The front-running scandal at Knight Trading ( NITE) continues to haunt a former executive who left the trading firm to run Crown Financial. In a regulatory filing, Crown said the Securities and Exchange Commission and the NASD have notified John Leighton, the firm's chairman and chief executive, that they intend to bring an enforcement action against him over his actions while working at Knight. Leighton had been a senior vice president at Knight, running the firm's institutional trading desk, before resigning in November 2000. Earlier this month, Knight, the largest Nasdaq market-making firm, said it also was informed by regulators that they intend to file charges against the firm's Knight Securities subsidiary and against former CEO Kenneth Pasternak, who left the trading firm two years ago. In a regulatory filing, Knight said the investigations focus on "specific trade activity, conduct, supervision and record-keeping." But sources familiar with the investigation and an arbitration complaint filed by a former Knight executive described the trading violations as front-running -- an illegal practice in which a trader with knowledge of another investors' intentions uses that information to make trades for his own benefit. Crown Financial said Leighton is contesting the allegations and will try to persuade regulators not to file civil charges against him. Leighton's attorney, Anthony W. Djinis, said regulators are acting under a "theory that is novel and unprecedented and not supported by the facts." It's no surprise that regulators are gunning for Leighton. He and his brother, Joseph, are the central figures in the front-running scheme outlined in a 2-year-old arbitration claim filed by former Knight executive Robert Stellato. The arbitration claim, which is still pending, sparked the regulatory investigation. In the arbitration complaint, a copy of which was obtained by TheStreet.com, Stellato alleges that he was fired by Knight after reporting the alleged front-running to Pasternak and other top Knight managers.
In the complaint, Stellato alleges that the elaborate front-running scheme, which involved price manipulation and price-gouging, meant Knight "failed to report realistic earnings for 1998 and 1999, as well as the first eight months of 2000." Joseph Leighton, who also left Knight the same time as his brother, is a trader with Jefferies & Co. ( JEF). It is not known whether regulators intend to file charges against Joseph Leighton, who could not be reached for comment. A Jefferies spokesman declined to comment. The Leighton brothers left Knight a few months after Stellato went to management with his concerns. In the arbitration complaint, Stellato contends the Leightons, despite his allegations, were allowed to resign with multimillion-dollar severance packages. Leighton, whose reign at Crown began a year ago, has been steadily converting the small market-maker into a mini-Knight. The firm has hired more than two-dozen former Knight traders and executives, including Knight's former general counsel Michael Dorsey. Crown used to be called M.H. Meyerson, named for its founder, Martin Myerson, who retired around the time Leighton took over. Two years ago, the NASD fined Meyerson $240,000 for artificially inflating the price of thinly traded bulletin board stocks. The trading firm also has been plagued with accounting issues and recently restated earnings for much of last year. Shares of Crown, which were delisted by the Nasdaq in November, currently trade on the pink sheets. Stellato now works for Soliel Securities in New York. His attorney, Jeff Liddle, said the actions taken by regulators lend credence to his client's claims. "It certainly is a clear indication that after an extensive review, the SEC and NASD think that there is something there to be concerned about," said Liddle.