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Squawk Probe Heats Up

More arrests may be coming in the investigation of daytraders getting illicit information about block trades.

A federal investigation into allegations that daytraders were given access to confidential information about big block trades at several Wall Street brokerages appears to be expanding.

Less than two weeks after federal prosecutors arrested and charged a former

Merrill Lynch

(MER)

broker in conjunction with the so-called squawk box investigation, sources close to the investigation say more arrests may be coming soon.

The sources, who requested anonymity, say prosecutors and lawyers with the

Securities and Exchange Commission

have been busy interviewing other employees from the Garden City, N.Y., branch office where former Merrill broker Timothy O'Connell had worked up until February. A Merrill Lynch spokesman had no comment.

As

TheStreet.com

previously reported,

prosecutors charged O'Connell with using "intimidation" to threaten and encourage a witness to lie to a federal grand jury about O'Connell's alleged role in permitting daytraders to eavesdrop on Merrill's internal communications system. The witness is identified in court papers as O'Connell's former brokerage assistant.

Prosecutors from the Eastern District of New York allege that O'Connell enabled traders at two daytrading shops to eavesdrop on Merrill's internal squawk box communication system by leaving a phone line off the hook for the entire day, according to a copy of the criminal complaint obtained by

TheStreet.com

. In return, the daytraders compensated O'Connell by making trades in a Merrill brokerage account and "generating substantial commissions" for the broker.

The identities of the daytrading firms O'Connell allegedly had deals with were not disclosed by prosecutors. But one of the daytrading firms believed to have had an arrangement with O'Connell is

AB Watley

TheStreet Recommends

(ABWG)

.

Sources familiar with Watley say the brokerage had offered elite daytraders access to squawk box communications from Merrill,

Lehman Brothers

(LEH)

and

Citigroup's

(C) - Get Report

Smith Barney brokerage group. Former Watley CEO John Amore, indicted last summer by federal prosecutors on an unrelated securities offense, is believed to be cooperating with the investigation.

Another Party Heard From

Watley disclosed previously that the SEC has served subpoenas on the two Watley executives, Robert Malin, the firm's vice chairman, and Linus Nwaigwe, the firm's chief compliance officer, seeking documents and testimony as part of the investigation.

A person familiar with Watley's operation says the firm worked with at least two Smith Barney brokers to gain access to the big brokerage's squawk box system. The source did not know the names of the brokers, but believed at least one had worked in a Smith Barney branch office in Long Island, N.Y. A Smith Barney spokeswoman declined to comment, but notes the firm's policy is to cooperate with all investigations.

Amore, who sources say negotiated the deals with the brokers, lives in Plandome, N.Y., a small Long Island village that's located near Garden City. Amore, who was fired from Watley in September 2003, had overseen the firm's now-defunct proprietary daytrading operation.

Prosecutors contend O'Connell and "certain stock brokers" in Merrill's Garden City branch office provided the daytrading firms with access to Merrill's squawk box communications from January 2002 through October 2003.

Getting unauthorized access to a brokerage's squawk box system would give a daytrader a big leg up over other traders. That's because getting a tip about a block trade, a single trade of 10,000 or more shares, can be advantageous to traders trying to cash in on sudden price movement in a stock. Such tips could have permitted daytraders to engage in front-running, an illegal practice in which a person buys or sell shares ahead of a trade he suspects will move a stock's price.

Meanwhile, a person familiar with the investigation says at least one former Lehman broker is drawing scrutiny from investigators over similar allegations. A Lehman spokeswoman declined to comment.

But there are indications that the squawk box scandal may extend beyond Watley and the other unnamed daytrading shop.

A former Lehman broker says when he worked at the Wall Street firm, he knew of several brokers who permitted traders to listen to the firm's squawk box communications. The broker declined to identify his former colleagues. A Lehman spokeswoman declined to comment.