United States v. Finnerty ( 2008 )

07-1104-cr
United States v. Finnerty
1
2 UNITED STATES COURT OF APPEALS
3
4 FOR THE SECOND CIRCUIT
5
6 August Term, 2007
7
8
9 (Argued: June 13, 2008 Decided: July 18, 2008)
10
11 Docket No. 07-1104-cr
12
13 - - - - - - - - - - - - - - - - - - - -x
14
15 UNITED STATES OF AMERICA,
16
17 Appellant,
18
19 - v.-
20
21 DAVID FINNERTY,
22
23 Defendant-Appellee.
24
25 - - - - - - - - - - - - - - - - - - - -x
26
27 Before: JACOBS, Chief Judge, POOLER, Circuit
28 Judge, RESTANI,* Judge.
29
30 The government appeals from a judgment of acquittal
31 entered in the United States District Court for the Southern
32 District of New York (Chin, J.), setting aside the jury
33 verdict in a securities fraud prosecution against a New York
34 Stock Exchange specialist who engaged in “interpositioning.”
35 We affirm.
*
The Honorable Jane A. Restani, Chief Judge of the
United States Court of International Trade, sitting by
designation.
1 LAUREN GOLDBERG, Assistant
2 United States Attorney, United
3 States Attorney’s Office for the
4 Southern District of New York,
5 New York, NY (Michael J. Garcia,
6 United States Attorney, on the
7 brief, Anirudh Bansal and
8 Celeste Koeleveld, Assistant
9 United States Attorneys, of
10 counsel), for Appellant.
11
12 FREDERICK P. HAFETZ, Hafetz &
13 Necheles, New York, NY (Tracy
14 Sivitz, on the brief), for
15 Defendant-Appellee.
16
17 DENNIS JACOBS, Chief Judge:
18
19 In this securities fraud case, the government appeals
20 from a judgment of acquittal entered by the district judge
21 following a jury’s guilty verdict. See United States v.
22 Finnerty, 474 F. Supp. 2d 530 (S.D.N.Y. 2007) (Chin, J.).
23 Defendant-Appellee David Finnerty was a specialist at the
24 New York Stock Exchange (“NYSE”) who engaged in the practice
25 of “interpositioning”--the arbitrage of the gap between
26 customers’ orders to buy and sell stock--to the benefit of
27 his firm’s account and (via compensation) himself. The sole
28 issue on appeal is whether the government proved that
29 Finnerty’s conduct was deceptive.
30 Because it did not, the judgment of acquittal is
31 affirmed.
32
2
1 BACKGROUND
2 This case is one of several arising from an
3 investigation into the practices of specialists on the NYSE
4 trading floor. The NYSE operates as an auction market with
5 specialists fielding competing bids and offers for stock in
6 the 2,800 listed companies. We recently described the role
7 of the specialist firms as follows:
8 Each security listed for trading on the NYSE
9 is assigned to a particular [specialist] Firm.
10 To execute purchases and sales of a particular
11 security, buyers and sellers must present
12 their bids to buy and offers to sell to the
13 specific Specialist Firm assigned to that
14 security. The primary method of trading on
15 the Exchange occurs through the NYSE’s Super
16 Designated Order Turnaround System, which
17 transmits orders to buy and sell to the
18 Specialist Firm electronically. The orders
19 appear on a special electronic workstation
20 often referred to as the “display book.” Each
21 Specialist Firm has a computerized “display
22 book” at its trading post that permits the
23 Firm to execute orders for the market.
24 In re NYSE Specialists Sec. Litig., 503 F.3d 89, 92 (2d Cir.
25 2007). In addition to executing trades for NYSE customers,
26 specialists trade for the “proprietary” or “principal”
27 account of their own firm.
