Squawk Boxes

Have you heard about this term "squawk box"?

According to Investopedia:

• Squawk box is an intercom speaker often used on brokers' trading desks in investment banks and stock brokerages.
• It allows a firm's analysts and traders to communicate with the firm's brokers.
• Firms usually use squawk boxes to inform their brokers about current analyst recommendations, market events and information about block trades. This line of communication helps to keep brokers updated on important market factors and allows the firm to guide the trading of its brokers.

However, can you imagine squawk box may become a tool for front-running?

SEC recently charged Merrill Lynch, Pierce, Fenner & Smith Inc. with securities laws violations for having inadequate policies and procedures to control access to institutional customer order flow information. Merrill Lynch agreed to settle the SEC charges and pay a US$7 million penalty, among other remedies. In a series of related cases, SEC previously sued brokers from Merrill Lynch and other broker-dealers and employees at the day-trading firms who used the information to illegally trade ahead.

According to the SEC proceedings, Merrill Lynch utilizes institutional equities "squawk boxes", which are internal intercom systems used by broker-dealers to broadcast institutional customer order information to traders and sales traders at the broker-dealer. From 2002 to 2004, several Merrill Lynch retail brokers at three branch offices permitted day traders at other firms to listen to confidential information on large unexecuted block orders of Merrill Lynch institutional customers. The Merrill Lynch brokers put their telephones next to the squawk boxes and let the day traders listen to the squawk box, often for the entire trading day. The day traders used the broadcasts to trade ahead of the orders placed by Merrill Lynch customers.

In fact, Merrill Lynch lacked written policies or procedures to limit which employees within the firm had access to the equity squawk box, to track which employees had access, or to monitor employees for possible misuse of the order information. This created conditions that rogue brokers could exploit, as happened in this case.