In a ruling that will shape how the U.S. Justice Department and Securities and Exchange Commission pursue several similar cases already in the pipeline, a federal appeals court threw out Jesse Litvak’s March 2014 conviction for defrauding the U.S. Troubled Asset Relief Program and making false statements to the government. Prosecutors will retry charges of lying to buyers and sellers of mortgage-backed securities.
Tuesday’s decision forces the U.S. to bolster its case that traders who lie to customers are committing fraud. In it, the appeals court faulted the judge for excluding some defense evidence, saying the accused must be allowed to show that his actions were in keeping with how Wall Street does business.
That puts the industry in the uncomfortable spot: To beat government accusations that bond traders are cheating investors, defense attorneys may have little choice but to tell juries the market’s sophisticated participants understand that trading securities is a lot like stepping onto a used-car lot.
A central issue in the Litvak case is whether it’s important for the buyer of a bond to know how much a trader paid for it. Prosecutors argued that Litvak’s lies about how much he paid constituted fraud. Litvak’s team compared their client to used-car salesman who isn’t expected to be honest about what he paid for a car: If a sophisticated bond-buyer agrees the price is fair, they argued, it doesn’t matter what the dealer originally paid.
The government welcomed the ruling, in which the judges said “a rational jury could have found that Litvak’s misrepresentations were material” after hearing all the evidence, including defense testimony that was excluded.
“We are gratified that the panel unanimously upheld the government’s securities fraud theory and found that the jury was justified in concluding that Mr. Litvak’s misstatements were material to investors,” Connecticut U.S. Attorney Deirdre Daly said in a statement. “Today’s opinion affirms the government’s ongoing efforts to investigate and prosecute fraud in the fixed- income markets.”
The defense also hailed the ruling.
“We’re very pleased with the decision today in Jesse’s case,” Kannon Shanmugam, Litvak’s attorney, said in an e-mailed statement.
The reversal threatens at least one criminal case — that of Matthew Katke, a former Royal Bank of Scotland Group Plc trader of collateralized loan obligations who pleaded guilty in March to fraud and agreed to cooperate with prosecutors. Katke’s agreement allows him to withdraw his plea if a “final decision” is reached that Litvak didn’t violate the laws he was charged under. The decision to retry Litvak keeps Katke in limbo for now.
Katke’s plea followed suspensions at Wall Street banks as regulators increasingly scrutinize asset-backed debt trades. Royal Bank of Scotland, JPMorgan Chase & Co., Morgan Stanley and Barclays Plc have put traders on leave amid the inquiries.
Spokesmen for Barclays, RBS, Morgan Stanley and JPMorgan declined to comment on the appellate decision.
In September, three former Nomura Holdings Inc. traders were charged with defrauding investors by inflating the prices of mortgage-backed securities. They deny wrongdoing.
Tuesday’s ruling “is terrific in the sense that it sends a message that the courts will push back when the government tries to criminalize legitimate business activity,” Marc Mukasey, an attorney one of the Nomura ex-traders, said in an e-mail.
Tom Carson, a spokesman for Daly, didn’t comment on how Tuesday’s decision might affect the Katke and Nomura cases.
The Litvak reversal comes just months after the Justice Department delivered a strong directive to federal prosecutors to hold individuals accountable for corporate crimes. The policy, known as the Yates Memo, was seen as a response to criticism from lawmakers and public-interest groups that the government has largely failed prosecute people even as it reaches multibillion-dollar settlements with Wall Street firms.
Litvak was convicted by a federal jury in New Haven, Connecticut, after a monthlong trial before U.S. District Judge Janet C. Hall and sentenced to two years in prison. He was accused of defrauding investors of $2 million by misrepresenting how much sellers were asking for the securities or what customers would pay and keeping the difference for Jefferies.
He was the first person convicted of fraud tied to TARP, the bailout that followed the financial crisis, and is the only person to be found guilty of fraud tied to the Public-Private Investment Program, which used TARP funds to encourage investments in mortgage securities following the 2008 financial crisis.
The appellate judges said Litvak’s actions couldn’t have significantly influenced the U.S. Treasury Department, which ran TARP, but could have swayed his customers.
Litvak didn’t dispute that he made misstatements, arguing at trial that they weren’t material and he didn’t think the other parties in the transactions would be harmed because he was selling the bonds at “fully disclosed and agreed upon fair prices” that stayed below Jefferies’ threshold for 4 percent profit.
He argued on appeal that his conviction could be used to prosecute any business involved in simple negotiations. Former SEC Deputy Director George Canellos said after Litvak’s January 2013 arrest that his tactics were “unfit for a used-car lot.”