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CORRUPTION AT THE AMERICAN STOCK EXCHANGE

February 7, 2013

Wall Street: See No Evil

Is this what Wall Street thinks of the little guys?

If you had perpetrated the crimes of either Louis Ligouri, or Joseph Manna, or Louis Paolillo you would be on a long bus ride, free of charge, singing: Allentown, here I come.

By Edward Manfredonia
July 8th, 2007

Series: The Wall Street Scandals

This article is concerned with three individuals, Louis Ligouri, Joseph Manna and Louis Paolillo, who were members of the American Stock Exchange- and their ability to violate federal securities laws with minor punishment.

Louis Ligouri was a floor broker and a member of the Board of Governors of the American Stock Exchange, when Louis Ligouri violated federal securities laws. Arthur Levitt, later Chairman of the Securities and Exchange Commission, was Chairman of the American Stock Exchange at the time Louis Ligouri violated the Securities Exchange Act of 1934.

Joseph Manna and Louis Paolillo were specialists and partners in the American Stock Exchange specialist firm of Manna, Paolillo, Bader, Katz & Co. at the time that they violated the Securities Exchange Act of 1934.

Furthermore, there is another common thread joining Louis Ligouri, Joseph Manna and Louis Paolillo– Spear Leeds and Kellogg processed their trades. Spear Leeds and Kellogg was purchased by Goldman Sachs in October 2000- against my prescient advice.

Although I am utilizing American Stock Exchange Disciplinary Decisions from 1989 for Louis Ligouri and 1996 for both Joseph Manna and Louis Paolillo, these disciplinary decisions are highly relevant to the present- and most notably provide more detail of violations of federal securities law than current American Stock Exchange Disciplinary Decisions.

The federal securities laws, which were violated by Louis Ligouri, Joseph Manna and Louis Paolillo go to the very heart of the Securities Exchange Act of 1934. Louis Ligouri stole $180,000 from public customers as quoted in the American Stock Exchange Disciplinary Decision in the Matter of Louis Ligouri 89-D-17. Joseph Manna posted prices, trades and quotes for the sole purpose of increasing the net capital in the account of the specialist firm of Manna, Paolillo, Bader, Katz, & Co. as stated in the American Stock Exchange Decision In The Matter Of Joseph Manna 1996. Louis Paolillo posted fictitious trades at advantageous prices to increase the net capital in the account of the specialist firm of Manna, Paolillo, Bader, Katz, & Co. as stated in the American Stock Exchange Disciplinary Decision In the matter Of Louis Paolillo 96-D-08.

It is easy to understand that Louis Ligouri’s theft of $180,000 is a crime. It is also easy to understand that Louis Paolillo’s posting fictitious trades is illegal. But it is more difficult to understand that Joseph Manna’s actions were illegal. So let us examine two examples.

The first example shall deal with a crime that has become common in the era of increasing real estate prices. In many areas of the metropolitan area unscrupulous real estate agents working with unscrupulous mortgage brokers and unscrupulous appraisers have perpetrated a similar crime to that of Joseph Manna. By selling a house to numerous straw buyers and steadily increasing the price of the house and the appraisal of the value of the house, these real estate agents and mortgage brokers steadily increase their profits by means of commissions on the sale of homes; commissions paid to mortgage brokers; and the illegal profits, which they split with the buyers. Eventually, there is a total collapse when the final purchaser of the home cannot meet his mortgage payments and the mortgage lender is stuck with an overvalued house.

The second example is analogous to falsely inflating the inventory, which a firm possesses to obtain a loan. Thus, assume that a jewelry store had inventory composed of 1 and 2 carat diamonds. The jeweler went to the bank to borrow money and the jeweler stated that he had an inventory of 4 and 5 carat diamonds. Thus the value of the inventory was falsely increased. But when the loan came due, and the bank seized his inventory, the bank could not recover the amount of its loan because the value of the inventory was not sufficient to cover the loan. This is what Joseph Manna did. By giving false values to his option inventory, Manna provided false information to his bank—in this instance, Spear Leeds and Kellogg, which cleared the trades and guaranteed the net capital, or minimum capital maintenance, of the American Stock Exchange specialist firm of Manna, Paolillo, Bader, Katz & Co.