28 In 2002, the NYSE opened an investigation into improper
29 trading by specialists. The investigation focused on two
30 practices: “interpositioning” and “trading ahead.” A
31 specialist engages in interpositioning when he “prevent[s]
3
1 the normal agency trade between matching public orders and
2 instead interpose[s]” himself “between the matching orders
3 in order to generate profits” for the principal account--in
4 other words, when the specialist acts as an arbitrager by
5 taking a profit on the spread between the bid price and the
6 ask price of customers’ orders. Id. at 93. A specialist
7 trades ahead when he trades for his own “account before
8 undertaking trades for public investors.” Id. These
9 practices implicate two NYSE rules.
10 NYSE Rule 104 allows for a proprietary trade when it is
11 “reasonably necessary to permit [a] specialist to maintain a
12 fair and orderly market,” and otherwise prohibits “such
13 dealings.” NYSE Rule 92(a) prohibits a proprietary trade
14 when the specialist “has knowledge of any particular
15 unexecuted customer’s order to buy (sell) such security
16 which could be executed at the same price.”
17
18 The Indictment
19 In 2006, Finnerty was charged with three counts of
20 securities fraud. The superseding indictment alleged that
21 while he was employed by Fleet Specialists, Inc. between
22 1999 and 2003, Finnerty “caused approximately 26,300
23 instances of interpositioning, resulting in illegal profits
4
1 to his dealer account of approximately $4,500,000, and
2 approximately 15,000 instances of trading ahead, resulting
3 in approximately $5,000,000 in customer harm.” The
4 indictment charged that Finnerty thus engaged in a
5 fraudulent and deceptive course of conduct, in violation of
6 15 U.S.C. §§ 78j(b) and 78ff and 17 C.F.R. § 240.10b-5.
7 Count One charged Finnerty with carrying out this fraud
8 while he was the specialist responsible for trading in the
9 stock of General Electric, from September 2000 through early
10 2003; Count Two, while specialist for Applera Corp.-Celera
11 Genomics Group, from November 1999 through February 2002;
12 and Count Three, while specialist for PE Biosystems, from
13 November 1999 through September 2000.
14
15 Pretrial Rulings
16 Finnerty moved to dismiss the indictment on the ground
17 that interpositioning is neither deceptive nor manipulative
18 and therefore does not constitute securities fraud.
19 In relevant part, the Securities Exchange Act of 1934
20 makes it
21 unlawful for any person, directly or
22 indirectly, by the use of any means or
23 instrumentality of interstate commerce or of
24 the mails, or of any facility of any national
25 securities exchange--
26
27 . . .
5
1 (b) To use or employ, in connection with
2 the purchase or sale of any security
3 registered on a national securities
4 exchange or any security not so
5 registered . . . any manipulative or
6 deceptive device or contrivance in
7 contravention of such rules and
8 regulations as the Commission may
9 prescribe as necessary or appropriate in
10 the public interest or for the protection
11 of investors.
12
13 15 U.S.C. § 78j (“§ 10(b)”). Rule 10b-5, promulgated
14 thereunder, makes it unlawful
15 for any person, directly or indirectly, by the
16 use of any means or instrumentality of
17 interstate commerce, or of the mails or of any
18 facility of any national securities exchange,
19
20 (a) To employ any device, scheme, or
21 artifice to defraud,
22
23 (b) To make any untrue statement of
24 material fact or to omit to state a
25 material fact necessary in order to make
26 the statements made, in the light of the
27 circumstances under which they were made,
28 not misleading, or
29
30 (c) To engage in any act, practice, or
31 course of business which operates or
32 would operate as a fraud or deceit upon
33 any person,
34
35 in connection with the purchase or sale of any
36 security.
37
38 17 C.F.R. § 240.10b-5 (1995).
39 The district court granted Finnerty’s motion in part,
40 but let stand the allegations based on subsections (a) and
41 (c) of Rule 10b-5. The court reasoned that the NYSE rules
6
1 obligate specialists “to place the interests of their public
2 customers above their own”; that Finnerty “made a profit for
3 [himself], and subordinated the interests of the trading
4 public below [his] own”; and that this practice “deceive[d]
5 the trading public, as investors believed that [specialists]
6 were working to match orders, first and foremost, and that
7 [specialists] traded for their own proprietary accounts only
8 to maintain a fair and orderly market.” United States v.
