|Source's Cover Blown by SEC |
Updated April 25, 2012, 6:50 a.m. ET
By SCOTT PATTERSON And JENNY STRASBURG
Federal securities regulators, in a sensitive breach, inadvertently revealed the identity of a whistleblower during a probe of a firm that ran a stock trading platform.
The gaffe by the Securities and Exchange Commission occurred during an investigation of Pipeline Trading Systems LLC when an SEC lawyer showed an executive who was being questioned a notebook from the whistleblower filled with jottings about trades, calls and meetings. The executive says he recognized the handwriting.
Pipeline, the operator of an alternative trading system known as a "dark pool," reached a settlement in October with the SEC, which asserted in findings released at the time that Pipeline had misled investors about how their orders were filled.
Pipeline, which didn't admit or deny the allegations, was the subject of a page-one Wall Street Journal article earlier this month. The article didn't name the whistleblower, but he has now agreed to be publicly identified. He is Peter C. Earle, 41, a former employee of a Pipeline trading affiliate. Mr. Earle said he was "disappointed" the SEC took steps in its probe that ended up disclosing his identity to Pipeline.
The SEC confirmed showing the notebook to an executive of the business it was investigating. SEC officials said there is always a risk a whistleblower's identity might be disclosed during an investigation, but its practice has been to avoid unnecessarily revealing an informant's identity.
"Our review of the facts confirms that we followed this practice in this case," an SEC spokesman said in a statement. "While we utilize evidence from all witnesses, we do not reveal which witnesses may be cooperating with the government except as required by law or the governing rules of civil procedure."
The SEC is encouraging whistleblowers to come forward under the 2010 Dodd-Frank regulatory overhaul. A provision lets tipsters claim up to 30% of penalties collected by the U.S. for their help in unearthing improper practices—which some market watchers see as a growing issue in the modern age of computerized, opaque markets.
The SEC has received more than 1,000 tips from people seeking to collect under the law since it took effect in August, and it is expected to announce its first recipient within weeks, according to people familiar with the matter. Mr. Earle isn't eligible because he contacted the SEC before the law took effect.
The notebooks in the Pipeline matter, which Mr. Earle said he gave to SEC lawyers in early 2010, helped frame questions the agency asked during the probe of Pipeline, according to people familiar with the investigation.
The person shown the notebook (in a November 2010 SEC interview), Gordon Henderson, was the head of Pipeline's trading affiliate, Milstream Strategy Group. He said in an interview that he previously suspected Mr. Earle was an SEC informant. Mr. Henderson's desk was near Mr. Earle's in Milstream's New York office, and he said he recognized Mr. Earle's handwriting in the notebook.
Mr. Henderson said he was allowed to go through it and look at details on its pages. He said he discussed the matter with others at Pipeline, saying: "Pete's the whistleblower."
The SEC lawyer who showed him the notebook was Daniel Walfish, according to people familiar with the matter. Mr. Walfish declined to comment.
For years, whistleblowers sought rewards from the SEC of up to 10% of regulatory penalties for passing along information pertaining to insider-trading cases. (The Pipeline matter didn't involve insider trading.)
The Dodd-Frank law broadened this and raised the bounty to as much as 30% of penalties collected by the government if original information from a whistleblower leads to enforcement actions and sanctions totaling more than $1 million.
SEC enforcement chief Robert Khuzami said at a conference last week the agency is getting about six or seven tips a day under the new program, some of "particularly high quality." That is up from roughly six applications for remuneration per year filed by tipsters in the much narrower rewards arrangement prior to Dodd-Frank's adoption.
The program reflects the reality that employees may put their jobs or careers at risk by speaking with their bosses or regulators about their concerns. "This is why you pay…bounties, so there's an incentive," said Reuben Guttman, a lawyer who represents tipsters. "You would hope there are certain precautions taken by the agency to protect confidentiality."
