Why it matters: A few interesting and diverse securities fraud matters from late 2015—one from the Second Circuit, two from the SEC—caught our eye. Read on for a recap.
Detailed discussion: The last two months of 2015 saw the announcement of three interesting and diverse matters from the world of securities fraud jurisprudence and enforcement that we found worthy of note. We recap them here:
December 8, 2015—The Second Circuit in U.S. v. Litvak reversed the securities fraud conviction of a defendant broker-dealer on evidentiary grounds: Defendant Jesse Litvak (Litvak), a registered broker-dealer with Jeffries & Co. (Jeffries), was indicted in January 2013 for securities fraud and other charges. The indictment alleged that Litvak made fraudulent misrepresentations to "purchasing counterparties" in order to "covertly reap excess profit for Jeffries in the course of transacting residential mortgage-backed securities (RMBS)." These included misrepresentations as to the costs to Jeffries of acquiring the RMBS and the price at which Jeffries had negotiated to resell them. In March 2014, after a 14-day jury trial, Litvak was convicted of securities fraud and sentenced to two years in prison. On appeal to the Second Circuit, the court considered four of Litvak's many challenges to his conviction, but the challenge that proved successful and led the court to vacate the conviction and remand the case for a new trial was evidentiary, having to do with whether the district court erred when it excluded portions of two experts' testimony proffered by Litvak at trial. The Second Circuit found that the district court exceeded its allowable discretion by excluding the experts' testimony in numerous instances, the two most relevant of which are:
Exclusion of expert evidence that went to "materiality": The first of Litvak's experts was excluded from testifying "about the process investment managers use to evaluate a security, and the irrelevance of the broker-dealer's acquisition price to that process [which] was directly probative of whether Mr. Litvak's misstatements would have been material to a reasonable investor." The Second Circuit found that the district court exceeded its allowable discretion by excluding this testimony because it "would have been highly probative of materiality, the central issue in the case" and could have "educated the jury…about the highly-specialized field of RMBS trading." The court found that "a jury could reasonably have found that misrepresentations by a dealer as to the price paid for certain RMBS would be immaterial to a counterparty that relies not on a 'market' price or the price at which prior trades took place, but instead on its own sophisticated valuation methods and computer model." The court held that the district court's error in excluding this testimony was "not harmless" and thus a reversal of Litvak's conviction was warranted.
Exclusion of evidence that went to "good faith"—the "standard operating procedure" defense: The second of Litvak's experts was excluded from testifying about "the widespread use of similar negotiation tactics [to those of Litvak] at Jeffries" which would have "shown that others at Jeffries engaged in the same conduct and that it was approved by supervisors and by Jeffries' compliance department." The second expert's testimony would have gone to the issue of Litvak's good faith by introducing evidence that, during the relevant time period, Litvak's conduct was "business as usual" and that "supervisors at Jeffries…regularly approved of conduct identical to that with which Litvak was charged." The Second Circuit found that the district court "exceeded its allowable discretion in concluding that this testimony was not relevant under the low threshold set forth by Federal Rule of Evidence 401… in determining whether Litvak 'held an honest belief that his actions were proper and not in furtherance of any unlawful activity.' " As a reversal of Litvak's conviction had already been found to be warranted earlier in the opinion, the court felt no need to reach a decision as to the harmlessness of this error.
December 7, 2015—SEC charged attorneys and law firms in numerous states with acting as unregistered brokers by offering EB-5 investments to immigration clients: The SEC announced a series of enforcement actions against attorneys across the United States who were charged with offering EB-5 investments—sold via a program created by the Immigration Act of 1990 to stimulate foreign investments—while not registered to act as brokers in violation of the Securities Exchange Act of 1934. The press release highlights one case filed in the Central District of California where the SEC alleged that a New York-based immigration attorney and his firm acted as unregistered brokers by selling EB-5 investments to more than 100 investors and also defrauded clients by failing to disclose that they received commissions on the investments in breach of fiduciary and legal duties. The SEC announced that it had settled administrative proceedings for similar charges (which were neither admitted to nor denied) against numerous attorneys and firms in Texas, Florida, New Jersey and California. Enforcement Director Andrew Ceresney stated that "[i]ndividuals and entities performing certain services and receiving commissions must be registered to legally operate as securities brokers if they're raising money for EB-5 projects…[t]he lawyers in these cases allegedly received commissions for selling, recommending, and facilitating EB-5 investments, and they are being held accountable for disregarding the relevant securities laws and regulations."
November 24, 2015—SEC charged political intelligence firm Marwood Group Research LLC with compliance failures in violation of the securities laws: The SEC announced that Marwood Group Research LLC (Marwood), a regulatory and legislative policy firm (a.k.a. a "political intelligence" firm) and registered broker-dealer/investment advisor, agreed to pay a $375,000 penalty and admit wrongdoing for failing to properly inform its in-house compliance officers about instances when analysts obtained potentially material nonpublic information from government employees in violation of its written policies and procedures. According to the SEC's order, Marwood's admitted misconduct occurred in 2010 when Marwood analysts obtained from government employees information about policy issues and pending regulatory approvals at the Centers for Medicare & Medicaid Services and the Food and Drug Administration. The information was obtained by the analysts in the usual course of Marwood's business as part of the firm's "research notes" service to "provide hedge funds and other clients with regulatory updates and analysis about potential timing and developments for future government actions or rulemaking decisions." The facts show that Marwood encouraged its analysts to "maintain relationships" with the government employees, which the SEC found to be a violation as government employees "often are familiar with confidential matters at their agencies" and thus "such interactions increased the likelihood that Marwood Group employees could acquire material nonpublic information in the course of their work." The facts show that Marwood's written policies and procedures in place at the time "expressly prohibited the acquisition and dissemination of material nonpublic information and required employees to bring it to the attention of the compliance department if they encountered anything confidential." The SEC found that "[d]espite the red flags," the analysts failed to run the confidential information they received from the government employees by the compliance department "so it could be properly vetted for any material nonpublic information ripe for insider trading" and instead drafted and distributed the research notes directly to the firm's clients "who could have used any material nonpublic information to inform securities trading decisions." As the result, the SEC's order finds that Marwood violated Section 15(g) of the Securities and Exchange Act of 1934 and Section 204A of the Investment Advisers Act of 1940.