9 Finnerty, 2006 WL 2802042, at *4 (S.D.N.Y. Oct. 2, 2006).
10 The district court ruled that the indictment failed to
11 state a violation of subsection (b) of Rule 10b-5 because it
12 did not identify any statements that were misleading or were
13 made misleading by Finnerty’s omission. Id. at *6. The
14 government argued that no such showing was required under “a
15 line of Second Circuit cases that allows for omission
16 liability based on implied misrepresentations” where a
17 securities dealer charges “excessive markups when selling
18 securities.” Id. Rejecting that theory, the court reasoned
19 that unlike securities dealers, “specialists do not actively
20 solicit customers,” nor do they “‘hang[] out [their]
21 professional shingle.’” Id. (quoting Grandon v. Merrill
22 Lynch & Co., 147 F.3d 184, 192 (2d Cir. 1998)) (alteration
23 in original). Because of the dealers’ direct relationship
24 with their customers, the court concluded that “the
7
1 situations are quite distinct,” and that the excessive
2 markup cases were inapposite. Id.3
4 Proof at Trial
5 At trial, the government narrowed its case. It did not
6 undertake to prove trading ahead; it focused exclusively on
7 interpositioning. It did not try to prove that Finnerty
8 owed a fiduciary duty to public customers. And, in
9 accordance with the pretrial rulings, it did not try to
10 prove a violation of subsection (b).
11 The government called three former NYSE clerks, who
12 testified that Finnerty directed them to execute
13 interpositioning trades for the principal account ahead of
14 (and to the detriment of) existing public orders. One of
15 the clerks, Philip Finale, testified that just before he was
16 scheduled to testify before the NYSE investigation, Finnerty
17 pulled him aside and whispered: “don’t say anything to
18 incriminate [me], because it’s going to incriminate [you]
19 also.”
20 The government displayed graphics showing the sequence
21 of keystrokes that compose an interpositioning trade. An
22 NYSE managing director testified about the computer codes
23 used to generate “exception reports,” which identify
8
1 instances of interpositioning and trading ahead.2 Several
2 summary charts of that data showed 26,283 instances of
3 interpositioning trades under Finnerty’s watch. In 95% of
4 those instances, Fleet’s principal account profited--
5 yielding a total of $4.5 million.
6 Joseph DiPrisco, who served as Fleet’s CFO during the
7 relevant period, testified that individual “profitability”
8 was one factor that determined a specialist’s bonus. Fleet
9 generally paid a specialist 15 to 20% of his profits.
10 Finally, the government introduced into evidence
11 Finnerty’s testimony before the NYSE, in which Finnerty
12 admitted that he and his clerks could trade for the
13 principal account only when necessary to maintain a fair and
14 orderly market, and only when the public customers
15 subsequently received the same or a better price than the
16 principal account received.
17 Finnerty called Dr. Patrick Conroy, who testified that
18 Finnerty’s 26,283 alleged acts of interpositioning
19 represented only .94% of the total trades executed by
20 Finnerty during the relevant time period.
2
The managing director testified to the following
definition of an interpositioning trade: “If two orders, a
buy order and a sell order[,] are present at the same time,
and the specialist instead of executing them against each
other trades separately with each of them, that would be an
interpositioning exception.”
9
1 The jury rendered a guilty verdict on all three counts.
2
3 Post-trial Rulings
4 The district court granted Finnerty’s post-trial motion
5 for a judgment of acquittal on the ground that the
6 government failed to prove that “interpositioning
7 constituted a deceptive act within the meaning of the
8 federal securities laws because it did not provide proof of
9 customer expectations.” United States v. Finnerty, 474 F.