But there is one major problem with utilizing derivative products- in this instance, equity options, specifically equity call options. (Definition: A call option gives an individual the right to purchase a stock at a specific price.) The problem is that equity call options have a limited life span and, therefore, lessen in value over time. Furthermore, all options are exercised at a specific stock price- if the stock is less than the strike price of the call option, the call option has no value. Let us assume that the option expires on June 15, 2007 and the price of a stock is $28. Thus, on the day in June when the option expires and the strike price of the call is 25, the value of the June 25 call option is: $28 (price of stock) – $25 (strike price of call) = $3.

Now let us utilize another example. It is May and the stock is trading at $28. An individual believes that the stock is going to go up. This individual purchases a June 30 call for $1.50. This means that on expiration day in June, the day when the option expires, the stock must go to $31.50 to break even. To determine the break even price we merely take the cost of the call, $1.50, and add it to the strike price of the call 30.00, $1.50 + 30= $31.50. But assume that the stock price remains at $28. The strike price of the June 30 call is above the price of the stock $28 – $30 = -$2, a negative value, so the value of the June 30 call option is $0 and you have lost the purchase price of the call, which is $1.50.

As I have shown, options have a limited life and the value of an option decreases over time. Usually, the life of an equity option is measured in a few months- at least the most active equity options.

One way to look at equity options is to think of equity options as stock. When stock trades at a higher price, the value increases. But there is a peculiarity with options. Options are a derivative product. If the price of the stock increases, the value of a call, which is the right to purchase stock at a specific price, increases. Or the price of an equity option can increase if, like a stock, someone purchases an equity option.

Equity options are usually valued at the last price, but there are exceptions- usually when the option is lightly traded. Joseph Manna, the option specialist with the firm of Manna, Paolillo, Bader, Katz & Co., knew this. So, if the last sale of an option were not at a high enough price, Manna could pursue two courses of action.

Manna could change the quote of the option and increase the bid, the price at which Manna would purchase the option, thereby, increasing the value of the option. Or Manna could purchase one or more options at a higher price than the last sale, thereby, increasing the value of the options.

By falsely increasing the value of the options in his inventory, Manna illegally increased the net capital, or Minimum Capital Maintenance, of the specialist firm of Manna, Paolillo, Bader, Katz & Co.

It must be noted that what led to the conviction of Ivan Boesky, who was convicted in the largest insider trading scandal ever and paid a fine of $100 million, was the violation of the “Net Capital Rule.” The “Net Capital Rule” is defined as: the amount of money that must be maintained in a brokerage account to meet the requirements necessary to cover the stocks and derivative instruments in the account. Net Capital is composed of: liquid assets, such as cash and Treasury bills, minus liabilities. In many respects the net capital rule is identical to the Minimum Capital Maintenance, except that in this instance Minimum Capital Maintenance applies to specialist firms at the American Stock Exchange. Minimum Capital Maintenance is set by a stock exchange, in this instance the American Stock Exchange. Net Capital is set by the Securities and Exchange Commission.

The Minimum Capital Maintenance is the American Stock Exchange equivalent to the “Net Capital Rule,” which has been set by the Securities Exchange Act of 1934. Net Capital is defined as liquid assets, such as cash and Treasury Bills, minus liabilities. The Minimum Capital Maintenance also includes as assets the market value of the long positions of stock and options (those options and stocks that are owned by a specialist firm) minus the liabilities (those options and stock that are sold, but not owned by a specialist firm). But the penalties for illegally violating Net Capital and Minimum Net Capital are identical in the Securities Exchange Act of 1934.

