Ex-RBS trader’s plea highlights issue at 2nd Circuit: Can brokers lie?

March 12, 2015

There is a very unusual paragraph at the beginning of the plea agreement former RBS trader Matthew Katke entered Wednesday with federal prosecutors in Connecticut. Katke admitted to conspiring to commit securities fraud when he worked at RBS. But he and prosecutors agreed that his conduct may turn out not to be a crime at all, depending on what the 2nd U.S. Circuit Court of Appeals eventually rules in an appeal by ex-Jefferies broker Jesse Litvak.

Litvak was convicted of securities fraud by a federal jury in Connecticut in March 2014. Katke is accused of pretty much the same conduct as Litvak: deceiving clients about how much money he and his shop stood to make in brokering sales of sophisticated mortgage-backed financial instruments. Under Katke’s plea deal, if the 2nd Circuit decides that, as a matter of law, Litvak’s lies to his clients don’t amount to securities fraud, Katke has the right to withdraw his plea.

Katke should not be the only Wall Street trader rooting for Litvak to win his appeal. The former RBS broker is cooperating with the government, so it’s safe to assume prosecutors are investigating other targets as well. RBS, which has not been charged, told my Reuters colleague Jon Stempel that it is also cooperating with the investigation. Litvak’s onetime employer, Jefferies, entered a $25 million non-prosecution agreement with the government. Litvak was the only individual Jefferies broker to be prosecuted, but according to evidence he sought to introduce at trial, he’s not the only one who misled clients about the margins he was making on the bonds he bought and sold. Every securities trader who has underreported profit margins to customers has a stake in Litvak’s case.

The 2nd Circuit has signaled that he has a decent shot at overturning his conviction on appeal. The trial judge who oversaw Litvak’s prosecution, U.S. District Judge Janet Hall of New Haven, denied him bail, but last October, after oral argument, a three-judge panel granted Litvak’s motion for bail pending the conclusion of his appeal. As I’ve previously explained, the standard in the 2nd Circuit is that defendants must show that their appeals raise such important issues that if they succeed, their convictions are likely to be overturned. Winning the right to remain free on bail during your appeal isn’t a guarantee you’ll ultimately overturn your conviction, though. Case in point: Rajat Gupta, the onetime Goldman director whose insider trading conviction was upheld even though he was permitted bail.

So what are the legal arguments asserted by Litvak’s appellate lawyers at Williams & Connolly? Broadly speaking, Litvak’s opening brief contests the government’s view of the law in two ways. Litvak’s representations to clients about his margins on the bonds they bought were not material and did not constitute intent to deceive. The key fact of the transactions in the case, according to Williams & Connolly, is that investors received the securities they contracted to buy at the price they agreed to pay.

Litvak’s lawyers contend that Jefferies’ profits on the transactions were besides the point under 2nd Circuit precedent in the 1996 case of Feinman v. Dean Witter, which held that reasonable investors wouldn’t change their minds about investment decisions based on misreported brokers’ fees. At Litvak’s trial, according to the appellate brief, his clients specifically testified that the broker’s statements didn’t affect their assessment of the bonds and that they would have paid the same price even if they knew the true profits Jefferies stood to make.

There’s more precedent on fraudulent intent, but according to Litvak, it stands for the proposition that to prove securities fraud, the government must show alleged fraudsters meant to harm their counterparties. Litvak’s misrepresentations about his potential profits, his brief said, were irrelevant to “the object of the contract” because they did not affect the securities customers agreed to buy or the price clients independently determined they would pay.

The government, of course, argued in its appellate brief, as it did at trial, that Litvak’s misrepresentations materially affected the price his customers ended up paying. (It also said the Feinman case is factually different than this one.) And according to prosecutors, Litvak’s brief is wrong about the burden for establishing fraudulent intent. The government brief contends that Supreme Court and 2nd Circuit precedent is clear that prosecutors must show only that Litvak intended to deceive his clients, not that he intended to harm them. His deceptive intent, the government said, is clear from his admissions to some clients that he needed to boost profits.

The 2nd Circuit is aiming to hold oral arguments in Litvak’s case in May. Kannon Shanmugam of W&C will be arguing for Litvak. Jonathan Francis of the Connecticut U.S. Attorney’s office is expected to argue for the government.

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