Second Circuit Orders New Trial in Securities Fraud Case
Commentary by Steven Lofchie
The U.S. Court of Appeals for the Second Circuit vacated the conviction of a former bond trader for securities fraud, under Exchange Act § 10(b). The Court remanded the case and ordered a new trial.
The Appellate Court found:
- with respect to charges against the bond trader of committing fraud against the United States and making false statements, the evidence adduced at trial provided an "insufficient basis for the jury to find that the defendant's misstatements were material to the government"; and
- with respect to the securities fraud counts, "the District Court exceeded its allowable discretion in excluding certain portions of the defendant's proffered expert testimony, and . . . such error was not harmless."
Commentary
This is a case that the government should not retry. The essence of the case is this: (i) what duty the trader owed the institutional customers in disclosing his cost of acquiring the positions and the source of those positions, (ii) whether the institutional customers should have believed what he told them, and (iii) whether the information he provided about the cost should have been relevant to the trading decision. The expert witness for the defense, whose testimony was excluded, would have testified on the record that such "statements from sell-side . . . traders are generally biased, often misleading, and unworthy of consideration in trading decisions." Additionally, the expert witness would have testified that purchase decisions are based not on what the seller paid, but on "analytical tools and methods . . . and the development of an investment thesis." In other words, (i) the buyers had no reason to believe the trader, (ii) this type of "dishonesty" is expected in the market and so could hardly be regarded as dishonesty, and (iii) the amount that the trader paid for the bonds is irrelevant to their worth.
Although the Appeals court reversed the conviction, it still held that the salesperson ultimately could be sent to jail even if the institutional customers should not have believed him or considered the price the trader paid for the bonds to be relevant to their value.
To take the opposing view: if the institutional customers should not have believed the salesperson, and should not have "relied" on information that is fundamentally irrelevant, then their trust ought not to be the basis for sending a person to jail or wrecking that person's career. Rather than retry the case, the DOJ should compel the SEC to urge FINRA to adopt a rule prohibiting this type of behavior. That way, future traders will know enough to answer customers' speculative questions by saying "none of your business."