10 Supp. 2d 530, 542 (S.D.N.Y. 2007).3 The district court
11 considered that, in a securities fraud prosecution, the
12 government generally must present “proof of what customers
13 ‘think they are getting’; otherwise, a juror has no way of
14 concluding whether customers were deceived by a defendant’s
15 conduct.” Id. at 539. Without holding that “evidence of
16 customer expectations is an element of the crime that the
17 Government must establish for a conviction under 10b-5,” the
18 district court concluded that the very definition of
19 “deceptive” calls for some showing of “what the investing
20 public expected.” Id.21 The government appeals.
3
In the alternative, the district court ruled that a
new trial was warranted based on several evidentiary issues.
Because we affirm the judgment of acquittal, we do not
review the alternative grant of a new trial.
10
1 DISCUSSION
2 “We review the grant or denial of a judgment of
3 acquittal de novo, and we apply the same standards governing
4 the sufficiency of the evidence as are applied by a district
5 court.” United States v. Temple, 447 F.3d 130, 136 (2d Cir.
6 2006). Thus, we will affirm the district court’s judgment
7 of acquittal only if “after viewing the evidence in the
8 light most favorable to the prosecution,” no rational
9 factfinder “could have found the essential elements of the
10 crime beyond a reasonable doubt.” Jackson v. Virginia, 443
11 U.S. 307, 319 (1979).
12
13 I
14 Section 10(b) of the 1934 Act prohibits the use of any
15 “manipulative or deceptive device or contrivance” in
16 connection with the purchase or sale of securities. “The
17 language of § 10(b) gives no indication that Congress meant
18 to prohibit any conduct not involving manipulation or
19 deception.” Santa Fe Indus. Inc. v. Green, 430 U.S. 462,
20 473 (1977). The government has abandoned on appeal any
21 claim of market manipulation. So the question is, what did
22 Finnerty say or do that was deceptive?
23 The government admits that Finnerty made no
24 misstatement. The government told the jury that the “real
11
1 issue” in the case was “whether David Finnerty directed” the
2 interpositioning trades and whether he did it “intentionally
3 and with the intent to defraud.” This was, in essence, a
4 theory of non-verbal deceptive conduct.
5 “Conduct itself can be deceptive,” and so liability
6 under § 10(b) or Rule 10b-5 does not require “a specific
7 oral or written statement.” Stoneridge Inv. Partners, LLC
8 v. Scientific-Atlanta, 128 S. Ct. 761, 769 (2008). Broad as
9 the concept of “deception” may be, it irreducibly entails
10 some act that gives the victim a false impression. “Theft
11 not accomplished by deception (e.g., physically taking and
12 carrying away another’s property) is not fraud absent a
13 fiduciary duty.” In re Refco Capital Markets, Ltd.
14 Brokerage Customer Sec. Litig., 2007 WL 2694469, at *8
15 (S.D.N.Y. Sept. 13, 2007) (Lynch, J.) (internal citation
16 omitted).
17 The government has identified no way in which Finnerty
18 communicated anything to his customers, let alone anything
19 false. Rather, viewing the evidence in the light most
20 favorable to the government, the government undertook to
21 prove no more than garden variety conversion. As the
22 government put it during summation, “David Finnerty stole
23 from his public customers tens of times a day, sometimes
24 over a hundred times in one day . . .” The government later
12
1 analogized Finnerty’s conduct to a bank teller who
2 takes in hundreds of deposits a day and he
3 gives out hundreds of withdrawals, and just
4 once, once every day takes he takes one of
5 those deposits, instead of putting it in the
6 till, he puts it in his pocket. He committed
7 a crime probably less than 1 percent of the
8 time in that example, but does that make it
9 right to steal? Of course it doesn’t.
10
11 Like a thieving bank teller, the government argued, Finnerty
12 had the motive and the means to profit from
13 interpositioning.4 But there is no evidence that Finnerty
14 conveyed an impression that was misleading, whether or not
15 it could have a bearing on a victim’s investment decision in
16 connection with a security. We need not decide whether some
17 form of communication by the defendant is always required to
18 prove deception (although that is the template of virtually
19 every case). To impose securities fraud liability here,
20 absent proof that Finnerty conveyed a misleading impression
21 to customers, would pose “a risk that the federal power
22 would be used to invite litigation beyond the immediate
23 sphere of securities litigation and in areas already
24 governed by functioning and effective state-law guarantees.”
