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Updated from 7:40 a.m. EDT

Knight Trading


said Tuesday that securities regulators are investigating the company, but the market maker said the probe is informal and that allegations of improper trading practices are false.

The company's confirmation of an inquiry follows a report in

The Wall Street Journal

that a former manager claims Knight ripped off investors through illegal trading techniques during the tech market bubble years.

Central to the accusations brought by Knight's former head of institutional trading, Robert Stellato, are claims that Knight traders often front-ran customer orders, or used knowledge of existing buy and sell orders to profit on their expected impact on prices.

The allegations, contained in an arbitration filing made by Stellato with the

National Association of Securities Dealers

in 2001, put pressure on Knight's shares for the second straight day. Lately, the stock was down 19% to $4.77.

On Monday, the

stock skidded after a software problem generated a large series of sell limit orders in Knight's stock. The orders were then routed to various destinations and disrupted trading in the security. The erratic activity in Knight's stock was initially attributed to rumors of an investigation.

Knight's Boat

In a press release, Knight said Stellato's claims are unfounded and that he invented the allegations for "personal gain." The company said it is cooperating fully with the NASD and the

Securities and Exchange Commission

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"Mr. Stellato originally raised concerns about an institutional trading practice last year, and Knight's Compliance Department conducted an immediate review with Mr. Stellato and determined that the concerns were unfounded. The SEC and the NASD routinely inquire into claims brought to their attention. After the arbitration claim was filed, Knight made the plaintiff's statement of claim available to the SEC and the NASD on a proactive basis. Knight is cooperating fully with their informal inquiries."

The company also emphasized that the arbitration claims apply to Knight's institutional trading business only and not to retail trading.

Stellato joined Knight in 2000. According to the arbitration complaint, he soon was warned of problems in the department by two managers. "These warnings prompted Stellato to interview the rest of the institutional sales traders," the NASD filing stated, "who each told him that

company executives were, at the least, front-running customer orders in concert with the traders and with the full blessing of

then-CEO Kenneth Pasternak and the rest of Knight's management."

The SEC declined to comment, and NASD representatives weren't immediately available.

Not the First Time

The market maker has had run-ins with regulators before. An earlier NASD investigation of Knight for trading-rule violations concluded in January, when the company agreed to pay a $1.5 million fine. Knight was also named in at least 10 NASD regulatory actions between late 1996 and 2000, according to

The Wall Street Journal


Knight hasn't confirmed or denied any of the allegations, but the company paid fines of between $1,000 and $50,000 for some of the alleged violations.

Trading Down

News of the investigation comes at a tough time for Knight. The company's business has been hit hard by a sluggish market and by new trading rules put into effect last year that reduce the spreads the company earns on trades. As a result, Knight has been plagued by plunging profits and a slew of executive departures.

Knight's board recently

named Thomas Joyce its new president and chief executive, a position it had been trying to fill for months. Last month, the company said it planned to slash $30 million in costs by the third quarter.