For E*Trade, $34M Illegal-Trading Fine May Be the Least of Its Troubles

(MoneyWatch)  Fourteen firms had to settle charges of illegal trading with the SEC at the beginning of the month. Charged with so-called trading ahead between 1999 and 2005, they had to pay a collective $70 million. Trading ahead occurs when a firm places its own trade orders before those of its customers and recognizes extra gains as a result.

Sure, $70 million may be chump change on Wall Street, as other blogs have noted. But what's more interesting to me is that online brokerage firm E*Trade is on the hook for $34 million, or almost half of the total amount. The $34 million include $5.7 million in civil penalty, the rest being restitution of the cash clients were cheated on. It means that the trades E*Trade engaged in resulted in an overall disadvantage to its clients of about $28.3 million, according to the SEC (PDF link).

E*Trade's fine is almost five times what Susquehanna Investment Group has to pay, for instance. The SEC estimated that Susquehanna's actions cost its customers about $6.4 million, and ordered the firm to pay an extra $1.27 million in penalty. It also dwarfs Goldman Sachs's payment of $7.2 million for trading ahead, which includes $1.2 million in civil penalty.

I've heard that the $34 million won't likely increase the company's loss for the first quarter, thanks to legal reserves of $55 million, which will help foot the bill. But it won't help the company return to profitability, either.

E*Trade has been dealing with several challenges in the past year and a half, particularly continued losses in its mortgage-loan portfolio, which it runs in parallel to its online-brokerage business. E*Trade has already said total losses on home-equity loans in the three-year period ending 2010 will be 15-20 percent higher than its previous forecast of $1.8 billion, delaying its return to profitability.

In need of cash, E*Trade applied for $800 million in funding from the U.S. government's Troubled Assets Relief Program in October, but still hasn't received approval from regulators. In its most recent 10-K filing, it noted that to receive TARP money, it may also have to raise capital from existing investors. But hedge fund Citadel Investments, its largest investor, has plenty of its own troubles. The distinct possibility that Citadel might decline to pony up has already led one analyst to question the long-term viability of E*Trade.