25 Stoneridge, 128 S. Ct. at 771.
26
4
The government presented this analogy to rebut Dr.
Conroy’s testimony that Finnerty’s interpositioning trades
represented less than one percent of his total trades.
13
1 II
2 On appeal, the government presses a number of arguments
3 in support of its prosecution theory. We are unpersuaded.
4 The evidence shows (in the words of the government’s
5 brief) that “Finnerty, while holding himself out as a
6 specialist obligated to follow NYSE rules and refrain from
7 interpositioning, interpositioned on a massive scale under
8 the guise of maintaining a fair and orderly market.”
9 Accordingly, the government argues, a reasonable jury could
10 find that at least some customers were aware of the NYSE
11 rules, would have expected Finnerty to comply with the
12 rules, and were therefore deceived when Finnerty violated
13 them. The government relies on the following chain of
14 premises and inferences: (1) brokerage houses are “members”
15 of the NYSE; (2) as members, brokerage houses know about
16 (and are subject to) the NYSE rules against
17 interpositioning; (3) brokerage houses were customers of
18 Finnerty; so (4) Finnerty’s violation of the NYSE rules
19 deceived the brokerage houses. In essence, the government
20 seeks to impose criminal liability based on a background
21 assumption of compliance with NYSE rules.
22 The government did not make this argument at trial.
23 Moreover, we rejected a similar argument (made by civil
24 claimants) in a statement case decided last term, Lattanzio
14
1 v. Deloitte & Touche LLP, 476 F.3d 147 (2d Cir. 2007).
2 There, shareholders sued the accounting firm Deloitte &
3 Touche based on allegedly false statements in corporate
4 quarterly statements that were neither audited by the firm
5 nor accompanied by its audit opinion. Id. at 152-53. A
6 federal regulation obligated Deloitte, as the issuer’s
7 outside accountant, to review interim quarterly statements
8 before expressing an audit opinion on a subsequent filing.
9 Id. at 155. The claim was that “an investor (understanding
10 Deloitte’s regulatory obligation) would construe Deloitte’s
11 silence as its imprimatur” on the quarterly statements in
12 question. Id. In other words, the shareholders alleged
13 that Deloitte’s “mandated review of [the issuer’s] quarterly
14 statements associated Deloitte with those statements to such
15 a degree that they became Deloitte’s statements, or that the
16 review created a regulatory duty to correct, the breach of
17 which qualifie[d] as a statement under § 10(b).” Id.
18 This argument failed because in a statement case like
19 Lattanzio, “a party can incur liability [under § 10(b)] only
20 if a misstatement is attributed to it at the time of
21 dissemination.” Id. It may be that “a requirement that an
22 issuer’s accountant review interim financial statements
23 supports an understanding among the investing public that
24 such reviews are in fact conducted.” Id. But that was not
15
1 enough to ground § 10(b) liability in Lattanzio:
2 Public understanding that an accountant is at
3 work behind the scenes does not create an
4 exception to the requirement that an
5 actionable misstatement be made by the
6 accountant. Unless the public’s understanding
7 is based on the accountant’s articulated
8 statement, the source for that understanding--
9 whether it be a regulation, an accounting
10 practice, or something else--does not matter.
