It’s been nearly a year since former Jefferies Group Inc. bond trader Jesse Litvak had his federal conviction overturned by the Second Circuit U.S. Court of Appeals, despite evidence that he lied to clients about mortgage bond prices in order to inflate his trading profits by $2.5 million. But whether you’re a sell-sider hawking merchandise to the highest bidder, or an institutional buyer looking to scoop up bargains from a slightly-less-in-the-know dealer, here’s a word to wise about playing fast and loose with the truth about bond prices: Not so fast!
While Litvak’s conviction was indeed overturned by the highly influential Second Circuit, where so many complex and cutting-edge securities cases are tried, the reasons could aptly be described as good old-fashioned “technicalities” in legal parlance.
Litvak’s fraud conviction related to misleading customers who were participants in the U.S. Treasury’s Troubled Asset Relief Program (TARP) could not stand, the Second Circuit decided, because of a lack of evidence that Litvak’s misleading conduct was material to an investment decision by the Treasury. Because the Treasury had ceded complete authority to its investment advisor—who actually purchased the bonds from Litvak for the TARP program—it wasn’t actually the Treasury’s finger on the trigger. Thanks to that technicality, Litvak’s conduct could not have been fraud against the TARP.
The Second Circuit also decided that the trial court judge, Chief Judge Janet Hall of the New Haven, Connecticut Federal District Court, erred when she did not allow Litvak’s trial attorneys to present expert testimony that Litvak’s misstatements were not material to the decision by other investors to purchase bonds from Litvak. This is where it gets very interesting for bond traders wanting to know where the right side of the line is when it comes to communicating with customers about pricing.
Despite having his conviction reversed, Litvak did not escape the Feds’ grasp entirely—unlike the portfolio managers whose insider trading convictions were overturned by the same court in its now-famous Newman decision back in 2014. There is a chance Litvak may not escape at all, because the Second Circuit ordered another trial—scheduled to begin in January—where such expert evidence about materiality will be permitted.
At Litvak’s new trial, his attorneys will present expert witness support for the idea that (brace yourselves) investors normally expect statements from bond traders they deal with to be biased and misleading, and so such statements should not be considered material to investor buy/sell decisions. The government will likely counter with arguments that investors, in deciding whether and at what price to buy or sell bonds, do take into account bond traders’ representations about the prices where they’ve traded the exact same bonds in the minutes and even hours prior to the investor’s buy/sell decision.
The overarching question is this: do sophisticated bond traders actually care, or even believe it when their broker tells them that he or she just bought the same bonds a few ticks lower—when in actuality the broker has been sitting on the bonds for days after having bought them for 5 percent less? In an opaque market like mortgage bonds, where you can’t just reliably punch up a ticker symbol and see a real-time quote like you can with stocks, it’s at least an interesting question. The government certainly thinks the answer is yes.
In the meantime, while they wait for a second crack at Litvak, the Feds have not exactly beat a retreat. They’ve been busy filing Litvak–type cases against other sell-side bond traders, as well as extracting guilty pleas and levying large fines and industry suspensions on others. Three ex-Nomura traders are slated to go on trial early next year in federal court in Hartford. This past August, the former top RMBS trader at Goldman Sachs Co. agreed to pay $400,000 and accepted a two-year ban from the industry in order to settle similar charges by the SEC. In September, a former Jefferies colleague of Litvak’s agreed to a smaller SEC fine and shorter suspension for merely stretching the truth, as opposed to bludgeoning it.
And the spotlight may not just be on sell-siders, as SEC enforcement staff have stated publicly that more Litvak-type cases would be coming, and that they would not just focus on bond dealers. What’s that mean exactly? It’s hard to say at this point as no similar cases have yet been brought against any buy-side bond market players. But unless President-elect Trump takes a hatchet to the SEC and DOJ after he gets done with the EPA, all bond traders may want to tap the brakes before telling clients or counterparties stories about bonds—the kind of stories that would more appropriately be found in the fiction aisle.
Andrew D. Beresin is a practicing securities attorney, former hedge fund trader, and a senior consultant with UnderwoodFX. He represents Wall Street firms and individuals in compliance, enforcement defense, and regulatory advisory matters, and provides expert services on exchange-listed trading. Beresin is a former federal district court judicial clerk and a graduate of Harvard Law School.