On December 8, the United States Court of Appeals for the Second Circuit reversed the March 2014 convictions of former Jefferies RMBS trader Jesse Litvak for fraud against the United States and making false statements and vacated Litvak’s conviction for securities fraud, remanding the case to the District Court for a new trial on the securities fraud charges.
The Second Circuit’s decision held that a broker-dealer’s misstatements about the prices of its back-to-back trades, or even whether there is such a trade, are not necessarily material under the securities laws. Especially in situations with complex securities that do not trade on efficient markets, a defendant should be able to introduce evidence that a reasonable investor would have performed its own valuation analysis and would not have considered the dealer’s misstatements as to price or inventory to be important.
The Second Circuit also advised that at the retrial, Litvak should be able to rebut any suggestion by the government that he was an agent earning a commission, as opposed to a principal earning a spread, as the duties of an agent to its principal are greater than that of a principal to its counterparty, and those duties may bear on whether statements made by the dealer are material. The Court also advised that evidence that Litvak’s supervisors were aware of similar misrepresentations by others in the office could be relevant to the issue of whether Litvak had the requisite intent to defraud.
This decision is important for its implications regarding materiality, including with respect to other similar cases.
While working as a bond trader at Jefferies, Litvak made three types of misrepresentations to representatives of the counterparties with whom he transacted on Jefferies’ behalf. First, he misrepresented to purchasing counterparties Jefferies’ acquisition costs of certain RMBS. Second, he misrepresented to selling counterparties the price at which Jefferies had negotiated to resell certain RMBS. Third, he misrepresented to purchasing counterparties that Jefferies was functioning as an intermediary between the purchasing counterparty and an unnamed third-party seller, when in fact Jefferies owned the RMBS and no third-party seller existed. In Litvak’s trial before the District Court, the jury found these misstatements to be material and sufficient to support Litvak’s conviction on all of the charges.
False Statements/Defrauding the U.S.
The government included charges for fraud against the United States and false statements, because Litvak’s misstatements had been made in connection with RMBS trades with certain Public-Private Investment Funds (“PPIFS”) which are overseen by the Department of the Treasury but managed by private investment managers. The Second Circuit found that the misstatements at issue were not material, and reversed Litvak’s convictions on these counts, because Litvak’s misstatements were made to the managers of the PPIFS and therefore no rational jury could have found that they were capable of influencing any decision made by the Department of the Treasury.
The Second Circuit rejected Litvak’s argument that his misrepresentations – which related to the price, as opposed to the intrinsic value, of the bonds – were immaterial as a matter of law. Litvak’s trade counterparties had testified that his misrepresentations were meaningful to their decisions to enter the RMBS transactions at issue, and the Court declined to disturb the jury’s finding of materiality based on that testimony. The Second Circuit also rejected Litvak’s argument that the government was required to prove “intent to harm,” holding that such intent is not a component of the scienter element of securities fraud.
The Court nonetheless agreed with Litvak that the District Court had erred in precluding certain expert testimony that Litvak had offered in his defense. First, the Second Circuit found that the trial court had erred in excluding the testimony of a business school professor and former portfolio manager, who had been called to testify that statements about acquisition price or valuation by a sell-side trader were considered to be generally biased and unreliable and therefore were not material to a reasonable professional investment manager’s decision-making process. The District Court excluded this testimony on relevance grounds, but the Second Circuit found that it would have been “highly probative of materiality, the central issue in the case.”
The Second Circuit found that this error was not harmless because it was substantially the only testimony offered in support of Litvak’s non-materiality defense. While the government had introduced testimony from particular counterparties as to the importance to them of Litvak’s misstatements, Litvak had been precluded from introducing expert testimony about what the importance would have been to a reasonable investor. The Court therefore vacated the judgment of conviction as to the securities fraud charges and remanded the case to the District Court for a new trial.
The Court also held that the District Court erred by excluding the testimony of a former FINRA general counsel who was called to testify about the “arms-length nature of the relationship between a broker-dealer and counterparty[.]” The Court found that although Litvak’s capacity as an agent or principal was not an element of securities fraud, it was relevant to a determination of whether his misstatements were material to a reasonable investor. Thus, Litvak was entitled to rebut the testimony of his trade counterparties that he had acted as an agent.
Finally, the Second Circuit held that it was error for evidence of Litvak’s supervisors’ knowledge of similar misrepresentations by other Jefferies employees to be excluded as irrelevant. The Court found that such testimony could have supported Litvak’s attempt to introduce reasonable doubt as to his intent to defraud and show that “he held an honest belief that his conduct was not improper or unlawful, a belief the jury may have found more plausible in light of his supervisors’ approval of his colleagues’ substantially similar behavior.”