In a list of frequently asked questions about the law, the SEC says it is "committed to protecting your identity to the fullest extent possible" but may be required to disclose it in certain instances, such as an administrative or court proceeding. The agency adds, "We may use information you have provided during the course of our investigation" and "in appropriate circumstances, we may also provide information, subject to confidentiality requirements, to other governmental or regulatory entities."
Michael Rubenstein for The Wall Street Journal
The identity of whistleblower Peter C. Earle, pictured near his Kinnelon, N.J., home, was inadvertently revealed by an SEC lawyer who showed one of his notebooks filled with jottings about trades, phone calls and meetings, to an executive at the trading business the agency was investigating
Mr. Earle, a West Point graduate, began trading stocks on Wall Street in the 1990s. He worked at several day-trading firms. In 2005 he joined Pipeline's trading affiliate, eventually named Milstream.
Pipeline ran a platform designed to fill stock investors' buy or sell orders privately, without disclosing them to the wider world of Wall Street—the dark pool system. The idea, as advertised by Pipeline, was software would privately match one customer's order to buy shares with another customer's sell order.
Because Pipeline didn't have enough customers to ensure quick order execution when it started up in 2004, its parent company, also bearing the Pipeline name, created a trading unit to fill orders. To fill a Pipeline customer's buy order, for instance, this affiliate could first buy shares of the stock on the open market and then use these to fill the customer's order.
Pipeline hoped to attract enough trading clients so it wouldn't need this affiliate forever. However, the SEC said in outlining its findings when it settled with Pipeline, the trading affiliate continued to fill most orders, even as Pipeline was telling customers their orders were being filled via a matchup with other customers. A spokesman for Pipeline acknowledged to the Journal that it had "misinformed" clients.
Mr. Earle said he and other employees were told that Pipeline's long-term goal was to turn the trading affiliate into an operation that could operate independently of the Pipeline dark pool.
Mr. Earle said that a few months after he joined the trading affiliate, he raised concerns internally about Milstream's trading activities. During trading days, he also began writing notes, which included observations about trading activities and conversations at the affiliate.
In December 2005, he emailed Mr. Henderson that an incentive system used to reward traders had "the potential for perverse incentives," according to a copy of the email reviewed by the Journal. Mr. Henderson said he didn't recall the email.
Mr. Earle said he made other internal complaints about trading, and was fired on April 3, 2009. Mr. Henderson said the reasons for dismissal included poor performance and a belief Mr. Earle was having an affair with the wife of another Milstream trader at the time. Mr. Earle denied both allegations, calling the notion of poor performance "ridiculous."
Mr. Earle first told the SEC about Pipeline's activities in an April 6, 2009, email. In it, he said he had "extensive information" about "an ongoing situation of which I have first hand knowledge, having worked at the firm for several years."
Mr. Earle said he never told any Pipeline employee about his involvement with the SEC. But soon after he contacted the regulators, he said, he told them that some Pipeline employees were suspicious he had spoken to the agency.
"Pipeline's efforts at all junctures have been to malign me. That's one of the reasons I went to the SEC in the first place," Mr. Earle said. Pipeline, which this year changed its named to Aritas Securities LLC, declined to comment on Mr. Earle's remark.
Mr. Earle said he has been the target of ire from current and former Pipeline employees. He said he ran into a Pipeline executive while walking in New York's Times Square in early December, a little over a month after the SEC fined Pipeline $1 million and two of its executives $100,000 each for failing to disclose Milstream's activities to clients.
Mr. Earle said he asked the executive, Reid Curley, how he was doing. "Just trying to clean up your wreckage," he said Mr. Curley responded. Mr. Curley declined to comment.
Write to Scott Patterson at firstname.lastname@example.org and Jenny Strasburg at email@example.com
A version of this article appeared April 25, 2012, on page A1 in some U.S. editions of The Wall Street Journal, with the headline: Source's Cover Blown By SEC.