Knight Pays Up in Trading Probe

Updated from 8:35 a.m. EDT

Knight Trading ( NITE) said second-quarter earnings will be depressed by the stock market's recent lethargy and a $79 million charge to settle a regulatory investigation into allegations of front-running at the Nasdaq trading firm.

The Jersey City, N.J., market-maker expects to earn 6 cents to 11 cents a share, excluding charges, in the three months to June 30. Bottom line results will also reflect a $79 million pretax charge to settle the trading case with the Securities and Exchange Commission and the NASD.

Analysts surveyed by Thomson First Call were forecasting earnings of 15 cents a share on revenue of $175.6 million.

The company said each of its segments were profitable in the second quarter but were pressured by low volatility and low volume in the stock and options markets. The company's asset management arm, which runs about $2.5 billion for wealthy investors as well as Knight itself, struggled with a bad market for arbitrage.

In early trading, shares of Knight were down 39 cents, or 4.2%, to $8.84.

The investigation into allegations of front-running -- an illegal practice in which a trader with knowledge of another investor's intentions uses that information to profit -- has bedeviled Knight for nearly two years.

The combination of fines and restitution being paid by Knight is more than the amount coughed up by any of the New York Stock Exchange specialist firms to settle allegations involving similar trading infractions. In March, five specialist firms paid a total of $242 million in fines and restitution to resolve that yearlong inquiry.

Regulators began looking into improper activities at Knight after former executive Robert Stellato filed an arbitration claim alleging he had been fired for raising complaints about the illegal activity.

All along, Knight has denied it did anything wrong. But the scandal ultimately reached the highest levels of the trading firm. In March, regulators alerted the firm that they not only intended to file civil charges against its Knight Securities subsidiary, but also planned to charge former Chief Executive Kenneth Pasternak, who left the company two years ago.

The tentative agreement with regulators requires Knight to disgorge $41 million in institutional trading profits, and pay $13 million in interest and $25 million in fines. The deal must still be approved by the regulatory agencies.

"The agreement in principle announced today demonstrates the management team of Knight that arrived after May 2002, together with our employees, is committed to resolving the regulatory inquiries we inherited," said Knight CEO Thomas Joyce. "We believe that the agreement in principle is an important next step in closing the chapter on these issues."

The company said the agreement with the regulators will have no bearing on the pending arbitration claim filed by Stellato, which it continues to oppose. Stellato's attorney, Jeffrey Liddle, could not be reached for comment.

The Knight investigation has had ramifications beyond the firm. The scandal has forced John Leighton, chief executive of Crown Financial, a small Nasdaq trading firm located down the street from Knight, to take a leave of absence from his job. Leighton is one of several former Knight employees regulators are considering filing charges against because of their role in the alleged front-running scheme.

Leighton had been a senior vice president at Knight, running the firm's institutional trading desk, before resigning in November 2000.

Leighton and his brother, Joseph, are the central figures in the front-running scheme outlined in the 2-year-old arbitration claim filed by Stellato. In the arbitration complaint, a copy of which was obtained by TheStreet.com, Stellato alleges that he was fired by Knight after reporting the front-running to Pasternak and other top Knight managers.

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.

Meanwhile, securities regulators also have notified Joseph Leighton, currently a trader at Jefferies & Co., that they intend to file civil charges against him, too.

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