won some of the contested elections.

And what do those FIA dissidents/reformers complain about? They hate the NASD nominating committee system. They claim that it is a self-perpetuating system, which relies too much on cronyism and has become incestuous. They argue that NASD uses its nominating committees to insulate itself from meaningful regulatory reform and fiscal responsibility.

On the other hand, maybe the NASD simply lost that one, simple, embarrassing sentence about Pasternak's role as its former Governor. It's possible that the line of type in the NASD's 2005 release fell on the floor and rolled under a radiator. However, maybe it's my old eyes. Maybe the disclosure is actually in the 2007 release. Here's the link once again, Maybe you can find the attribution to Pasternak's former Board role?

Leo Tolstoy remarked that hypocrisy may deceive the cleverest of men but "the least wide-awake of children recognizes it, and is revolted by it, however ingeniously it may be disguised."

Tolstoy anyone?