11
12 Id. (internal citation omitted).
13 The government’s argument fails for much the same
14 reason. Some customers may have understood that the NYSE
15 rules prohibit specialists from interpositioning, and that
16 the rules amount to an assurance (by somebody) that
17 interpositioning will not occur. As a consequence, some
18 customers may have expected that Finnerty would not engage
19 in the practice. But unless their understanding was based
20 on a statement or conduct by Finnerty, he did not commit a
21 primary violation of § 10(b)--the only offense with which he
22 was charged. See Central Bank of Denver, N.A. v. First
23 Interstate Bank of Denver, N.A., 511 U.S. 164, 177 (1994)
24 (holding that in the civil context, § 10(b) “does not itself
25 reach those who aid and abet a § 10(b) violation”); Wright
26 v. Ernst & Young LLP, 152 F.3d 169, 175 (2d Cir. 1998)
27 (explaining that under Central Bank, a defendant “cannot
28 incur primary liability” for a statement neither made by him
29 nor “attributed to [him] at the time of its dissemination”);
16
1 Shapiro v. Cantor, 123 F.3d 717, 720 (2d Cir. 1997)
2 (“‘Anything short of such conduct is merely aiding and
3 abetting, and no matter how substantial that aid may be, it
4 is not enough to trigger liability under Section 10(b).’”
5 (quoting In re MTC Elec. Techs. Shareholders Litig., 898 F.
6 Supp. 974, 987 (E.D.N.Y. 1995)).
7 Taking a slightly different tack, the government argues
8 that Finnerty’s scheme was “self-evidently deceptive”
9 because he had “two critical advantages” over his customers:
10 he could see all pending orders to buy and sell a particular
11 stock, and he determined the price ultimately paid.
12 It may be that Finnerty unfairly profited from superior
13 information. But “not every instance of financial
14 unfairness constitutes fraudulent activity under § 10(b).”
15 Chiarella v. United States, 445 U.S. 222, 232 (1980). And
16 characterizing Finnerty’s conduct as “self-evidently
17 deceptive” is conclusory; there must be some proof of
18 manipulation or a false statement, breach of a duty to
19 disclose, or deceptive communicative conduct. “Section
20 10(b) is aptly described as a catchall provision, but what
21 it catches must be fraud.” Id. at 234-35.
22 The government points to evidence showing Finnerty’s
23 consciousness of guilt: (1) Finnerty testified before the
24 NYSE that he traded ahead of customers only when the public
17
1 received the same or a better price than his principal
2 account did (testimony that was countered by the
3 government’s demonstrative chart, which showed that the
4 customer was disadvantaged 95% of the time); (2) clerk
5 Philip Finale testified that Finnerty pressured him to lie
6 about being instructed to execute interpositioning trades;
7 and (3) shortly after Finnerty learned about the NYSE
8 investigation, his rate of interpositioning declined almost
9 to zero.
10 Viewed in the light most favorable to the government,
11 United States v. Iodice, 525 F.3d 179, 182 (2d Cir. 2008),
12 this evidence shows that Finnerty knew he had violated an
13 NYSE rule, and tried to cover it up. But violation of an
14 NYSE rule does not establish securities fraud in the civil
15 context, Shemtob v. Shearson, Hammill & Co., 448 F.2d 442,
16 445 (2d Cir. 1971), let alone in a criminal prosecution.
17 Finnerty may have known that interpositioning was wrong
18 within the context of his employment, and that it put him at
19 risk professionally; but an awareness of peril, a guilty
20 conscience or an impulse to cover one’s tracks does not
21 bespeak criminally fraudulent conduct within the context of
22 the securities laws.
23 Finally, the government cites Basic Inc. v. Levinson,
24 485 U.S. 224 (1988), for the idea that (in the government’s
18
1 words) interpositioning violates “common sense notions of
2 fair play and honest dealing in the securities market.”
3 Basic Inc. says that under the “fraud-on-the-market”
4 doctrine, “the reliance of individual plaintiffs on the
5 integrity of the market price may be presumed” when
6 “materially misleading statements have been disseminated
7 into an impersonal, well-developed market for securities.”
8 Id. at 247. However, the Basic Inc. presumption of reliance
9 arises where a civil plaintiff can point to “public,
10 material misrepresentations” that impugned the integrity of
11 a stock’s market price. Id. at 248. Here, the government
12 has attributed to Finnerty nothing that deceived the public
13 or affected the price of any stock: no material
14 misrepresentation, no omission, no breach of a duty to
15 disclose, and no creation of a false appearance of fact by
16 any means.
17
18 CONCLUSION
19 For the foregoing reasons, we affirm the judgment of
20 acquittal.
19