Another Firm Surfaces in 'Squawk Box' Probe

Prosecutors believe Millennium Brokerage had access to Merrill's internal communications.
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Millennium Brokerage

, a small New Jersey company, is the second daytrading firm to be linked to an ongoing federal investigation into allegations that Wall Street brokers sold access to their firms' internal communications systems, sources say.

Prosecutors believe Millennium, which is in the process of shutting its doors, had access to so-called "squawk box" speakers used by

Merrill Lynch

(MER)

traders to disseminate information about imminent block trades by customers, according to people familiar with the investigation.

Calls to Millennium were not returned. The brokerage, which at one time had an office on Park Avenue in Manhattan, filed a notice with the NASD on March 18 that it was seeking to withdraw its operating license.

Millennium submitted its notice to the NASD a month before federal prosecutors in New York announced their first arrest in the 16-month investigation, a former Merrill Lynch broker named Timothy O'Connell. Prosecutors have charged O'Connell with trying to get his former assistant to lie to a grand jury about his role in the scandal.

Prosecutors allege that O'Connell enabled traders at two unidentified daytrading shops to eavesdrop on Merrill's internal communication system by leaving a phone off the hook. In return, the daytraders compensated O'Connell by making trades in a Merrill brokerage account and "generating substantial commissions" for the broker.

TheStreet.com

previously reported that one of the daytrading firms under scrutiny is

AB Watley

(ABWG)

, a brokerage that at one time provided more than 100 proprietary traders with daily access to communications from Merrill Lynch,

Citigroup

(C) - Get Report

Smith Barney

and

Lehman Brothers

(LEH)

, according to people familiar with the inquiry.

Millennium allegedly began getting access to Merrill's squawk-box system around the time it took in a group of daytraders who left Watley in 2003, sources say.

Besides charging O'Connell, prosecutors also have filed witness-tampering charges against Benjamin Grimaldi, the senior compliance officer for the Garden City, N.Y., office where O'Connell worked. The

Securities and Exchange Commission

, meanwhile, has notified Kenneth Mahaffy, a former Merrill Lynch broker now at Smith Barney, that he could face civil charges in conjunction with the investigation.

Citigroup fired Smith Barney broker Ralph Casbarro in March for providing "inappropriate" squawk-box information, according to Casbarro's broker registration statement and conversations with sources.

Prosecutors contend that the daytraders used the squawk boxes to gather trading tips in order to engage in front-running, an illegal practice in which a person buys or sells shares ahead of a trade he suspects will move a stock's price.

In the criminal case involving O'Connell, investigators contend that records from the two unnamed daytrading firms reveal "numerous instances" in which daytraders "purchased and sold securities in front of large orders that were subsequently executed by Merrill Lynch's institutional customers."

Over the past several weeks, prosecutors have been calling witness before the grand jury in order to bring an indictment in the investigation. People familiar with the inquiry say a number of former Watley traders have testified before the grand jury.

Investigators believe the selling of squawk-box access wasn't limited Watley and Millennium. Authorities suspect that a handful of other daytrading firms and several hedge funds had similar arrangements, according to sources.

One former Watley trader, who did not want to be identified, says he recalls seeing an advertisement in spring 2002 on

Monster.com

in which a small hedge fund claimed to have access to a brokerage squawk-box system. The hedge fund was seeking to hire traders. The source did not remember the name of the hedge fund.

Millennium's name surfaced in the investigation almost by chance.

In December 2003, when regulators from the NASD visited Millennium in conjunction with an unrelated inquiry, they discovered that chatter about stocks and trades was being broadcast into a room used by some of the firm's daytraders. The regulators, according to people familiar with incident, inquired about it and were told that Millennium had a deal to listen in on Merrill Lynch's squawk box.

The NASD investigators thought the situation was a curious one but weren't sure what to make of it. They made a call to Merrill Lynch and alerted the firm to what they had found and suggested the brokerage look into the matter.

It's not clear if the NASD pursued the matter further. An NASD spokesman declined to comment.

What the NASD didn't know was that Merrill Lynch's compliance department had already begun an internal investigation into the matter after receiving an anonymous tip about potential misuse of the firm's squawk-box system. Merrill Lynch ultimately decided to remove squawk boxes from the offices of an unknown number of brokers, concluding that the potential for abuse was too great.

"When the firm received a tip in December 2003 that there might be an issue related to so-called squawk boxes, it began investigating and subsequently determined to remove the squawk boxes from offices where the firm determined they should not be,'' said Merrill Lynch spokesman Mark Herr.

He would not comment of what, if any, disciplinary action the firm took.