Manna was the partner in charge of the options division of the specialist unit of Manna, Paolillo, Bader, Katz & Co. Manna was the specialist in the options of PXQ (Pyxis Corp.).

During the relevant time period, January to March 1995, the specialist firm of Manna, Paolillo, Bader, Katz & Co. was hemorrhaging money. If the firm continued to lose money, the specialist firm of Manna, Paollilo, Bader, Katz & Co. would become insolvent.

Manna was faced with an insoluble dilemma. Manna knew that he could not obtain additional financing. Manna could not liquidate his positions in the options of Pixis Corp. at favorable prices. Manna knew that he needed to increase the value of his positions in the hope that the market would favor him.

So, Manna decided to illegally change the value of the options, which the specialist firm of Manna, Paolillo, Bader, Katz & Co. had in its inventory, thereby, meeting the requirements of Minimum Capital Maintenance as established by the American Stock Exchange.

In a three month period from January to March 1995 Manna made 310 quote changes after 4:10 p.m., after the close of trading, to increase the value of the option inventory of the specialist firm of Manna, Paolillo, Bader, Katz & Co. On 49 occasions Manna also made purchases of nominal amounts of options to increase the value of the specialist firm’s inventory.

Manna was fined $30,000 and suspended for 60 days from Exchange membership. And it is here that I must note that Manna’s violations of the equivalent of the Net Capital Rule, or Minimum Capital Maintenance, were far more serious than Ivan Boesky’s violation of the net capital rule. And Ivan Boesky spent several years in federal prison. For details please refer to Part I of my personal web site, http://www.WallStreetScandals.com.

Paolillo, the stock specialist for Manna, Paolillo, Bader, Katz, & Co. was charged with printing 36 fictitious transactions. Paolillo plea bargained to printing 6 fictitious transactions.

Paolillo was fined $35,000 and was suspended for one year. For more details please refer to Part I of my personal web site, http://www.WallStreetScandals.com.

Louis Ligouri did not have the elegance of Manna or Paolillo. On or about June 15, 1987, Louis Ligouri opened a Registered Trading account at Spear Leeds and Kellogg.

The most important fact here is that Louis Ligouri never traded- and Spear Leeds and Kellogg knew this. Ligouri opened a Market Maker account. But the only trading activity that took place were 130 trades that were placed in Ligouri’s trading account.

Ligouri participated in an arrangement whereby, beginning in July 1987 until January 1989, more than 130 profitable rejected options trades (DK’s) that Ligouri had not made, were put into his Registered Trader account. Ligouri then liquidated these trades for a nearly riskless profit.

The American Stock Exchange imposed the following penalties upon Ligouri: a censure; a permanent ban from membership in the Exchange; and, a three year suspension from association in any capacity with any Exchange member or member organization.

Ligouri stole in excess of $180,000 and served no time in jail. For more details refer to Part I on http://www.WallStreetScandals.com.

It is important to note that after the specialist firm of Manna, Paolillo, Bader Katz & Co. went out of business, Spear Leeds and Kellogg took over the American Stock Exchange stock specialist unit of Manna, Paolillo, Bader & Katz.

Having served their suspensions, Louis Ligouri, Joseph Manna, and Louis Paolillo resumed their profitable careers on Wall Street- earning in excess of $100,000 per annum.

When contacted by The Black Star News concerning his egregious violations of federal securities laws, Louis Paolillo replied with a terse: “No comment.” The Black Star News was unable to contact either Louis Ligouri or Joseph Manna.

Just imagine what would happen to you if you had committed an equivalent crime- such as stealing $180,000. Or if you had committed bank fraud, which is similar to the crime of falsifying your assets to meet the minimum capital maintenance.

If you had perpetrated the crimes of either Louis Ligouri, or Joseph Manna, or Louis Paolillo you would be on a long bus ride, free of charge, singing: Allentown, here I come.

The author worked on Wall Street for several years

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